Net Income and Adjusted Net Income

So they’ve taken a net income of 87 million, and adjusted it to $136 million for 2016.

Hi Billy, Let me start off by saying that I have no interest in CRTO one way or another, and I am not defending it, but it always puzzles me when someone says something like that.

The company made Net Income of $136 million. It’s real dollars. It’s in the bank. It’s actual money. It’s still there.

They diluted their shares by $49 million worth of stock-based compensation. That has no effect on the $136 million which they made and which is still sitting there in the bank. It does mean that the $136 million is spread over more shares, which reduces earnings per share. But we already know the new diluted share count and resultant earnings per share. The $136 million is still there in the bank.

GAAP accounting rules force the company to make-believe that they only made $87 million in Net Income, which is pretty ridiculous since the $136 million is still sitting there in the bank. Which is why every company that gives any stock based compensation reports adjusted earnings without that subtraction.

One more time: they made $136 million, real money, real dollars. It is there, sitting in the bank right now. Diluting the shares doesn’t make it go away.

But that’s GAAP.

Saul

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Some nit picking: It’s in the bag but not in the bank. Net income is not net cash flow. :wink:

Denny Schlesinger

Right, I get it. Thanks Saul. And you’ve actually repeated the above many times on this board and I’ve read them all (GAAP vs Non-GAAP). So I apologies for being a bit thick and bringing it back up again!! GAAP makes them subtract share compensation from their bottom line twice.

So going by the adjusted net income for CRTO


Year                    2012      2013      2014     2015     2016
Adjusted income (k)     5,635     14,472    70,846   89,835   136,777
Diluted shares (mil)    48.6      53.7      63.5     65.1     65.6
EPS (adjusted)          0.11      0.27      1.12     1.38     2.09
**% growth                          145%      314%     23%      51%**

Okay thanks for the help. I’ll stop with CRTO now.

Some nit picking: It’s in the bag but not in the bank. Net income is not net cash flow. :wink:

I think it is a point worth nit picking, and one that has been picked before. In fact, I was looking for a prior post I thought I’d saved regarding this matter. Alas, I could not find it.

I like the idea of stock based compensation being accounted for in the denominator of the EPS equation (non-GAAP). It makes intuitive sense to me, and I thank Saul for pointing it out long ago.

However, the idea that stock based compensation increases cash flows makes zero sense to me. The company isn’t receiving any cash for giving away stock to employees. It can’t be used for anything. Yet, there it sits as cash on the books.

What am I missing?

Thanks,
A.J.

However, the idea that stock based compensation increases cash flows makes zero sense to me.

Hi AJ,

As I understand it, stock based compensation doesn’t “increase” cash flow. It’s the same argument as the one I presented above for Net Income. As you said, the cash is there on the books. It’s real. But GAAP wants you to reduce it by the amount of SBC. I often see people write “The Adjusted Cash Flow is $50 million, but $15 million of that is stock based compensation.” What that means, as I understand it, is that Cash Flow was $50 million in real dollars, but that the writer feels they should subtract the SBC from cash flow (although diluting the stock doesn’t reduce the cash the company added to their bank account).

Saul

However, the idea that stock based compensation increases cash flows makes zero sense to me. The company isn’t receiving any cash for giving away stock to employees. It can’t be used for anything. Yet, there it sits as cash on the books.

What am I missing?

The point you address is not what my nit pick was about. What you are missing is that the option gives the right to buy shares at a set price and, when they are exercised, the company does get cash.

Denny Schlesinger

BTW, I’ve said it again and again, expensing stock options is IMPROPER accounting. Stock option compensation is a deal between shareholders and employees with the company a passive entity in the deal. The only transaction the company should record is the sale of the shares when it happens. The proper way to report the options is in a footnote to the financial statements.

Accounting 101

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Right, so it has nothing to do with income from the actual business itself.
I’m going to use CRTO as an example again.

Their adjusted net income was, 137 million but they only actually received 87 million during 2016 from their business. That’s a difference of 50 million, of which 43 million was stock based compensation. So essentially they sold to their employees 43 million worth of stock, and added that to their bottom line. That amounts to a share count increase of approx. 1.5%

Taking it to extremes, you can have a company making 0 dollars in revenue and profit, have a hefty stock-based compensation scheme, and end up with a huge adjusted income. That tells you little about how the actual business is growing.

I’m assuming the answer is that this is just one of many features to consider and not to look at it in isolation.

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It appears there are some more nits to be picked. And once again, if this is beating a dead horse to some, please just skip over this. I still have questions.

Their adjusted net income was, 137 million but they only actually received 87 million during 2016 from their business.

Net income for CRTO was $87M. Stock Based Compensation (SBC) for that period was $43M. However, the stock based compensation expense was already taken out of the Net Income in the form of Operating Expenses. And since giving away shares really isn’t an expense, they really did make $87M + $43M = $130M. At least that is how I see it.

Now on to the cash question:

What you are missing is that the option gives the right to buy shares at a set price and, when they are exercised, the company does get cash.

Is this really the case? Are we to assume that CRTO employees paid the company $43M last year? That doesn’t seem plausible to me. If the company really is getting the actual cash from employees I can see putting it there the same way an IPO generates cash for a company along with any subsequent stock issuances. But I suspect this is not the case. I assume the vast majority of the $43M in SBC was simply “gifted” to employees.

Can anyone enlighten me?

Thanks,
A.J.

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When a company grants a stock option, no actual transaction takes place. It is simply a grant of a right for the employee to purchase shares at some future date and some price. The hope, of course, is that the shares are worth much more than the option price at that future date and the person gets a windfall and the company gets the option price. Many options expire worthless because the company is not worth the option price at the time the option matures.

However, the stock based compensation expense was already taken out of the Net Income in the form of Operating Expenses

Ahh yes. I just had to double check that and you’re right. Silly me.

So in this case, criteo does actually have that 43million in cash. They earned it from operating income. They issued 43million worth of outstanding shares, upon which sometime in the future the employees can buy and pay crto 43 million, and if they want to sell it immediately for whatever the market values the shares at that future time.

But does that mean the company gets another 43 million for the outstanding shares issued this year? That also doesn’t make sense, does it?
Sorry for banging on about this, just trying to get my head around it. Definitely clearing up a lot of areas for me so thank you all!

They issued 43million worth of outstanding shares, upon which sometime in the future the employees can buy and pay crto 43 million, and if they want to sell it immediately for whatever the market values the shares at that future time.

The shares issued generally vest over a period of time. But the employee does not have to pay for them. The cash is fictional IMO.

AJ

Are we to assume that CRTO employees paid the company $43M last year?

No.

I assume the vast majority of the $43M in SBC was simply “gifted” to employees.

It’s not a gift. If things go well, the company actually receives cash, and the employee
is rewarded for their hard work and loyalty by also pocketing some cash. Win, win.

Here’s a simple example. An employee, Joe, in return for all those extra hours he’s putting in,
is given the right – but not the obligation – to buy a set amount of shares at a predetermined
price for a specific period of time. For example, 100 shares at $48/share starting March 1, 2018 and
expiring March 1, 2019. If the market price on March 1, 2018 is $60/share, then Joe might want to
exercise his option at $48, but he’s not obligated to do so. He might wait to see if the price goes
up more. If he does exercise his option for $48 on March 1, 2018 and then sells his shares at $60,
the $4,800 cash would go to the company and Joe would pocket the $1,200 difference. The employee
really does have to pay for the shares – the “gift” (some would call it compensation!) is that
$1,200 difference Joe pockets. And the company really does get the $4,800 in cold, hard cash.

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If he does exercise his option for $48 on March 1, 2018 and then sells his shares at $60,
the $4,800 cash would go to the company and Joe would pocket the $1,200 difference. The employee
really does have to pay for the shares – the “gift” (some would call it compensation!) is that
$1,200 difference Joe pockets. And the company really does get the $4,800 in cold, hard cash.

Thanks, Ears. I realized that companies didn’t actually have to pay for SBC, but I guess I hadn’t realized that (at least if they do it in the form of options…I assume most do?) it is actually a cash generating event for the company. Thanks!

Bear

PS I guess this is a big part (all?) of why you see the “Additional Paid-In Capital” line growing each quarter on the balance sheet of for example, SPLK?

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I assume the vast majority of the $43M in SBC was simply “gifted” to employees.

Can anyone enlighten me?

What is “gifted” is two things: 1) no premium is charged for the options, and 2) the excess of the street price over the strike price of the optioned shares. Say you get 1000 shares with a strike price of $4 and they are selling for $10. Your “gift” is the $6 difference on which you have to pay income tax. The employee typically sells part or all of the shares to pay for them and to pay the tax.

If the company really is getting the actual cash from employees I can see putting it there the same way an IPO generates cash for a company along with any subsequent stock issuances.

Yup, more like a secondary, except they get a lot less cash than the going price of the shares which makes the option based compensation dilutive. This is why they then buy back shares to hide the dilution.

Denny Schlesinger

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Here’s a simple example. An employee, Joe, in return for all those extra hours he’s putting in,
is given the right – but not the obligation – to buy a set amount of shares at a predetermined
price for a specific period of time. For example, 100 shares at $48/share starting March 1, 2018 and
expiring March 1, 2019. If the market price on March 1, 2018 is $60/share, then Joe might want to
exercise his option at $48, but he’s not obligated to do so. He might wait to see if the price goes
up more. If he does exercise his option for $48 on March 1, 2018 and then sells his shares at $60,
the $4,800 cash would go to the company and Joe would pocket the $1,200 difference. The employee
really does have to pay for the shares – the “gift” (some would call it compensation!) is that
$1,200 difference Joe pockets. And the company really does get the $4,800 in cold, hard cash.

On this an accounting question. In my wife’s company she had the option of buying stocks at 15% discount to the the current market price up to 10% of her salary - vested for a period of few months. Whether to opt for this is completely on us. When we did opt for it, the salary was automatically deducted by that 10%. So if we opt for it how is the wage tread on the expense line for the company ? Would it be the same whether we opt for stock based compensation or not ?

For clarity - assume monthly in hand pay check is 5000 USD.

  1. When not opting for stock based compensation entire 5000 USD is an expense to the company.
  2. Assume she opting for 10% stock based compensation, so employee pays 500 of the 5000 USD for stocks. so the paycheck the employee gets is 4500, rest 500 stays vested in stocks.
    In this scenario:
    a) For the company is the expense line (before non-gaap earnings computations) still 5000 ?
    b) or will it be 4500 and the 500 company receives will be paid up capital will be accounted for when doing the non-gaap to gaap conversion ?
    c) My current understanding is expense line (before non-gaap) is still 5000, but 500 of 5000 goes to paid up capital. When going from non-gaap to gaap the gift portion (Market price - exercise price when option is granted to employee) is deducted as expense.

It would be good to have clarity on the above.

So far my approach has been look at adjusted EPS or adjusted net income year over over year, but also keep a watch on actual share count dilution (no of shares). For e.g CRTO dilution is approximately 5% annually over the years. I like to think of true adjusted growth rate as growth in net income - share count dilution rate. I think approach still holds regardless, but the accounting will add clarity.

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The company made Net Income of $136 million. It’s real dollars. It’s in the bank. It’s actual money. It’s still there.

This is a hard subject but as was pointed out - my understanding is that net income is a fiction. It isn’t real dollars, it isn’t money in the bank, it isn’t actual money. It is based on a series of accounting changes and it has little to nothing to do with whether ‘money in the bank’ is being made. With LGIH for example where up-front costs are the norm there are wide differences between ‘money made’ and ‘money reported’.

I think adjusted earnings are a joke for the most part. Stock based compensation is an expense (we can argue whether it is expensed correctly, but that is rarely worth exploring), though as noted it doesn’t have a cost and results in higher cash flow. So to me the answer is to track GAAP net income figures while also tracking cash flow from operations. You should also pay attention to how many shares are being purchased each year - and you ought to see if the share count is going down in a proportional manner (if not, they are giving your profits away to their employees and asking you to ignore this - this is nuts).

In CTRO case, I know zip about it, but there is a world of stuff to analyze. For example, they spent 235m in acquisitions last year, they did 85m in PPE and intangibles, they gave this and that share compensation (see note 19 in the 10K).

We can even count on the share count - there might be anti-dilutive shares not included at higher prices (there could be a bundle of them for all I know).

One more time: they made $136 million, real money, real dollars.

No, they didn’t.

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that didn’t come out right - I just meant I don’t think 136 is a number that mean something but opinions differ

again, a 2c look

In the past 3 years Criteo did 406m in CFFO, and 282m in acquisitions, and 209m in PPE and intangibles and had a ‘proceed from capital lease’ of 66m (no idea what this is but I mention it cause it is a big number).

So what did they earn over this period?

I have no clue…some things are too hard

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It’s not a gift. If things go well, the company actually receives cash, and the employee
is rewarded for their hard work and loyalty by also pocketing some cash. Win, win.

Thanks Ears. I don’t dispute your accounting knowledge. However, I think what you wrote is true for SBC via options only. Companies issue many shares of restricted stock that vest over time.

Take, for example, Amazon. This comes from someone I know who was recently hired. The highest base salary they pay is $200,000. Bonuses are granted at the end of the year in the form of stock. The stock is valued at, let’s say, $500. So, the company issues 10 shares to an employee. The employee records an additional $5,000 in income on which he/she has to pay taxes. Many times, employees will sell a portion of their stock to cover the tax hit.

However, there is another part. Since the shares are worth much more than $500, when the employee sells, he/she has to pay capital gains taxes on the difference in the stock price at the time of the sale and $500 per share.

The above puts this in context of the employee. But as you can see, in this example, the employee never pays the company squat and the company does not record any cash based on the issuance of shares (or shouldn’t record any cash).

Ears?

Thanks,
A.J.

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So what did they earn over this period?

I have no clue…some things are too hard

Deduct staring Total Stockholder Equity from ending Total Stockholder Equity adjusted for share count – if you trust GAAP which I don’t.

Accounting started out as a way for the owners to make sense of the business. Then it was mutilated by the government when they used it as the basis for income tax. Then they mutilated it some more when they capped the deductible executive pay promoting the stock based compensation tax loophole. Then they screwed it up some more with accelerated depreciation, and some more with merger goodwill, and some more with mark-to-market accounting, and some more with expensing stock based compensation and outstanding warrants to buy shares. What’s left of accounting is a bowl of overcooked spaghetti called GAAP. It’s not generally accepted, if it were there would be no need for adjustments to it.

GAAP is CRAP.

Denny Schlesinger
For what it’s worth, I studied accounting and practiced it.

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