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Jubak's Journal
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| | Jubak's Journal
The pro forma problem won't go away
War looms and the economy stinks. Yet parts of Wall Street look like business as usual, circa spring 2000. To see how far we havent come, just look at Amazon.com.
By Jim Jubak
Investors reading the earnings press release last week from Amazon.com (AMZN, news, msgs) might have thought they were back in 2000.
For the fourth quarter of 2002, Amazon.com reported, pro forma earnings were 19 cents a share, way above the 14 cents that Wall Street had projected.
Sales soared 68% from the previous quarter and climbed 28% from the fourth quarter of 2001. Morgan Stanley Internet analyst Mary Meeker -- remember her? -- headlined her report, Q4: Lookin good, feelin good and led her analysis with the 28% jump in revenue.
Gee, isnt that exactly how we got into this mess to begin with? By letting companies get away with pro forma earnings numbers calculated any way the company found convenient?
And by convincing ourselves that it didnt matter if a company wasnt making a profit, because as long as it kept growing, the profits would follow one day?
Take a closer look at Amazons numbers and the feeling of dj vu only gets stronger.
The GAAP gap
Pro forma net profit at Amazon came to 19 cents a share for the quarter. But by stricter GAAP standards, net income came to just a penny a share. GAAP stands for generally accepted accounting practices, and earnings calculated by those standards give investors an apples-to-apples comparison across companies and across quarters.
So were did that extra 18 cents a share come from?
Two big items make up most of the difference.
First, Amazon.com recorded a pro forma gain of about $41 million in the quarter by revaluing debt that was denominated in euros and not dollars. You dont get to count this kind of currency gain in GAAP earnings.
Second, Amazon didnt count almost $36 million in expenses paid not in cash but in Amazon stock. That included $7 million for fulfillment, $2 million for marketing, $19 million from something the company calls technology and content, and $9 million for general and administrative expenses -- what most accountants would call the cost of running the company.
GAAP accounting says you have to deduct these costs from earnings even if you paid for them in stock instead of cash.
Using pro forma earnings instead of GAAP did more than just make earnings per share look a whole lot better at 19 cents rather than a penny. Using pro forma accounting also changed the entire growth story at Amazon to positive from negative.
With pro forma accounting, Amazon shows earnings growth of $75 million in the fourth quarter of 2002, up from $40 million in the same quarter of 2001.
Using GAAP accounting, however, earnings per share actually fell in the fourth quarter of 2002 to 1 cent from 2 cents a share a year earlier. By GAAP standards, Amazon isnt getting more profitable as revenue increases.
And that casts a somewhat different light on Amazon.coms revenue growth.
Behind the sales boost
Neither Amazon nor any analyst on Wall Street quibbles about whats driving revenue growth at the company: free shipping. Amazon will pay the shipping costs for any customer who orders $25 or more. This program started as a holiday promotion but has proved to be so successful that Amazon has made it permanent and is expanding the program to its international customers.
But whats free to Amazon customers costs Amazon, itself, money: The company says it lost $30 million on shipping in the fourth quarter of 2002.
And that had an effect on Amazon.coms gross margin, which in the fourth quarter fell to 23.5%, down from 25.4% in the third quarter of 2002.
All this raises questions about Amazon.coms growth story and the companys ultimate march toward meaningful profitability, which the headlines gloss over -- just as they did in 2000.
But one thing about Amazon.com doesnt have any aura of dj vu about is this: In 2000, Amazon didnt have any earnings, so it didnt have a measurable price-to-earnings ratio that could be compared to other companies.
Now, thanks to pro forma accounting, it does. Amazon currently trades at 120 times trailing 12-month pro forma earnings and at 70 times projected 2003 pro forma earnings. eBay (EBAY, news, msgs), which is growing faster than Amazon.com, trades at 60 times 2003 projections. Bookseller Barnes & Noble (BKS, news, msgs) trades at just 10 times 2003 estimates.
Makes you wonder about all those Amazon.com buy ratings. Again.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index.
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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