Amazon.com (AMZN) Earnings Analysis: Possible Sandbagging?

Amazon.com Inc. (AMZN)Is Amazon.com, Inc. (NASDAQ:AMZN) understating or sandbagging its reported net income number? We wrap up this week’s analysis of the company with our earnings analysis. Our analysis is always peer-based. The following list of peers was used for the analysis that follows: Wal-Mart Stores, Inc. (NYSE:WMT), Google Inc. (NASDAQ:GOOG), eBay Inc. (NASDAQ:EBAY), Costco Wholesale Corporation (NASDAQ:COST), Mercadolibre Inc. (NASDAQ:MELI), Barnes & Noble, Inc. (NYSE:BKS), Hot Topic, Inc. (NASDAQ:HOTT), Overstock.com, Inc. (NASDAQ:OSTK).

Accounting Quality

Possible Sandbagging
AMZN-US’s relatively weak net income margins for the last twelve months combined with a relatively conservative accrual policy suggest the company might likely be understating and possibly even sandbagging its reported net income number.

Management of Reserves

Strong Buildup
The company’s accrual levels over the last twelve months are both positive and greater than the peer median suggesting the company is not only building reserves but is doing so in a relatively strong manner compared to its peers.

Material Categories

Excluding the effects of change in revenue, the accounting categories causing the most impact on the movement of net income from the prior period to the current period are SG&A, PP&E and R&D.

Earnings: From Accounting or Cash Flow?

Net Income = Net Operating Cash Flow – “Accruals”

Accruals are estimates by company management of non-cash expenses, assets and liabilities that are recognized before they are paid. They are calculated as net operating cash flow less net income.
The analysis of accruals can help signal possible earnings management of reported net income and EPS results. For example, ‘Over-Accrued’ can signal under reported net income and/or the building of balance sheet reserve accounts, while ‘Under-Accrued’ can signal inflated Net Income results and/or release of balance sheet reserves to aid reported earnings.

Recent trend for AMZN-US’s accruals

The annual trend suggests that AMZN-US’s accruals to revenue ratio continues to trend downward and is now similar to its four-year average accruals to revenue ratio of 7.1%. Though its accruals to revenue ratio has remained relatively stable at 6.8% compared to 2010, its peer median has decreased to 4.2% from 5.5% during this period. Relative to peers, accruals to revenue ratio rose 1.2 percentage points.
On a quarterly basis, AMZN-US’s accruals to revenue ratio has increased 24.1 percentage points from last quarter’s low and is now above its four-quarter average accruals to revenue ratio of 3.3%. The increase in its accruals to revenue ratio to 4.6% from -19.5% was also accompanied by an increase in its peer median during this period to 4.1% from -0.8%. Relative to peers, accruals to revenue ratio rose 19.1 percentage points (and ended higher than its peer median).
Graph of Annual Accruals (TTM) showing Peer Median for Amazon.com Inc. (AMZN-US)
Graph of Quarterly Accruals (TTM) showing Peer Median for Amazon.com Inc. (AMZN-US)

Accounting Quality

Financials suggest possible sandbagging of net income.

AMZN-US reported relatively weak net income margins for the last twelve months (0.7% vs. peer median of 2.1%). This weak margin performance and relatively conservative accrual policy (5.2% vs. peer median of 3.5%) suggest the company might likely be understating its net income, possibly to the extent that there might even be some sandbagging of the reported net income numbers.
Accounting Quality or Net Margin vs. Accruals charted with respect to Peers for Amazon.com Inc. (AMZN-US)

Management of Reserves

AMZN-US’s accounting suggests a relatively strong buildup in its reserves.

AMZN-US’s accruals over the last twelve months are positive suggesting a buildup of reserves. In addition, the level of accrual is greater than the peer median — which suggests a relatively strong buildup in reserves compared to its peers.
Management of Reserves, Buildup or Drain? Charted with respect to Peers for Amazon.com Inc. (AMZN-US)

Key Items Impacting Cash Flow

Accounts Payable, PP&E and SG&A have the most material impact on the movement of net income.

We assess the impact of various categories on the cash flow of the company by performing a variance analysis. For each category, this variance analysis measures the movement between the current and previous periods, normalized for the size of the company (e.g. days outstanding or percentage of revenues). This normalization eliminates any movement attributable to period-by-period growth and helps isolate the impact of any accounting policy changes the company might have made in recording the values in each category.
The chart on the right shows the impact of the top accounting categories on Amazon.com Inc.’s cash flow for the current quarter. We consider both positive and negative impacts on the cash flow since the categories could have either decreased or increased the reported net income.
% Impact on Cash Flow for Amazon.com Inc. (AMZN-US)
The table below details the impact of the major accounting categories on Amazon.com Inc.’s net operating cash flow for the current quarter. While we have identified the major accrual categories, and conduct several tests on this standardized set, it should be noted that companies can sometimes have a non-standard accrual item that has a higher impact on the difference between net operating cash flow and net income.
Amazon.com, Inc. (AMZN)

Supporting Tests and Analytics

For further reference, we provide an extended analysis of the quality of accounting for each accrual category and the company’s results. We judge these results by comparing (i) against the company’s previous accounting policy — to ascertain if the policy has changed or (ii) against the peer group — to check if the company is being more aggressive or conservative than the peers or (iii) the appropriateness of the change and its implication.
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Company Profile

Amazon.com, Inc. provides online retail shopping services. It provides services four primary customer sets: consumers, sellers, enterprises, and content creators. The company generates revenue through other marketing and promotional services, such as online advertising and co-branded credit card agreements. It serves consumers through its retail websites with a focus on selection, price, and convenience. It designs its websites to enable millions of unique products to be sold by the company and by third parties across dozens of product categories. It also manufactures and sells the Kindle e-reader and strives to offer customers the lowest prices possible through low every day product pricing and free shipping offers, including through membership in Amazon Prime. The company offers programs that enable sellers to sell their products on its websites and their own branded websites, earning fixed fees, revenue share fees or per-unit activity fees from these transactions. It also serves developers and enterprises of all sizes through Amazon Web Services, which provides access to technology infrastructure that enables virtually any type of business. The company operates in two principal segments: North America and International. The North America segment consists of retail sales of consumer products and subscriptions through North America-focused websites such as www.amazon.com and www.amazon.ca. The International segment consists of retail sales of consumer products and subscriptions through internationally focused locations. This segment includes export sales from these internationally based locations, including export sales from these sites to customers in the U.S. and Canada. Amazon was founded by Jeffrey P. Bezos in 1994 and is headquartered in Seattle, WA.

Disclaimer

The information presented in this report has been obtained from sources deemed to be reliable, but AnalytixInsight does not make any representation about the accuracy, completeness, or timeliness of this information. This report was produced by AnalytixInsight for informational purposes only and nothing contained herein should be construed as an offer to buy or sell or as a solicitation of an offer to buy or sell any security or derivative instrument. This report is current only as of the date that it was published and the opinions, estimates, ratings and other information may change without notice or publication. Past performance is no guarantee of future results. Prior to making an investment or other financial decision, please consult with your financial, legal and tax advisors. AnalytixInsight shall not be liable for any party’s use of this report. AnalytixInsight is not a broker-dealer and does not buy, sell, maintain a position, or make a market in any security referred to herein. One of the principal tenets for us at AnalytixInsight is that the best person to handle your finances is you. By your use of our services or by reading any of our reports, you’re agreeing that you bear responsibility for your own investment research and investment decisions. You also agree that AnalytixInsight, its directors, its employees, and its agents will not be liable for any investment decision made or action taken by you and others based on news, information, opinion, or any other material generated by us and/or published through our services. For a complete copy of our disclaimer, please visit our website www.analytixinsight.com.
This article was originally written by abha.dawesar, and posted on Capital Cube.
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