Amazon will turn its first profit in fourth quarter if you don't count its expenses

By DAVID MOON, Moon Capital Management
November 18, 2001

Earlier this year, Amazon.com CEO, Jeff Bezos, announced that the company would reach profitability in the fourth quarter of this year, after years of bleeding shareholder cash. Somewhere in the announcement was the term "pro forma," indicating that Amazon.com wouldn't really make money, but they would if they presented their results ignoring certain expenses. (Of course, ignoring Georgia, the Vols are undefeated this year. I suppose they will face Florida State in the Pro Forma bowl.)

The term "pro forma" comes from a Latin phrase meaning "for the sake of form." Well, for the sake of form, Amazon, poster child of Dot.com boom and bust, decided to explain that fourth quarter operating results would be positive, if they exclude depreciation, amortization, stock-based compensation expenses and interest expense. For the sake of form, Amazon wants the investment community to ignore its very real interest cost on its $2.1 billion in debt. The stock has fallen from more than 100 to 7 and the company wants folks to ignore their interest expense? Excuse me, Mrs. Lincoln, other than that little thing about the bullet in your husband's head, how did you like the play?

Amazon.com is hardly alone in this issue. That most companies have such cozy and self-severing relationships makes the problem even tougher. Company feeds analyst pabulum; analyst repeats pabulum. Shareholders who rely on pabulum make ill-informed investment decision.

It is bad enough when a company just wants to mislead investors, or - more politely - lead investors toward a more palatable truth. But some accounting reports are blatant violations of generally accepted accounting principals. Accounting principals are hard enough to interpret when folks actually use them. When someone violates the rules but you don't learn until well after the fact, results can be disastrous. Consider the recent fate of Enron shareholders.

In January, Enron shares were trading as high as 80. The Houston-based energy trader was on top of the world. Last week, the company announced its financial statements as far back as 1997 "should not be relied upon" and will be restated. The company admits overstating its income by over $500 billion dollars. In 2000, the company overstated its shareholders' equity by more than $172 million. This year, it added another $828 million to the misstatement. The auditors, well-respected Arthur Anderson, missed the error - an error described by former SEC chief accountant, Lynn Turner, as a violation of a simple Accounting 101 rule. The stock is now at 10.

The worst part of the Enron story is that these accounting irregularities only came to light after the company began reporting huge losses, apparently due because of an investment in a company controlled by its CFO. It seems the CFO's personal company made tens of millions of dollars (if not hundreds of millions) while the CFO's employer misreported its results - then disclosed hundreds of millions of dollars in losses.

The story is not a new one. Every few months, it seems there is another tale of accounting shenanigans or, at worst, outright fraud surrounding the preparation of some public company's financial statements. It is difficult enough for investors to wade through mounds of the legitimate information needed to make an investment decision. To have to determine which information is misleading makes that job terribly difficult. And to have to deal with outright misstatements of fact makes the job impossible. Amazon.com's suggestion that investors look beyond certain operating expenses for the sake of form is laughable. But it is not comparable to the accusations at Enron. If the Enron accusations are proven correct, the auditors, managers and board ought to be punished to the most severe extent allowed by law.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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