Growth in Amazon's U.S. Books Business Gets a Second Look

Amazon.com (AMZN) is back under the microscope.

Only two weeks ago, the online retailer made its critics eat crow with a first-ever quarterly profit. The fourth quarter's milestone triumph was only sweetened by a solid rebound in Amazon's closely watched core U.S. books, music and videos business, which had stumbled badly in the third quarter.

But now some people on Wall Street are asking just how Seattle-based Amazon was able to revive the books-music-video business so quickly during an economic slowdown. Judging by regulatory filings and earnings reports, it appears that books-music-video numbers may have benefited from a shift in which Amazon reports revenue from its partnership with Borders.com, the online retail site for Borders (BGP) now co-branded with Amazon.com. Moreover, it appears that many analysts and investors weren't aware of the change.

"If you include Borders, it certainly is not looking quite as well as otherwise," says Dan Geiman, an analyst at McAdams Wright Ragen. "That's certainly interesting to me. My understanding was that they booked that under third-party services." (Geiman has a moderate buy rating on Amazon, and his firm doesn't have a banking relationship with the company.)

Surging

Amazon's first-ever profit grabbed the headlines when the company reported fourth-quarter earnings. But equally important from Wall Street's vantage point, fourth-quarter domestic books-music-video sales rose 5% from a year ago. The strong performance was all the more impressive considering that only three months earlier, investors and analysts had been irked when third-quarter sales in the segment plunged 12% from the year-ago period.

But what investors may not have realized about the fourth-quarter surge was that the company included fees and commissions from operating the Borders.com site in fourth-quarter results for U.S. books. Previously, according to press releases and regulatory filings, Amazon had reported that revenue under its so-called service segment -- the group of partnerships it has formed with other retailers such as Toys R Us (TOY), Target (TGT) and online travel agent Expedia.com (EXPE).

There is nothing untoward about Amazon's decision to change where it reports the Borders.com revenue. The shift was clearly disclosed in the fine print of the company's earnings reports and regulatory filings; moreover, where the Borders.com financial results are reported has no effect on overall sales and revenue. That said, it seems that many people on Wall Street weren't aware of the move, which could conceivably change the light in which analysts and investors view Amazon's fourth-quarter core business gains.

"That was the big deal," says Jeff Matthews, a hedge fund manager at RAM Partners who is short Amazon stock but wasn't aware of the reporting change. "That was the big turn -- 'Oh, the books business is better.' "

Uncertainty

It is impossible to quantify how much the inclusion of the Borders.com revenue might have helped the U.S. books business because Amazon doesn't disclose the numbers for individual partnerships. But notably, Amazon's fourth-quarter performance put it in line with the same-store sales growth of bricks-and-mortar booksellers, such as Barnes & Noble (BKS) and Borders, a big selling point with Wall Street.

Amazon says it didn't change its financial reporting to make its core business look better. "In the case of Borders, it probably has to do with the fact that it is our inventory," says Bill Curry, Amazon's spokesman. Curry says he wasn't aware of a prior disclosure that listed Borders.com revenue as part of the services segment.

After rallying sharply immediately following the January earnings report, Amazon shares have pulled back in the past week. The Internet retailer has seen its stock drop 24% following a published report that rekindled investor worries about Amazon's cash position, an issue that dogged the company for much of 2001.

All this highlights Wall Street's nervousness over accounting practices as it watches the Enron scandal unfold. And Amazon, which has been plagued in the past by controversy over how it "spins" its finances to investors, likely will remain under a watchful eye.

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