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Amazon - Enron of the Internet Era?
This company came to my attention in the late 90's. The range of products, pricing and customer reviews have made me a big fan. However, recent events have convinced me to evaluate the stock and the company.
Red Flags
19 Mar 2007 - Mark Peek resigned his position as the Company's principal accounting officer, effective April 15, 2007
24 Apr 2007 - Company releases Q1'07 results. Year on year, all major indicators are up:
* Net sales increased 32% to $3.02 billion, compared with $2.28 billion; Excluding the $84 million favorable impact from year-over-year changes in foreign exchange rates throughout the quarter, net sales grew 29% compared with first quarter 2006. * Operating income increased 38% to $145 million, compared with $106 million * Net income increased 115% to $111 million, or $0.26 per diluted share, compared with net income of $51 million, or $0.12 per diluted share
...with one exception:
* First quarter 2007 effective tax rate was 23% compared with an effective tax rate of 47% in first quarter 2006
Now why would a company be aggressive in reducing its estimated tax rate by more than 50% if it is rapidly expanding international operations? How could the auditors sign off on this estimate if the company is facing several tax examinations and assessments? From Note 8 of the company's Q1'07 10-Q:
* We may be subject to examination by the Internal Revenue Service ("IRS") for calendar years 2003 through 2006. Additionally, any net operating losses that were generated in prior years and utilized in these years may also be subject to examination by the IRS.
* We are under examination, or may be subject to examination, in the following major jurisdictions for the years specified:
1. Pennsylvania for 2002 through 2006 2. Kentucky for 2003 through 2006 3. Delaware for 2004 through 2006 4. France for 2003 through 2006 5. Germany for 1998 through 2006 6. Luxembourg for 2003 through 2006 7. United Kingdom for 1999 through 2006.
* In addition, in February 2007, Japanese tax authorities assessed income tax, including penalties and interest, of approximately $90 million against one of our U.S. subsidiaries for the years 2003 through 2005.
The company further states:
We believe that these claims are without merit and are disputing the assessment. Further proceedings on the assessment will be stayed during negotiations between U.S. and Japanese authorities over the double taxation issues the assessment raises, and we have provided bank guarantees to suspend enforcement of the assessment. We also may be subject to income tax examination by Japanese tax authorities for 2006.
Is this similar to them trying dispute the IBM patent lawsuits in one quarter and paying a settlement in the next quarter?
In October 2006, IBM filed two patent infringement lawsuits against us in the United States District Court for the Eastern District of Texas. The complaints allege that various aspects of our website technology infringe five patents obtained by IBM purporting to cover a "System for Ordering Items Using an Electronic Catalog" (U.S. Patent No. 5,319,542), a "Method for Storing Data in an Interactive Computer Network" (U.S. Patent No. 5,442,771), a "System for Adjusting Hypertext Links with Weighed User Goals and Activities" (U.S. Patent No. 5,446,891), a "Method for Presenting Applications in an Interactive Service" (U.S. Patent No. 5,796,967), and a "Method of Presenting Advertising in an Interactive Service" (U.S. Patent No. 7,072,849). The complaints seek injunctive relief, monetary damages in an amount no less than a reasonable royalty, treble damages for alleged willful infringement, prejudgment interest, and attorneys' fees. In response, we asserted counterclaims in both actions alleging that IBM's WebSphere service infringes several of our patents. We dispute IBM's allegations of wrongdoing in these lawsuits and intend to vigorously defend ourselves in this matter.
08May2007 - Amazon, IBM settle patent lawsuit
However, Paul McDougall at Information Week did bring up some questionable issues in his Weblog: Did dispute with insurer force Amazon to settle with IBM?
"Oddly, and I mean really oddly, an Amazon spokeswoman told the Associated Press on Tuesday that the company had already factored in damages to be paid to IBM in its second quarter and full year guidance, and thus does not need to restate its financial estimates in light of the settlement.
* Amazon issued that guidance on April 24th. So for how long exactly has Amazon known that it was going to settle with IBM?
* Did Amazon pony up to IBM because it knew ultimately that it was, in fact, violating IBM's patents? Or did it simply not want to play legal Russian roulette before a jury given the possibility that its insurance for such things may be ruled null and void.
Amazon isn't talking, but it's a question worth asking--especially if you're an Amazon shareholder."
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