Reed Elsevier's Fine Print

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Anglo-Dutch publisher Reed Elsevier (NYSE: ENL) reported its interim 2004 results yesterday, blaming a weak dollar (more than half of Reed's revenues come from North America) for its 3.5% revenue decline and 2.8% pretax earnings growth. Absent the effects of exchange rates, Reed says it would have increased revenues by 4% and pretax profits by 11% over the first half of 2003 -- still considerably weaker than the results that archrival Thomson (NYSE: TOC) turned in last week. And Reed expects its earnings growth to slow somewhat through the rest of 2004, resulting in "mid- to high-single-digit adjusted earnings growth," followed by a return to double-digit earnings growth in 2005. Again, that assumes a dollar trading for what it bought a year ago.

Still, Reed turned in a pretty decent first half, all things considered. It termed its science and medical division's performance "satisfactory" and said its business and legal divisions both "performed well." Overall, its operating margins increased from 10.5% to 12.6%. Pretax profit margins rose from 9.2% to 9.8%.

At this point, those of you who have had an opportunity to scan the company's press release may be thinking, "Hold on a sec. The press release says operating margins were 22%, not 12.6%. What gives?" And that's a good question. The answer is that Europeans appear to share the American corporate penchant for choosing their words carefully as to confuse their investors (unintentionally, I'm sure). In Reed's case, the relevant term of art here is "adjusted figures." The press release gives you two sets of numbers: one impressive (the "adjusted" set) and the other less so (the "reported" set). The operating margin that the company highlights derives from the adjusted figures.

The adjusted figures include all the good stuff such as profits and such. But they exclude all the bad stuff, for example, "the amortization of goodwill and intangible assets, exceptional items, and related tax effects" -- in other words, the things that make the profit numbers go down. Sound familiar? You guessed it. "Adjusted figures" are European-ese for the American term "pro forma" (Latin for "think happy thoughts") numbers.

Just as in America, the European version of pro forma reporting is not necessarily misleading. In fact, "adjusted figures" can provide a useful metric for evaluating the development of a company's core businesses. However, as investors, while we might use pro forma numbers to evaluate a company's core growth, it is essential to differentiate between numbers used as a metric (adjusted figures) and figures that accountants generally agree represent "real" profits (reported figures). A pro forma profit, by any other name, may smell sweet, but it won't pay the electric bill.

Fool contributor Rich Smith has no interest in any of the companies mentioned in this article.