Negative Aspects Of Bigger Amortization Charges
Network Associates restated loan amortization schedule 2006 and 2007 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 non cash 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 pre amortization 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 pre amortization 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, non cash 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 pre amortization basis.
After much deliberation, First Call decided to use the pre amortization 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 pre amortization 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 Yahoo! was even bolder the following day, reporting only the pre amortization 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 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."
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