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

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.

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).

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.

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.

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.

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. 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.

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