GAAP v. non-GAAP

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Dear all,

I have a very practical question on obtaining non-GAAP income for some companies.

Some companies break this out very nicely and consistently in their earnings releases. However, some other companies are making it hard.

Take AFOP: In their Q1/2014 release, they show non-GAAP income. In all their previous releases, they don’t. What they do instead is break out tax benefits (Q4/2013), and stock-based compensation (e.g., Q3/2013).

Now, I could back these things out of their GAAP earnings manually. However, I’m not sure if this would result in an apples-to-apples comparison. That is: If I back out the stock-based compensation from their Q3/13 release, and the tax break from their Q4/13 report – would those numbers be comparable to the Q1/14 non-GAAP income as reported?

Confusedly,
Elmar

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Great question, Elmar. I think they just decided to start giving adjusted earnings this last quarter. For AFOP’s earlier quarters, I added back the stock based compensation less tax. Here’s what I got. Some came out to half cents and I rounded them, but this is pretty close.

Saul

2011 - 06 08 09 06 = 29
2012 - 07 08 12 11 = 38
2013 - 12 27 34 29 = 102
2014 - 35

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Thank you, Saul. This is very helpful. After looking at the GAAP/non-GAAP reconciliation in their Q1/14, I’m pretty confident that we’re comparing apples to apples. All they do is back out the stock based compensation.

This raises the philosophical question of why one would back this out. Sure, it’s non-cash, but it does dilute shareholders and may very well be a recurring operating expense. Not sure if adding it back to earnings yields a truer view of the business.

Are there any possible benefits to ignoring stock-based compensation for earnings purposes?

Elmar

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Saul,

Now taking the adjusted EPS numbers in your message, we get the TTM Adj EPS and TTM y/y growth (below).

It makes AFOP still look very cheap at a PE of 14.8 given it’s recent growth rate. The stock has sold off from around $22 to close at $18.47 on Friday. Two things to consider with AFOP are

  1. This has historically been a cyclical business. We are in the midst of the boom cycle. IMO, I think the boom will continue into around mid to late 2015. Will growth slow or turn negative after that? The CEO has stated that “this time is different” because data center will continue to need storage and networking equipment. I guess well see if he’s right. I was planning on getting out of AFOP in mid 2015 to avoid the bust cycle (I am skeptical of the CEO’s thinking that there will be no bust cycle this time).

  2. Last Q TTM Adj Earnings Growth was 190%. However, if you look at Q1 to Q2 EPS growth in 2013 it was also huge at 125% (that sequential q/q growth). AFOP has guided a 31% increase in y/y revenue for Q2 2014 and the consensus estimated EPS from Q2 is 32 cents (not sure if this is adj EPS or GAAP though). Assuming it’s non-GAAP, this means that the TTM y/y adj EPS increase will decelerate to 109% (from 190%). Also, the q/q sequential deceleration will be more dramatic to 18.5% (down from 192% for sequential Q2/Q1 2013). I think the stock price will respond more to what AFOP guides for Q3 and the rest of 2014.

TTM Adj EPS TTM y/y growth
12/31/2011 29
3/31/2012 30
6/30/2012 30
9/30/2012 33
12/31/2012 38 31.0%
3/31/2013 43 43.3%
6/30/2013 62 106.7%
9/30/2013 84 154.5%
12/31/2013 102 168.4%
3/31/2014 125 190.7%
6/30/2014 130 109.7% ESTIMATED

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All they do is back out the stock based compensation. This raises the philosophical question of why one would back this out. Sure, it’s non-cash, but it does dilute shareholders and may very well be a recurring operating expense. Not sure if adding it back to earnings yields a truer view of the business.

Elmar

The way I think about it is that the additional shares are already accounted for in the number of diluted shares. Taking it as an expense too is double counting it. That’s why almost every company backs it out for adjusted earnings. I think this silly rule was put in as a moralistic “punishment” of the tech companies who don’t have much money when they are starting out so have to pay a considerable part of salary in stock.

JMO

Saul

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A couple additional points about AFOP.

  1. I think we can expect the adj EPS to come in at around 37 cents (up from 27 cents from Q2 2013). This will drop the P/E from 14.8 to 13.7.

  2. Based on the above, I’m definitely inclined to hold on to my position (3.8% of my portfolio currently). I’m also consider resuming selling puts which I stopped doing when the stock price went above $17.

Chris

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The way I think about it is that the additional shares are already accounted for in the number of diluted shares. Taking it as an expense too is double counting it.

Thanks! This makes a lot of sense.

Elmar