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Regulators and Investors have for decades grown accustomed to a comforting and well-understood standard which all listed companies must follow when filing financial statements with the Securities and Exchange Commission ("SEC"). All annual and quarterly financial reports filed with the SEC must follow generally accepted accounting principles ("GAAP") as promulgated by the Financial Accounting Services Board ("FASB").
During the heyday of the dot.com economy during the past two years, many Internet companies found it increasingly difficult to explain to the financial community how their continued quarterly losses should not be seen as negative news (after all, they were all building infrastructure or market share), so it is understandable that some of the more prominent ones grabbed a reporting crutch which could explain away a lot of expenses not deemed "recurring", "operational", or, for that matter, "relevant" and exclude such expenses from the earnings statements released to the public via the Internet and discussed with financial analysts.
By the time these companies filed their quarterly or annual financial statements with the SEC (in conformance with GAAP principles), all emphasis was off the most recent quarter (being reported), and all of the public's eyes already set on the following three month period.
The use of pro forma earnings announcements gained popular use, and in the case of Amazon.com, gave rise to notoriety, public outrage, day-trader euphoria, SEC scrutiny, and - understandably, a dialogue as to their merits.
Jeff Bezos, the Chairman and CEO of Amazon, mocked securities analysts who questioned him, against a background of more than a dozen successive losing quarters, of when Amazon might, eventually, attain "profitability". Profits, according to Bezos, is an unimportant metric when there are such objectives at play as building the company into a market leader. Eventually, he claimed, once Amazon attained the pre-eminent global stronghold on the Internet sale of books, records, cameras, tools, and an ever-expanding array of consumer goods, profits would fall in place as predictably as the sun's rise in the East.
Nonetheless, under the constant haranguing of analysts, Bezos eventually had to come to terms with the "P" word, and with his disdain for conventional thinking and expectations, it is no wonder he grabbed hold of the "pro forma" income notion. Fixed corporate overhead, he preaches, is in the long run merely a de minimus carbuncle on the earnings stream as this stream attains cosmic proportions. The only thing which truly matters, is the variable profit which an e-retailer makes, defined as the difference between selling price and variable cost. Everything else is essentially irrelevant and becomes substantially immaterial as revenues rise (and fixed costs remain fixed). Or so his argument went.
Starting in 1999, Amazon would elaborate at great length during meeting with Analysts on the new metric which was shaped in large part by the fact that companies, Amazon prominently among them, were unable to report quarterly profits. Clearly, non-cash charges like amortization and depreciation were to be disregarded when zeroing in on a company's real, meaningful operations. Merger related costs surely also should be disregarded in any analysis which focused on the relative health of an Internet company, particularly one which had gained market prominence by swallowing up one of several of its smaller (and equally unprofitable) competitors.Interest expenses went out the door, too, since they only represented interim carrying costs of "equity alternatives". Anything "extraordinary", by definition, was outside of the mainstream and similarly should be excluded from consideration.
During the 2000 pre-Christmas season, Amazon decided to offer custmers free shipping, in an effort to attain new customers. How should such a cost be classified? Well, clearly, since this was a one-time campaign, designed exclusively to build Amazon's customer base, it was decidedly NOT a period cost, not even a marketing expense (which a liberal interpretation of FASB rules would permit) - but an infrastructure investment requiring that the campaign's cost be capitalized and (ugh) amortized over the useful life of the period of time during which these "free shipping" customers remained loyal AMAZON customers.
Result? The Free Shipping Cost charges were to be excluded from Amazon's pro forma earnings statement. Anyone who couldn't swallow the logic of that argument clearly didn't understand what the Internet was all about. So what to the uninitiated observer might look like a low profit sale (the free shipping consisted of Federal Express Overnight delivery to the tune of $13 per package which Amazon absorbed in full) - in Amazon's eyes were, in fact, higher-than-usual margined sales since normally, shipments enjoyed a small subsidy to cover the cost of ground shipping.
By early 2001 Amazon was unable to address the issue of positive pro forma earnings. While the pro forma losses continued to pile up, the long road to pro forma breakeven appeared arduous. At the time, Amazon realized that the group of its detractors from within the financial community was starting to grow, and its stock price was, perhaps, starting to reflect this growing lack of confidence.
Was there a different way to skin the cat?? Yes - the answer lay in the pie cutter. Amazon, after all, had several divisions. The Books and records division was clearly its bread an butter, and since it was more mature, perhaps should be the one looked at with the most (only??) scrutiny. So Bezos started to break pro forma results into a divisional array. There was the books and records division, there was "all else" with in the USA (conveniently described as DEVELOPMENTAL) and finaly, there was the rest of the Universe (International). Amazon, looking at the biggest possible picture, clearly had to develop nascent markets abroad, hopefully before others got there, and perhaps, even before there was much of an Internet presence in such places. Understandably, one could hardly expect to be held accountable for the obvious and necessary losses which piled up outside the US??
Lastly, since many expense categories were difficult to break out in a meaningful way insofar as they benefited individual divisions, Amazon allocated such benefits to "corporate". While others might have described "corporate" as "shared overhead", Amazon described it as a separate division, currently without associated sales or revenue.
Under this scenario, it was conceivable to view Amazon's bread-and-butter division as a separate entity, and even speak of it attaining "profitability" in its own right (albeit without any allocation of non-cash, non-period, extraordinary, non-recurring or incapable-of-allocation expenses).
On March 17, 2001 Bezos trumpeted to the world:" Our Books and Record Division was profitable!"
