Wall Street Finds It's Ambivalent About Amortization

SEC efforts to make merger-related write-offs more transparent are adding to earnings confusion.
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SAN FRANCISCO -- When the Securities and Exchange Commission moved to crack down on aggressive in-process research-and-development charges, it intended to make corporate accounting more transparent. Little did it know that, at least initially, the fruit of its actions would be more confusion.


Network Associates'


earnings last week illustrated, Wall Street hasn't fully decided how to read SEC-guided restatements. The security software maker posted a fourth-quarter profit of 50 cents a share excluding amortization expenses, 40 cents including them. Adding to the confusion, the

First Call

consensus of analysts, which called for a 46-cent profit, was unclear as to whether forecasts included the amortization costs.

Most analysts and investors, seeking to determine the health of firms' everyday operations, judge earnings excluding extraordinary items such as acquisition-related charges. Now, restated earnings throw a new wrench into the balance sheet: Should analysts look at earnings before the adjusted amortization, or after?

A week into the current earnings season, the confusion over whether to use postamortization or preamortization earnings has come to the foreground. For example First Call, Wall Street's arbiter of analysts' estimates, is moving to create new forecast tables to accommodate both figures.

"We've never had this before, so we're in the process of setting up two tables -- one excluding amortization and one including amortization," says Greg Dowling, earnings analyst at First Call.

When the SEC asks a company to restate in-process R&D charges, it often means regulators think the company took too large a writedown. Tech companies in particular have taken large charges in recent years to lessen the long-term burden on earnings of amortizing the costs of their myriad acquisitions. To comply with SEC guidelines for one-time in-process R&D charges, some companies are restating earlier earnings to reflect a smaller in-process charge and bigger amortization expenses.

Last week, chip design software company

Cadence Design


and Network Associates said they restated previous earnings and took on bigger future amortization charges. Cadence restated 1998 results, cutting in-process R&D charges to $194 million from $339 million, and posted revised figures for the year. The company earned $1.20 per share before amortization, up from $1.18 as a result of lower one-time charges, and 14 cents per share including all charges and amortization. A Cadence spokesman says the company will continue to post both figures in the future, but he encourages analysts to focus on the preamortization figure, which he says provides a better picture of the company's cash flow.

Network Associates restated 1997 and 1998 earnings by decreasing its charges by $45 million and $169 million, respectively. Restatements such as these boost historical earnings and put a drag on future quarters.

Because of the negative effect that the bigger amortization charges have on earnings per share, companies such as Network Associates have been urging Wall Street to look at earnings excluding amortization expenses. But that move has split analysts into two camps. One side agrees with the companies and argues that amortization is a noncash expense. This camp is willing to exclude amortization expenses to look at cash flow. The other analyst group says investors should look at postamortization figures because amortization is not a one-time charge and should be considered an expense since it is made each quarter to pay for an acquisition.

"I think people will be looking at the preamortization numbers, but there's really no consensus yet," says Dawn Simon, analyst at

Brown Brothers Harriman

, noting that the morning after Network Associates announced earnings, even First Call was scrambling to figure out which numbers to use.

Kevin Wagner, analyst at

Adams Harkness & Hill

, says "the buzz word is the preamortization earnings per share," but he believes the figure people will actually refer to as the earnings per share will be the postamortization figure, with analysts noting large, noncash amortization expenses. "There will probably have to be two sets of numbers -- pre- and

postamortization -- given out," he says.

An SEC spokeswoman says the SEC only makes sure that companies are compliant and is leaving it up to the investment community to decide what's best.

When Network Associates reported fourth-quarter earnings and preliminary first-quarter earnings last Tuesday, it gave both pre- and postamortization earnings per share for the fourth quarter. Network Associates also gave estimates for the first quarter, but only on a preamortization basis.

After much deliberation, First Call decided to use the preamortization number of 50 cents a share for Network Associates' fourth quarter and to use the preamortization number for all estimates going forward. "We decided to go with what the majority of the analysts sent in," says First Call's Dowling. For Network Associates, he says, First Call received about eight or nine preamortization estimates and five postamortization estimates. He says First Call had to call back the five analysts with postamortization numbers to get new estimates.

Internet company



was even bolder the following day, reporting


the preamortization earnings per share of 11 cents. That beat estimates that called for earnings of 8 cents a share, with barely anyone on Wall Street batting an eyelash. Analysts say that's because, as in all other measures, Internet companies are an exception: They're expected to make a lot of acquisitions to grow in a nascent market.

"With Internet companies, it's almost expected that they do it

use preamortization figures because they're building a business," says portfolio manager Louis Giglio at

American Express Financial Advisors


But that doesn't mean the issue of which numbers to use is anywhere near settled. Until it is, analysts and investors will likely have to wade through two sets of numbers each quarter, says Dowling, who hopes to have the new tables "finished by the end of this earnings period."

What do you think people should be looking at?

Preamortization earnings

Postamortization earnings