SSYS Down -27% in AH trading

This is a classic example of how management’s presentation of non-GAAP earnings can be grossly abused.

GAAP net income was a loss of between $116 and $129 million. The non-GAAP net income number management hopes you look at was a profit of $102 to $105 million. So taking the mid-point of the ranges, the difference between non-GAAP and GAAP net income is a swing of around $224 million. What gives?

Well, it must be stock based compensation, right? Not really. Stock based comp is only $30 million of the $224 million difference. So what else is in there? A goodwill impairment charge of between $115 and $125 million. What is this? It means that management overpaid in previous acquisitions by between $115 million and $125 million and booked the overpayment as goodwill i.e. intangible assets. Since the cash and/or stock used in the acquisition was for the purchase of assets, nothing was expensed at the time. However, management is now saying that the acquired assets aren’t worth nearly what management paid, so management has to book a goodwill impairment and asset write-down of between $115 million and $125 million. This is management admitting that it took up to $125 million and essentially lit it on fire. But management didn’t have to record this as an expense when the acquisitions were made, and now management is backing out the write-down for its non-GAAP net income. This is management saying, “We wasted $125 million of your money, but please do not look at our GAAP earnings number where this expense is reflected. Please look only at our non-GAAP net income WHERE THIS EXPENSE WILL NEVER, EVER SHOW UP.”

OK, so we’ve covered around $155 million of the $224 difference. What else? There is also “intangible assets amortization expense” of $81 million that management is asking you to pretend does not exist. When a company buys fixed assets, GAAP allows management to spread the expense of the asset over a period of years (the asset’s useful life) instead of recording the full expense in the first year. This is called depreciation expense, and I don’t think even the most ardent GAAP detractors would go so far as to say that depreciation should be excluded from net income calculations. Well, the same thing exists for non-acquisition intangible assets, and instead of depreciation it is called amortization. So management used cash today and is allowed to spread the cost of the purchase over a series of years (this is the amortization expense). For its non-GAAP earnings however, management is asking you to pretend that this expense does not exist either. I should say that I have not reviewed the SEC filings for SSYS, so there could be something more going on here. But at first glance, it does not pass the smell test.

Oh, and there’s another $28 million of merger related expenses that management has backed out of its non-GAAP earnings. Management is saying that these expenses aren’t really business expenses, but rather one time expenses related to a merger or acquisition and therefore shouldn’t be included in “normal” earnings. I don’t follow SSYS, so I don’t know if this is legit or not. 3D Systems, SSYS’s major competitor, buys multiple companies each quarter. If their management team tried to back out merger-related expenses as “one-time events” it would be ridiculous.

So, to recap, we have over $220 million of items that are included as expenses in GAAP net income that management would have you ignore for its non-GAAP net income, of which only $30 million is stock based compensation. And of course these items that management excludes in its presentation of non-GAAP net income swing the quarter from a net loss to a net profit, allowing management to say “No, don’t look at our GAAP numbers which indicate a large loss, look instead at our non-GAAP numbers which show an amazing profit. Aren’t we a great management team?”

Moral of the story is that even if you’re fine with management backing out stock based comp to get to adjusted earnings, you should never assume that the only difference between your company’s GAAP and non-GAAP results are adjustments for stock based comp. This is a great example of how there can be WAY MORE than just stock based comp adjustments. And you would never know it unless you did the analysis I did above. That’s my problem with non-GAAP numbers - you just never know what deviations from GAAP are being presented in those non-GAAP numbers from company to company. At least GAAP is consistent for all companies, even if flawed.

I am not a shareholder in SSYS, but if I were, I’d have real trouble with a management team asking me to ignore $125 million impairment write-downs and $80 million of amortization expense. And as for the question of which set of numbers, GAAP or non-GAAP, presents a more true picture for SSYS? The GAAP numbers do, and it’s not close on this one.

Fletch

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