IN THE MONEY: More Reasons To Raise Eyebrows Over Amazon
By MICHAEL RAPOPORT
A Dow Jones Newswires Column
NEW YORK -- Amazon.com Inc. (AMZN) is at it again.
In the past year, the e-commerce bellwether has developed a reputation for ... well, let's call it "intriguing" accounting. The kind of accounting that rewards careful scrutiny: Chances are when you look at an Amazon financial report, you'll find some interesting accounting tactic that - son of a gun! - just happens to make the company's finances look better than they would otherwise.
As previously reported in this space, for instance, Amazon's accounting has helped it increase its cash position and cash flow. That's no small thing for a company fervently trying to convince the market that it's really not in danger of running short of money, not at all.
And a look at Amazon's 10-K annual report, filed last Friday, reveals that the company hasn't lost its knack for prompting raised eyebrows about its finances. Among other things, Amazon is using a broader-than-typical definition of "marketable securities" - albeit one that's entirely legitimate and accepted - that has the effect of increasing its much-touted cash hoard by $195 million, as well as boosting its much-questioned level of working capital.
Marketable securities are highly liquid, typically short-term securities that are classified as available for sale. They're current assets on a company's balance sheet, counted as part of its total cash position. There's no set criteria under accounting standards for what a marketable security is, but ordinarily they're securities the company may intend to sell within a year and which will mature in that time frame.
But Amazon includes "intermediate-term" debt securities in that amount - some of which don't mature until as late as 2005. According to figures in the 10-K, about $116 million of Amazon's $278.1 million in marketable securities as of Dec. 31 were Treasury and corporate debt with maturities beyond a year; another $42.5 million were asset-backed and agency securities (like Fannie Mae and Freddie Mac) that don't mature for at least a year.
Put those together with $36 million in stock investments that the company reclassified last fall as marketable securities - a move which itself raised eyebrows - and you get about $195 million that might not be counted under a more typical definition of marketable securities. That's about 70% of Amazon's marketable securities, and about 18% of its total $1.1 billion cash position. (The reclassified $36 million was originally $96 million; much of it consisted of Webvan Group Inc. (WBVN) stock, which has since plunged in value.)
Why is this seemingly small, technical matter important? Because using this definition boosts Amazon's reported cash position higher than it would be otherwise. It also boosts Amazon's current assets, and thus its level of working capital, or current assets minus current liabilities.
And Amazon's working-capital level has come under fire. Ravi Suria, the Lehman Brothers convertible-bond analyst now headed to a hedge fund, has argued that Amazon's working capital is eroding and will soon turn negative, jeopardizing its relationship with its vendors. (Amazon has called Suria's assertions "silly and chock full of errors.") If that working-capital level is being propped up by a broad accounting definition, surely that's worth knowing about.
An Issue Of Liquidity
Tim Halladay, Amazon's director of investor relations, acknowledges that the effect of Amazon's definition of marketable securities is to increase reported cash position and working capital. But he said Amazon does things "very similar" to other companies, and the longer-term securities are properly classified as current assets.
It's an issue of liquidity, Halladay says. Even if you don't expect to have to sell your longer-term securities to raise quick cash, classifying them as available for sale gives you the flexibility to do that if necessary.
"From our perspective, that's where they belong," he said.
But the fact that Amazon categorizes the securities as available for sale doesn't imply an intention to sell them this year, Halladay said.
"The reality is, we don't feel a need for those funds today." The company has said repeatedly that it has no cash or cash flow problems, so selling those securities to raise cash might also raise questions.
It's important to note that under accounting standards, it's perfectly okay for Amazon to do things this way; companies have a fair amount of discretion in how they classify the securities they hold. And this definition of marketable securities isn't new for Amazon; it's been the company's policy ever since it went public, so this isn't some recent, deliberate attempt to boost working capital.
Moreover, current conditions provide some justification for classifying longer-term securities as available for sale: When interest rates fall, as they've been doing, the value of longer-term debt securities increases, so Amazon would get a better price if it did decide to sell them.
But the questions over marketable securities aren't the only ones prompted by the 10-K:
- A big debt payment that just came due could hurt Amazon's cash flow this quarter. According to the 10-K, the first interest payment on the big euro-denominated debt offering Amazon had last year was due in February; a quick calculation shows that amount was roughly $42 million.
That's paid in arrears, and most of it has already been assessed against earnings, as part of the $131 million in interest Amazon paid in 2000. But because the payment is being made in the current first quarter, any cash Amazon lays out will contribute to its cash burn for the quarter - just one more expense weighing on Amazon.
- Have you ever seen a company that recorded a gain when one of its investments went bankrupt? Amazon did.
Amazon posted a $6 million gain when Living.com, in which Amazon owned an 18% stake, filed for bankruptcy. How? Amazon had $20 million of "unearned revenue" from Living.com - cash and stock Amazon had received from Living.com and other of its partners that was to be amortized gradually into Amazon's income.
When Living.com went bankrupt and Amazon and the company terminated their agreement, that amount became recognizable immediately - and outweighed the $14 million loss Amazon took on the investment itself. Hence the gain.
But besides the oddness of the gain itself, it calls attention to Amazon's use of such unearned revenue. It amortized $108.2 million of unearned revenue into its results during 2000, and it still had $131.1 million in unearned revenue on its books as of Dec. 31, which will be recognized in future results. But with the economy sagging and the dot-coms from which Amazon received much of its unearned revenue faltering, how long will the company continue to be able to count on such revenue in the future? (Halladay says Amazon also has strong partners like Microsoft Corp. (MSFT) and Hewlett-Packard Co. (HWP), and that the unearned revenue is only a small part of Amazon's total revenue anyway.)
None of these questions appear to have dampened Amazon's optimism - Chief Executive Jeff Bezos reiterated Monday that Amazon would show a "pro forma operating profit" in the fourth quarter. But that itself is a cagey way of putting things; for Amazon, "pro forma operating profit" doesn't count interest, a net $90 million expense last year, as well as assorted noncash items. Amazon's real bottom-line loss for 2000: $1.41 billion. Even on a "pro forma operating" basis, it lost $317 million.
With Amazon stock mired in the low teens, investors appear to be in a show-me-the-money mood - they want profits from Amazon, no creativity or caginess required. Amazon might be well advised to listen to them.
-By Michael Rapoport, Dow Jones Newswires; 201-938-5976; michael.rapoport@dowjones.com
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