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a revisitation for 2001

by Duncan Williamson

Introduction

In May 2001 we wrote an analysis of amazon.com, the Internet based bookshop. We analysed amazon.com’s income statement, balance sheet and cash flow statement. We also took a look at amazon.com’s share dealings and at some of the comment that had been made on and around Wall Street about amazon.com.

Our conclusion in May 2001 was that amazon.com was in a parlous state and that any supposed analyst who tipped amazon.com as a safe investment needed seriously to evaluate his position. We found that only one mainstream analyst had anything like the reservations we had concerning the potential for amazon.com’s survival.

This revisitation of the life and times of amazon.com takes a look at what has happened to the company since we last took a look at them. The basis for what we see here is largely amazon.com’s annual report for the year ended 31 December 2001.

Last time …

The headline news from our last report is shown in the table that follows, set alongside the equivalent headline news from amazon.com’s latest annual report:

What happened in 2001	What we said about 2000
Sales grew to $3.1 billion in 2001	Sales grew to $2.76 billion in 2000
Gross profit grew to $799 million in 2001	Gross profit grew to $656 million in 2000
We served 25 million customers in 2000	We served 20 million customers in 2000

So, sales are still growing, gross profit is still growing and the number of customers served is still growing. Good, there is growth; but is the business a better bet than it was before? The behaviour of amazon.com’s share price on the NASDAQ shows an increasing trend: take a look at the equivalent graph for last year and you will see a trend in definite decline. The market, at least, likes the look of amazon.com if the share price is anything to go by.

At the start of this year the share price was $9.03 and as at the end of business on 14 November 2002, the share price had climbed to $23.35.

AMAZON COM

Source: http://finance.yahoo.com/q?s=amzn&d=c

A graph we constructed for the last report compared sales with gross and net profit: you might remember that the overall impression was that of a leaping frog! Have things improved for amazon.com? Not really. Perhaps the frog is more in control of its actions now, but there is still a massive gap between current levels of net income and the break even position. For the year ended 31 December 2001, amazon.com’s net loss was $(567,277,000): that’s a half a billion Dollar Net Loss. That’s bad enough, we think, but nevertheless, it’s a lot better than the almighty $1,411,273,000 loss from the previous year!

We have already seen that sales are increasing; but we can see from this graph that the rate of increase of sales has fallen; and the figures in the following table confirm that three of amazon.com’s key results are slowing down.

	Rates of Growth
years	Net sales	Gross Profit	Net Income
2000 - 2001	13.05%	21.77%	59.80%
1999 - 2000	68.43%	125.63%	-96.02%
1998 - 1999	168.91%	117.44%	-478.07%
1997 - 1998	312.63%	363.82%	-301.50%

At least we can see that net income is increasing for the first time since 1997; even though we can see that the rate of increase of gross profit has slowed along with the slowing growth in sales.

Here’s the reformed frog now:

Source of data: amazon.com annual report and accounts y/e 31/12/2001

We provided segmental information in our previous report and here we are again: still no one segment that can be held out as an exemplar for the rest of the world!

Segment Information	US Retail
$’000	Books, Music and DVD/Video	Electronics, Tools and Kitchen	Total	Services	Inter national	Consoli dated
	2001
Net sales	1,688,752	547190	2235942	225117	661374	3122433
Gross profit	453,129	78384	531513	126439	140606	798558
Pro forma income (loss) from operations	156,753	(140685)	16068	42042	(103112)	(45002)
Net loss						(567277)
	2000
Net sales	1,698,266	484151	2182417	198491	381075	2761983
Gross profit	417,452	44655	462107	116234	77436	655777
Pro forma income (loss) from operations	71,441	(269890)	(198449)	26519	(145070)	(317000)
Net loss						(1411273)

We can see that three of amazon.com’s segments are returning what is called a pro forma income (or profit) now but pro forma profit is profit before stock based compensation, amortisation on intangible assets, restructuring costs, net interest expense and a couple of other items. Moreover, the final net loss for the financial year 2001 is more than ten times the pro forma net loss.

Still a long way to go, amazon.com!

Cost Behaviour Analysis

In our previous report we discussed the level of fixed costs for amazon.com. We mentioned cost behaviour because the CEO said

Online selling (relative to traditional retailing) is a scale business characterized by high fixed costs and relatively low variable costs. (2000 letter to shareholders)

Our analysis of total costs last time showed that they seemed to be effectively entirely variable! Here’s the equivalent analysis that takes us up to 31 December 2001:

Mathematically, we find the amazon.com’s cost equations to be:

Total Costs              = 87,606,226.94 + 1.304x    r² = 0.931

Operating Costs        = 140,680,981.72 + 1.1756x          r² = 0.967

Where x is the value of sales

That is, for total costs, we estimate amazon.com’s fixed costs to amount to $87 million and fixed operating costs amount to $141 million. Given amazon.com’s sales level of around $3 billion, costs seem hardly to be anywhere near as high as the CEO suggests.

The r² (coefficient of determination) values are both very high at greater than 0.9 in each case: this suggests that we are dealing with linear cost functions: we can see from the graph that this is essentially true, despite the downturns we can see at the top of both cost curves.

The Latest Income Statements and Balance Sheets:

amazon.com Income Statement for the years ended 31 December

	Years Ended December 31,
	2001	2000	1999	1998	1997
Net sales	3,122,433	2,761,983	1,639,839	609,819	147,787
Cost of sales	2,323,875	2,106,206	1,349,194	476,155	118,969
Gross profit	798,558	655,777	290,645	133,664	28,818
Operating expenses:
Fulfilment	374,250	414,509	237,312	65,227	15,944
Marketing	138,283	179,980	175,838	67,427	24,133
Technology and content	241,165	269,326	159,722	46,424	13,384
General and administrative	89,862	108,962	70,144	15,618	6,741
Stock-based compensation	4,637	24,797	30,618	1,889	1,211
Amortization of goodwill   and other intangibles	181,033	321,772	214,694	42,599	0
Restructuring-related and other	181,585	200,311	8,072	3,535	0
Total operating expenses	1,210,815	1,519,657	896,400	242,719	61,413
Pro forma income (loss) from operations	(45,002)	(317,000)	(352,371)	(61,032)	(31,384)
As a % of Revenues	(1.44%)	(11.48%)	(21.49%)	(10.01%)	(21.24%)
Income (loss) from operations	(412,257)	(863,880)	(605,755)	(109,055)	(32,595)
Interest income	29,103	40,821	45,451	14,053	1,901
Interest expense	(139,232)	(130,921)	(84,566)	(26,639)	(326)
Other income (expense), net	(1,900)	(10,058)	1,671	0	0
Other gains (losses), net	(2,141)	(142,639)	0	0	0
Total non-operating expenses, net	(114,170)	(242,797)	(37,444)	(12,586)	1,575
Income (loss) before equity in losses of  equity-method investees	(526,427)	(1,106,677)	(643,199)	(121,641)	(31,020)
Equity in losses of equity-method investees, net	(30,327)	(304,596)	(76,769)	(2,905)	0
Pro forma net income (loss)	(157,031)	(417,158)	(389,815)	(73,618)	(29,809)
Cumulative effect of change in accounting principle	(10,523)	0	0	0	0
Net income (loss)	(567,277)	(1,411,273)	(719,968)	(124,546)	(31,020)

amazon.com Balance Sheets as at 31 December	2001	2000
Assets
Current assets:
Cash and cash equivalents	540,282	822,435
Marketable securities	456,303	278,087
Inventories	143,722	174,563
Prepaid expenses and other current assets	67,613	86,044
Total current assets	1,207,920	1,361,129
Fixed assets, net	271,751	366,416
Goodwill, net	45,367	158,990
Other intangibles, net	34,382	96,335
Investments in equity-method investees	10,387	52,073
Other equity investments	17,972	40,177
Other assets	49,768	60,049
Total assets	1,637,547	2,135,169
Liabilities and Stockholders’ Deficit
Current liabilities:
Accounts payable	444,748	485,383
Accrued expenses and other current liabilities	305,064	272,683
Unearned revenue	87,978	131,117
Interest payable	68,632	69,196
Current portion of long-term debt and other	14,992	16,577
Total current liabilities	921,414	974,956
Long-term debt and other	2,156,133	2,127,464
Commitments and contingencies
Stockholders’ deficit:
Preferred stock, $0.01 par value:
Authorized shares: 500,000
Issued and outstanding shares: none	—	—
Common stock, $0.01 par value:
Authorized shares: 5,000,000
Issued and outstanding shares: 373,218 and 357,140 shares,
respectively	3,732	3,571
Additional paid-in capital	1,462,769	1,338,303
Deferred stock-based compensation	(9,853)	(13,448)
Accumulated other comprehensive loss	(36,070)	(2,376)
Accumulated deficit	(2,860,578)	(2,293,301)
Total stockholders’ deficit	(1,440,000)	(967,251)
Total liabilities and stockholders’ deficit	1,637,547	2,135,169

amazon.com Redrafted Balance Sheet: a much more realistic view

We find the above balance sheet to be misleading, combining as it does the stockholder’s deficit and the total liabilities. If we redraft the balance sheet in the way we did in our previous report, we see a much more realistic value of stockholders’ interests in amazon.com:

	2001	2000	1999
Total Assets	1637547	2135169	2465850
Total Liabilities	197547	3102420	2199572
Net Assets	(1440000)	(967251)	266278
Stockholders’ Equity (SE)	(1440000)	(967251)	266278
Change in SE	(48.88)%	(463.25)%

amazon.com’s balance sheet is in a parlous state as it is getting progressively worse year after year: the rates of deterioration of stockholders’ equity demonstrates this most clearly: perhaps this rate of deterioration is slowing, in line with the other aspects of the business that we have seen already?

Ratio Analysis

	Years Ended December 31,
amazon.com analysis	2001	2000	1999	1998	1997
Gross Profit %	25.57%	23.74%	17.72%	21.92%	19.50%
Loss from Operations %	-13.20%	-31.28%	-36.94%	-17.88%	-22.06%
Interest Income as a % of Sales	-13.20%	-31.28%	-36.94%	-17.88%	-22.06%
Interest Expense as a % of Sales	-4.46%	-4.74%	-5.16%	-4.37%	-0.22%
Net Loss %	-18.17%	-51.10%	-43.90%	-20.42%	-20.99%
Working capital ratio	1.31	1.40	1.37
Acid test ratio	1.15	1.22	1.07
Stock turnover	22.57	30.25	59.69
Debtors turnover	n/a	n/a	n/a
Creditors turnover	69.85	131.37	172.93
Total asset turnover	1.91	1.29	0.67
Net asset turnover	(2.17)	(2.86)	6.16
Net assets ($000)	(1,440,000)	(967,251)	266,278

Of all the measures of profitability only gross profit is positive; but the improvements we have mentioned already are showing through in these figures as the extent of the losses are reducing.

Working capital is coming under control and the stock turnover ratio is falling dramatically year by year as is the creditors’ turnover ratio: both good signs within the overall view of working capital management.

Cash Flow Statement

Years ended 31 December	2001	2000	1999
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	822,435.0	133,309.0	71,583.0
OPERATING ACTIVITIES:
Net loss	(567,277.0)	(1,411,273.0)	(719,968.0)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation of fixed assets and other amortization	84,709.0	84,460.0	36,806.0
Stock-based compensation	4,637.0	24,797.0	30,618.0
Equity in losses of equity-method investees, net	30,327.0	304,596.0	76,769.0
Amortization of goodwill and other intangibles	181,033.0	321,772.0	214,694.0
Non-cash restructuring-related and other	73,293.0	200,311.0	8,072.0
Loss (gain) on sale of marketable securities, net	(1,335.0)	(280.0)	8,688.0
Other losses (gains), net	2,141.0	142,639.0	-
Non-cash interest expense and other	26,629.0	24,766.0	29,171.0
Cumulative effect of change in accounting principle	10,523.0	-	-
Changes in operating assets and liabilities:
Inventories	30,628.0	46,083.0	(172,069.0)
Prepaid expenses and other current assets	20,732.0	(8,585.0)	(54,927.0)
Accounts payable	(44,438.0)	22,357.0	330,166.0
Accrued expenses and other current liabilities	50,031.0	93,967.0	95,839.0
Unearned revenue	114,738.0	97,818.0	6,225.0
Amortization of previously unearned revenue	(135,808.0)	(108,211.0)	(5,837.0)
Interest payable	(345.0)	34,341.0	24,878.0
Net cash used in operating activities	(119,782.0)	(130,442.0)	(90,875.0)
INVESTING ACTIVITIES:
Sales and maturities of marketable securities	370,377.0	545,724.0	2,064,101.0
Purchases of marketable securities	(567,152.0)	(184,455.0)	(2,359,398.0)
Purchases of fixed assets, including internal use software and web-site development	(50,321.0)	(134,758.0)	(287,055.0)
Investments in equity-method investees and other investments	(6,198.0)	(62,533.0)	(369,607.0)
Net cash provided by (used in) investing activities	(253,294.0)	163,978.0	(951,959.0)
FINANCING ACTIVITIES:
Proceeds from exercise of stock options and other	16,625.0	44,697.0	64,469.0
Proceeds from issuance of common stock, net of issuance costs	99,831.0	-	-
Proceeds from long-term debt and other	10,000.0	681,499.0	1,263,639.0
Repayment of long-term debt and other	(19,575.0)	(16,927.0)	(188,886.0)
Financing costs	0.0	(16,122.0)	(35,151.0)
Net cash provided by financing activities	106,881.0	693,147.0	1,104,071.0
Effect of exchange-rate changes on cash and cash equivalents	(15,958.0)	(37,557.0)	489.0
Net increase (decrease) in cash and cash equivalents	(282,153.0)	689,126.0	61,726.0
CASH AND CASH EQUIVALENTS, END OF PERIOD	540,282.0	822,435.0	133,309.0

Whilst they haven’t managed to maintain the $822 million cash mountain that they started the year with, amazon.com has behaved reasonably prudently with their cash. However, operations simply are not sufficient to finance this business. We can see that amazon.com sold $370 million of their marketable securities during the year, to add to the $2.5 billion they had sold over the previous two years; and to add to the $1.9 billion debt they floated in those same two years.

This statement helps to explain why amazon.com has a negative balance on the stockholders’ funds account!

Insider Share Trading

In our previous report we said,

Over the last year or so, officers of the company, together with a number of shareholders, have been classified as Insiders who have sold a total of 3,089,954 shares at a value of $87,906,528.

(Source: http://biz.yahoo.com/t/a/amzn.html)

2001 saw a similar set of circumstances when, in the year to 31 December 2001 amazon.com’s Insiders disposed of total of 5,832,530 shares with proceeds of $70,836,735.63. CEO Bezos’ personal haul in 2001 was $55,210,350. The source of this information is http://biz.yahoo.com/t/a/amzn.html

Why do we repeat this insider dealing information for the second time? Well, we still find it astonishing that senior executives in an organisation that is persistently on the verge of liquidation are allowed to cash in on their stockholdings to such an extent. Moreover, look at the statement on amazon.com’s dividend policy from its annual report:

Dividends

We have never declared or paid cash dividends on our common stock. We intend to retain all future earnings to finance future growth and, therefore, do not anticipate paying any cash dividends in the foreseeable future. In addition, we are restricted from paying cash dividends under our Senior Discount Notes.

True, Bezos and co are not robbing retained earnings to pay themselves their handsome rewards; but they are rewarding themselves handsomely … unless, they are dealing in shares for the benefit of legitimate trust funds that benefit the poor and needy; but the information we have doesn’t suggest such a thing.

Conclusions

Amazon.com is trundling along and it is being financed to the extent that we imagine that bankers and financiers feel they cannot afford to let it sink. Otherwise, the losses that the company has racked up for so long cannot but help us to conclude that it ought to close down forthwith. At the time of writing, we are almost at the end of the financial year 2002 and amazon.com is still operating … we’ll be back to analyse the next chapter in the history of this fascinating creation!

© Duncan Williamson

1 December 2002

© Webmaster Duncan Williamson 2002