News Analysis: USA Networks Uses Innovation in Programming -- and Accounting

USA Networks' (USAI) core business strategy appears to be a ceaseless devotion to schlock. One-fifth of the items sold on its Home Shopping Network are returned; USA's Miami television station tried -- and failed -- to generate viewer interest last year with innovations like having portions of the evening news read by a pair of sultry female lips.

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Unfortunately, USA's far-flung operations don't generate much net income. But what the company lacks at the bottom line, it makes up with its own very special style of reporting earnings.

Most public companies stick to a standard form for their earnings statements -- revenue minus costs equals operating income. Then, operating income minus taxes and interest expenses equals profits.

On the other hand, USA last week filled eight full pages to present its 1998 earnings -- without ever giving investors a simple income statement. Instead, USA offered a mishmash of Nielsen ratings, EBITDA (earnings before interest, taxes, depreciation and amortization), run-rate revenue and gross profit margin, presented in a format that had all the narrative coherence of a bad B-movie on the company's Sci-Fi Channel.

For example: "On a pro forma basis, USAI generated 15% higher EBITDA from its cash-generating divisions in the fourth quarter as compared to the same period in 1997." Say what?

Then, on page three of its statement, USA offered this whopper: "Pro forma diluted earnings per share increased to $0.22 for the three months ended Dec. 31, 1998, from a $0.15 loss for the same period in 1997. Cash net income increased on a pro forma basis to $80.4 million for the three months ended Dec. 31, 1998 from $1.0 million for the same period in 1997."

Wow! A 22-cents-per-share gain instead of a 15-cents-per-share loss? Not bad. Unfortunately, the profit comes with an enormous asterisk, an asterisk that USA referred to only obliquely in its release. Only by finding and deciphering the actual USA Networks profit-and-loss statement (which was available only as a four-page addendum to the company's eight-page earnings statement) could investors discern that USA's profit improvement came almost entirely from a $109 million one-time gain it recorded from its December IPO of TicketMaster Online-City Search (TMCS), its electronic ticketing subsidiary.

Factoring out that gain, here's USA's real P&L for the fourth quarter: Revenue increased 7.8% to $767 million, compared to the same period in 1997. Operating income rose all of $130,000, or 0.2%, to $58 million. And, real bottom-line net income? About $15 million, or 4 cents per share, compared with about $4 million in 1997. That's a net profit margin of less than 2%.

In other words, USA runs essentially a break-even business with mid-single-digit revenue growth. USA says it stands by its method of presenting earnings and says the one-time gain was properly footnoted.

The company has some other questionable accounting methods, including capitalizing the fees it pays cable companies so that they will carry Home Shopping Network. The company then amortizes the fees as a capital expense, rather than counting them as operating costs. The difference may seem subtle. But it has the effect of artificially inflating USA's EBITDA. And for companies that don't have real bottom-line earnings, like USA, EBITDA is a common valuation benchmark. USA says there's nothing wrong with how it accounts for the fees.

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