Heard on the Street Amazon.com's Own Books Could Confuse Some Readers
By NICK WINGFIELD
Staff Reporter of THE WALL STREET JOURNAL
You almost have to be a wizard-in-training of Harry Potter's stature -- or
at least a very savvy accountant -- to figure out how much money
Amazon.com is raking in these days.
Everyone knows Amazon.com's claim to fame is selling huge volumes of
books, compact disks and a growing number of other goods to consumers
over the Internet. But some of its biggest sales recently have come from
promoting other Internet companies to Amazon's huge customer base, not
from Harry Potter novels.
The issue is that these Internet companies
often pay in stock for the promotions. Treating
the stock payment as revenue, which
accounting experts say is legal, raises questions.
To wit: What happens when the value of the securities fall? In Amazon's
case, the company doesn't go back and restate its revenue. Instead, it
records the losses in other less-scrutinized areas of its financial statements,
including lines devoted to investment gains and losses.
The company's accounting treatment has drawn the scrutiny of the
Securities and Exchange Commission. In its third-quarter earnings
announcement last month, Seattle-based Amazon revealed that the
regulators are scrutinizing both its accounting treatment and its disclosure of
stock deals with other dot-coms. Amazon says it believes it is
appropriately handling both matters.
With Internet stocks far off their highs, Amazon would appear to be taking
a hit. It disclosed in its third-quarter earnings a $33.8 million "noncash
loss," connected Internet audio company Audible and credit-card issuer
NextCard.
Amazon hasn't gone out of its way to call investors' attention to the stock
component of the payments from commerce partners. But its most recent
federal filing does state that 64% of the $166 million it received in
payments from commerce partners during the nine months ended Sept. 30
was in stock. It stashed much of that payment as unearned revenue to be
booked on its top line, over the term of the marketing alliances with the
companies, usually one to three years. The company recorded $94.8
million on its top line from its commerce partnerships during the first nine
months of the year. During those nine months, Amazon posted $1.8 billion
in total revenue.
The concern of investors -- and possibly the SEC -- is that money-losing
Internet operations like Amazon are generally valued as a multiple of
revenue, rather than of earnings. But "the value of those securities has gone
down dramatically and the quality of revenues associated with them is very
low," says Tom Courtney, an analyst at BancAmerica Securities.
Adds John Spytek, a technology analyst at Banc One Investment
Advisors, which has a small position in Amazon: "We all start with
revenues" in valuing the company. "If they find ways to over-inflate it, it
becomes an issue."
The appealing aspect to investors of the Amazon Commerce Network is
that it is potentially very profitable. Selling what is, in effect, advertising
space to other Internet companies carries little marginal cost to Amazon.
Indeed, in the first half of this year, Amazon reported that the network's
gross profit margin was 98%.
But the value of the stock portion of these payments is generally
determined by the publicly traded share price of a stock at the moment
Amazon completes a deal with a commerce partner. (When a commerce
partner is closely held, there is a more subjective valuation process.) And
for anyone watching the carnage in the consumer Internet sector, it is
obvious that dot-com stock is a serious risk compared with cold cash.
In booking stock as revenue, Amazon says -- and accounting experts and
Wall Street analysts agree -- that the company is in accordance with
generally accepted accounting principles. "Accounting regulators have
come out with some pretty clear guidelines," says Tim Stone, Amazon's
director of investor relations. "Receipt of equity for service is something
that's been a long-standing practice in corporate America."
But critics fret about the effect of the accounting treatment at unprofitable
companies where revenue and gross margins become very closely watched
gauges of performance. "To say that this is a means of payment with a high
probability of being paid stretches the rule in my opinion," says Baruch
Lev, an accounting and finance professor at New York University's Stern
School of Business, who maintains that revenue must be backed by cash
or some other equally dependable form of payment. "Equity, particularly
for companies that are not highly liquid, strains" the accounting rule for
revenue.
So what happens to Amazon's finances when those Internet shares sink?
For stock that has already been recorded as revenue, Amazon doesn't go
back and restate revenue for previous quarters. By the same token, its
recorded revenue doesn't get a retroactive kick if the stock of a commerce
partner rockets. Unearned revenue doesn't change, either.
When Amazon determines a stock is permanently "impaired," it records an
investment loss. During the most-recent quarter, even as Amazon took the
$33.8 million loss connected with the Amazon Commerce Network
partners, it recognized an overall investment gain of $12.4 million.
For stocks that aren't deemed permanently impaired, the company lists the
declines on its balance sheet as unrealized losses. Along these lines,
Amazon took a combined unrealized $65.6 million loss during the third
quarter on Internet luxury-goods retailer Ashford.com, online grocer
Webvan Group and auctioneer Sotheby's Holdings, according to its
federal filing. Ashford and Sotheby's are commerce partners.
Some other commerce-partner losses are reflected through Amazon's use
of so-called equity-method accounting to address ownership stakes
generally ranging from 20% to 50%. During the nine months ended Sept.
30, Amazon recorded $266.9 million in total equity-method losses.
Overall, Amazon.com posted net losses totaling $866.1 million during the
period.
Amazon says its new commerce partnerships will be based primarily on
cash payments, and it has renegotiated some older pacts so that cash is a
bigger slice, though the deals are at lower terms. There is no guarantee that
cash-starved Internet companies will be able to pay Amazon, of course.
But Amazon counters that more of its new partners are established
companies like Microsoft and Hewlett-Packard.
To critics, the change can't happen soon enough. "I think people tend to
focus on revenue," largely overlooking any investment losses that could
follow, says Sirine Hafez, an analyst at the Center for Financial Research
and Analysis, Rockville, Md., which has published a report critical of
Amazon's accounting. "I don't want to say no one pays attention, but it
definitely gets less attention."
Amazon's Mr. Stone thinks investors in fact do look for the losses. "I can
tell you investors are pretty darn interested in all aspects of our financial
statements," he says.
Write to Nick Wingfield at nick.wingfield@wsj.com |
