Pro forma earnings may be
1999, but that doesn't mean they've lost popularity with companies and analysts.
reported its first-quarter results on Thursday, for instance, company officials pointed not to the company's $10.1 million loss, but its $40.3 million pro forma profit. That nonstandard method excluded several charges that Amazon felt detracted from its core performance.
New laws and investor disgust over accounting scandals and three straight years of declining stock markets was supposed to make pro forma accounting pass¿. But the practice is almost retro chic with many companies and analysts.
Those companies and analysts argue that pro forma is a needed crutch that helps reveal a company's real performance. But others say the practice lives on only because it makes companies and analysts look good.
It's not just the executives at Amazon, poster child of the dot-com boom, that are still highlighting pro forma figures. Old-school companies such as
also touted non-GAAP earnings in their recent quarterly reports. Meanwhile, the earnings results and projections reported in Thomson Financial/First Call or Multex often differ widely from GAAP figures.
"People all say that pro forma is dead, but I think that's wishful thinking," said Gary Lutin, an investment banker and frequent critic of public companies' governance and reporting policies. "The basics of human nature are what we're dealing with. They can impose new rules, but that doesn't change the nature of people that were inclined to use fantasy numbers in the past."
Fall Into the GAAP
It wasn't supposed to be this way. The fallout of the stock market bust seemingly focused investor attention on companies' true bottom lines. Meanwhile, new regulations, particularly those developed under the Sarbanes-Oxley Act, were supposed to clean up corporate accounting and reporting and bring them in line with generally accepted accounting principles.
Among the latest of the Sarbanes-Oxley reforms is the
Securities and Exchange Commission's
Regulation G. Under Regulation G, which took effect last month, companies that present non-GAAP figures or estimates in their earnings reports now have to reconcile those figures to GAAP and have to display GAAP figures as or more prominently than non-GAAP figures. Meanwhile, companies cannot exclude from their pro forma numbers charges they label as unusual when they are, in fact, recurring expenses.
But Regulation G doesn't prohibit non-GAAP reporting in its entirety. And it specifically allows companies to continue to report such nonstandard figures as EBIT (earnings before interest and taxes) and EBITDA (earnings before interest, taxes, depreciation and amortization).
Amazon used its pro forma definition in a nearly stereotypical "earnings before the bad stuff" way. Each quarter the company assesses the effect exchange rate fluctuations have had on its euro-denominated debt. While the company chose to exclude $22 million in charges related to that reassessment in its pro forma first-quarter numbers, it included in those numbers the $51 million revenue and the $4 million operating profit benefits it saw in its international operations due to currency rate changes.
Amazon has been consistent in its reporting, company spokeswoman Patty Smith said, noting that Amazon has reported the effects of the currency fluctuations the same way in prior quarters.
By excluding restructuring charges and the effect of an accounting change, International Paper was able to tout its $68 million, or 14 cents a share, pro forma first-quarter profit, in lieu of its $44 million, or 9 cents a share, bottom line profit under GAAP.
Old Habits Dying Hard
"That's International Paper, not priceline.com," noted Jeff Brotman, a corporate attorney who teaches accounting at the University of Pennsylvania's law school. Noting that he's seen little movement by companies away from pro forma figures, he added, "That's a real disappointment to me."
But it's not just the companies that are sticking with pro forma. Analysts also continue to deviate from GAAP figures in their reports and earnings estimates.
In its year ended March 31, 2003,
reported GAAP earnings of $1.54 a share. But you wouldn't know that by looking at Thomson Financial/First Call. The reporting service, which collects analysts' earnings estimates that typically exclude a host of charges, shows that Symantec earned $1.72 in its just-completed fiscal year.
It often makes sense for analysts to use pro forma numbers instead of GAAP ones in their analyses, said Chuck Hill, director of research at Thomson Financial/First Call. For example, if a company not normally in the real estate business recognizes a huge gain from a one-time land sale, it's hard to argue that gain was part of the company's normal business and should be included when trying to evaluate its performance, he said.
"It makes no sense (for analysts) to move toward GAAP," Hill said. "There are certain things that are validly excluded."
"It's very easy to say that analysts are optimistic, that they exclude one-time items all the time," said Ozan Akcin, chief market strategist at investment banking house Ehrenkrantz King Nussbaum. "But it's the analysts' job to get an estimate of the company's underlying earnings picture."
The problem is that there's no standard for pro forma numbers.
So some analysts may exclude some items with one company that other analysts may include in their pro forma estimates for another company. While GAAP numbers are comparable both to a particular company's prior reporting periods and across all other companies, pro forma numbers are not.
That becomes important when investors are trying to judge the value of a particular company by looking at such statistics as its price-to-earnings ratio, if such measures are taken from non-GAAP figures. While Regulation G governs how companies report earnings, it says nothing about how analysts interpret them.
Jerry Czarzasty, global estimates manager at Reuters, which runs the Multex reporting service, said his company should take an active role in trying to standardize earnings estimates from analysts. But ultimately, it's up to enforcement bodies such as the SEC and the NASD, not to mention investors themselves, to press analysts for standardized, comparable estimates, he said.
But Regulation G may force companies and analysts to move closer toward GAAP, Akcin said. Because the new rule requires companies to prominently report GAAP figures, that's going to be the number that investors see, he said.
"And if that's the number that people are going to see, that's what analysts are going to pay attention to," he said.
For now, though, investors are often still fighting their way through the pro forma jungle. With everyone focusing on quarterly numbers, corporate executives and analysts have a big incentive to focus investor attention on fantasy numbers that they can control rather than real numbers over which they have less sway, said Lutin.
"An analyst wants people to believe that he's good at producing accurate forecasts and if he's off, he can fix it by making up the number himself," he said. "That's no different from a corporate executive wanting people to believe he had earned his bonus. That's what drives lot of this stuff."