Updated from 11 a.m. EDT: Did Metris ( MXT), the credit card lender to tainted borrowers, speed up recognition of fee revenue in an effort to goose second-quarter earnings? Wednesday, the Minnetonka, Minn.-based company reported second-quarter earnings of 63 cents a share, up 19% from last year and 3 cents more than analysts expected. The stock jumped $1.81, or 4.6%, to $38.81. Earnings were aided by an unexpected jump in revenue from Mertis' fee businesses, known as enhancement services. Revenue from enhancement services totaled $82.9 million in the second quarter, 6% above the $78.3 million in the first quarter. Enhancement services are particularly important because they are so lucrative, carrying a pretax profit margin in the region of 70%.
On the Rise Metris stock for 2001
So what happened in the second quarter that smells strange? Well, in the previous nine quarters, enhancement services revenue has equaled between 31% and 35% of the previous quarter's deferred income (a balance sheet item that represents money received but not booked as revenue in the income statement). In the last four quarters, the ratio has been steady at 31%-33%. But in the second quarter, enhancement services revenue jumped to 39% of the previous quarter's deferred income. One explanation is that Metris, fearing that it would miss earnings forecasts, decided to recognize as sales a greater share of its deferred income than before.
What It Means
On the company's Wednesday conference call with analysts, a Metris executive commented on the relationship between enhancement services revenue and deferred income, in response to an analyst question on the subject. (Metris didn't return a call seeking comment.) He said the deferred income from enhancement services was mostly derived from fees for warranties on consumer products, as well as fees for joining Metris' travel and auto clubs. It's probably the case that most of the enhancement services deferred income comes from warranty income. According to the executive on the call, deferred income has been falling in 2001 as Metris sheds clients it gained as part of its onetime relationship with the catalog retailer Fingerhut. Most of the Fingerhut-derived contribution to deferred income would have been from warranty fees. Warranty revenue did drop in the second quarter, providing some measure of validation to Metris' explanation of why deferred income is dropping. However, it's hard to believe that Metris suddenly shed a large amount of Fingerhut-derived relationships in the first and second quarters of this year. After all, the company has been talking about its desire to reduce dependence on Fingerhut relationships for over a year. In fact, since the end of 1999, it appears that Metris' enhancement services membership has almost completely turned over. At the end of 1999, it had 4.9 million members. In the following five-quarter period, ending in March 2001, a total of 4.6 million members lapsed, according to an analysis of Metris' numbers. Surely, a good chunk of the Fingerhut members were among that 4.6 million. If Metris did bring forward revenue recognition, how much could it have added to earnings? Possibly around 6 cents. By going to 39% from 33% of deferred income, Metris booked an extra $12 million in revenue. Let's assume 70% of that, or $8.6 million, flowed through to pretax earnings. Adjust for taxes and Metris' net income was boosted by $5.3 million in the quarter, which is about 8% of net income. Detox examined Metris last month.