Many internet companies, have become clever about finding ways to recycle
their balance sheets through their income statements: recording barter
deals as revenue, investing in companies that turn around and buy
advertising on their Websites, and so on. Here are a couple of particular
tricks to watch, as net stocks overstate their revenue. Such activity
repeats every business cycle.
From Fortune Magazine March 27 2000.
Net vs. gross
Many Internet firms "gross up" their revenues by reporting the entire sales
price a customer pays at their site when in fact the company keeps only a
small percentage of that amount.
Take Priceline.com, the company made famous by those William Shatner ads
about "naming your own price" for airline tickets and hotel rooms. In its
most recent quarterly SEC (Securities Exchange Commission) filings
Priceline reported that it earned $152 million in revenues. But that
includes the full amount customers paid for tickets, hotel rooms, and
rental cars. Traditional travel agencies call that amount "gross
bookings," not revenues. And much like regular travel agencies, Priceline
keeps only a small portion of gross bookings-namely, the spread between the
customers' accepted bids and the price it paid for the merchandise. The
rest, which Priceline calls "product costs," are paid to the airlines and
hotels that supply the ticket and rooms.In the most recent quarter, those
costs came to $134 million, leaving the Priceline just $18 million of what
it calls "gross profit" and what most other companies would call revenue.
And that's before all of Priceline's other costs-like advertising and
salaries-which netted out to a loss of $102 million. The difference isn't
academic: Priceline currently trades at about 23 times its reported
revenue but at a mindboggling 214 times its "gross profit."
Priceline says it counts gross bookings as revenue because, unlike a travel
agency, it has assumed the full risk of ownership as the "merchant of
record" and can determine the size of its spread. Travel agencies, on the
other hand, have a fixed commission and do not own tickets they sell.
So far the SEC has given the not to Priceline's logic.
When Star Media Network, a prominent Latin American Web portal, announced
is third-quarter results on Oct. 26 its press release boasted of the
company's impressive growth-revenues up to 44% from the prior quarter, to
$5.6 million. What the press release didn't say was that 26% of that $5.6
million.didn't represent real cash. Instead, it was barter revenue-Star
Media had exchanged advertising space on its Web pages for ads on
television and radio.
Coupons, discounts, and loss leaders.
Fledgling e-commerce companies know that nothing draws potential customers
like free stuff-hence the proliferation of give-aways, special introductory
offers, deep discounts cupons and rebates on the Web. Nothing wrong there.
But to the consternation of the SEC, some Net companies have discovered
ways to hide the effect all the free stuff has on sales.
For instance, let's say a customer buys a $50 sweater using an electronic
coupon that entitles her to 20% off.
The customer pays only $40, but some companies record the full$50 in
revenue and simply take a $10 charge under "marketing expences". Again,
there's no effect on the bottom line-which, in case of so many Internet
firms, shows a net loss anyway-but such methods pump up the top line.
Amazon.com, eToys, and 1-800-flowers are among the many e-commerce
companies playing a shell game with "fulfillment costs," which are the
expenses associated with warehousing, packaging, and shipping products.
Offline companies usually record the expense on their income statements as
a cost of sales. But not dot-coms. A lot of them classify fulfillment
costs as a "marketing expense".
Why? Because cost of sales cuts directly into a company's gross profit
margin. Many e-commerce companies already operate with extremely narrow
margins and have little interest in seeing them trimmed further. The other
benefit: The practise enables dot-coms to hide operational expences amid
the huge marketing costs that investors believe are a temporary splurge
associated with establishing brand recognition. If investors realized that
these "marketing" numbers concealed large portions of the bussiness'
permanent cost structure, they might change their opinion about the
company's prospects. Textbook e-tailer Varsity-books.com went so far as to
dismiss auditor KPMG in October when it objected to lumping fulfillment
costs under marketing expenses. The company's new auditor
PricewaterhouseCoopers, approved the practice.
Auction houses, both real and virtual, make money by charging "listings
fees" to those putting items up for bid. They also take a percentage of the
price when an item is sold. The GAAP rules say auction houses should
realize listing revenue over the whole period that an item is on the block.
Instead the SEC says many online auction sites are recognizing all the
revenue immediately. Similarly, transaction fees are supposed to be
recognized only when a deal has been completed and the goods have been
shipped. But according to the SEC some auction sites (many of which don't
even control the delivery of goods between seller and buyer) recognize
transaction revenue immediately. The best known of the group, eBay, does
not specify in its filings exactly when it recognizes revenue. Its
executives, on the advice of company lawyers, refused to fully explain
their revenue recognition policy to FORTUNE.