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Pro Forma Performances

Pro forma per-share figures in earnings announcements seem to be crowding out traditional earnings in many industries.

1Nov

Are GAAP net earnings on the endangered species list? Pro forma per- share figures in earnings announcements, a number derived after removing an expanding list of items and sometimes real cash expenses, seem to be crowding out traditional earnings in many industries. But who can blame the CFO? The special packaging of financial data helps boost valuation expectations, according to a recent study.


The pro forma movement has evolved out of the acquisition frenzy of the past few years, says Gerald White, president of Grace & White Inc., an investment adviser in New York. Factoring out goodwill, in-process research- and-development write-offs, and other merger- related charges has encouraged a growing trend. "Pro forma somehow got created and I don't know who did it first," says White. "What disturbs me is when companies say you should exclude certain categories of expense. It's no longer this quarter; it's every quarter. That's what I think is dangerous." Stock option expenses, for example, are routinely excluded when arriving at a pro forma number, and some companies have taken things a step further by backing out the taxes they have to pay when employees exercise option grants.


The earnings release is not directly regulated by the Securities and Exchange Commission. "The rule that governs is the antifraud provision," says SEC spokesman John Heine, adding that communications can't be misleading or false--or omit information that makes them misleading or false.


Misleading, however, is a broad term. "It's a quandary. Are companies misleading investors when they report certain elements but dress them up to look like something more familiar?" asks Patrick Hopkins, an assistant professor at the Kelley School of Business at Indiana University. "It's self-serving behavior in the guise that the companies are helping you out."


Hopkins co-authored a study that shows that when companies isolate their goodwill amor- tization for the benefit of analysts, they are rewarded with higher valuation targets. "Packaging matters," says Hopkins. "We've known that for years in marketing, so why should that be any different when presenting the corporate face and financial results?"


Companies naturally defend the practice as a way of presenting a clearer picture of how they're actually performing--and moreover, they say, everyone else is doing it. "It's pretty well standard in the technology industry," says Kevin McCarty, head of investor relations at Liberate Technologies, which provides software for interactive television applications. Liberate, which went public in July 1999, announced its first- quarter results with a pro forma net loss of 9 cents per share. Actual net loss, however, was 90 cents per share, once acquired R&D and amortization of purchased intangibles, warrants, and deferred compensation were included. "It's giving you two bottom lines to look at," says McCarty. "The top bottom line is closer to actual operating results."

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