The enterprise cloud computing company Salesforce (CRM) reports quarter ending January 2013 earnings on Thursday, February 28, after market close. I'll preview the details in a later post. Cloud visionary CEO Marc Benioff is once again expected to report a GAAP loss and Non-GAAP earnings.
This GAAP / Non-GAAP divergence has been occurring for years, as it does with other companies. However, please note that not all companies report Non-GAAP. Some report only GAAP [e.g. Apple (AAPL), Microsoft (MSFT), Rackspace (RAX)]. Usually the most common and material differences in Non-GAAP and GAAP are employee stock incentive plans and amortization of intangibles such as goodwill.
The issue I have with Salesforce is a Non-GAAP profit and a GAAP loss with increasing items to reconcile. The GAAP EPS dropped to $0.00 for the quarter ending April 2011, then to a loss for July 2011. A GAAP loss per share has subsequently been reported for 6 consecutive quarters. The divergence has, on average, generally increased. What's going on here? Should investors be concerned?
As can been seen in the chart below, the core operations Non-GAAP earnings per share have been consistent. The GAAP loss per share and divergence from Non-GAAP earnings per share speaks for itself. The quarter ending January 2013 estimate is management's outlook midpoint: an estimated Non-GAAP earnings per share of +$0.39 and an estimated GAAP loss per share of -$0.24.
For the 7 quarters ended October 2012 (from April 2011) the averages have been:
GAAP Loss per Share -$0.26
+ Stock Based Expenses +$0.49
+ One-Time Tax Charge +$0.14
+ Amortization of Purchased Intangibles +$0.13
+ Amortization of Debt Discount +$0.03
+ Quarterly Change in Valuation Allowance $+0.02
- Income Tax Effect of Non-GAAP Items -$0.20
= Non-GAAP Earnings per Share $0.35
These items above are causing this divergence in Non-GAAP earnings per share and GAAP loss per share. The components of this difference, the reconciling items, are charted below. Most of these adjustments are recurring items. Two new items were reported for the latest quarter October 2012: a One-Time Tax Charge and a Quarterly Change in Valuation Allowance which are related. The Quarterly Change in Valuation Allowance is a new and yet another recurring item.
Frankly, after being an auditor for over 30 years, the more reconciling items the more suspicious I become. However, the Non-GAAP versus GAAP game is open for all to play, especially including management. In fact, management has enough leeway to define their very own version of Non-GAAP for reporting purposes. That is, tout the Non-GAAP earnings and ignore the GAAP loss. CEO and CRM promoter Benioff is adept at this gamesmanship in the quarterly earnings calls and ongoing conferences (analysts, DreamForce, CloudForce, technology, etc. to ad nauseum). Let the Games Begin!
For the latest quarter October 2012, these two new material items appeared and boosted Non-GAAP earnings per share: a +$0.99 "One-time Tax Charge" and a +$0.17 "Quarterly Change in Valuation Allowance". These items are based on management's judgment, and creativity, and increased the Non-GAAP earnings. For the sake of some brevity for this article, these "Non-GAAP Financial Measures" or exclusions are defined and explained by Salesforce in the prior quarterly earnings press release here beginning on page 4.
Amortization of Purchased Intangibles, usually Goodwill, is not necessarily a bad thing and can actually be pointless. Goodwill is basically the premium paid for the acquisition of a company. The fair market value of Goodwill is dynamic, not a static accounting balance being amortized. So, if the acquisition is astute, the fair market value of Goodwill could increase and amortization of same is pointless. However, if the acquisition is a blunder, the fair market value of Goodwill could decrease to possibly even $0. All or a portion of the Goodwill may eventually be charged-off as an impairment. The HP (HPQ) acquisitions of Compaq and Autonomy are recent examples of subsequent huge impairment charge-offs of Goodwill. So I will give Salesforce this Amortization of Purchased Intangibles as an acceptable exclusion from Non-GAAP earnings per share which is averaging +$0.13 per share per quarter.
That leaves Stock Based Expenses as a material recurring item excluded from Non-GAAP earnings per share. This too is a common practice, especially with technology companies I cover. These are stock incentives given to CEO Benioff, officers, and employees of Salesforce. The argument is, and I agree, that being a stakeholder changes your perspective and motivation compared to being just a salaried employee. Of course, the issue is how much should these stock incentives be because the outside shareholders are seeing their share holdings diluted and their share of earnings decreased. How expensive should the incentive plan be? Should insider incentives be allowed if a GAAP loss results?
Stock Based Expenses have been averaging $+0.49 per share per quarter since April 2011. Considering Salesforce has not made $0.49 per share in a quarter during this time period, this means all Non-GAAP earnings from core operations have essentially been given to CEO Benioff and other insiders. For the outside shareholder, that means $0 in earnings has been reserved for you.
For perspective, as of this writing, Salesforce had approximately 140+ million shares outstanding. Per the SEC Form 10-Q filed November 28, 2012, for the quarter ending October 31, 2012, the number of shares reserved and available for future issuance under a variety of stock incentive plans was 35+ million or just under 25% of existing shares outstanding.
So what is my point? A significant amount of shares are being reserved and ultimately issued to and sold by insiders per SEC Form 4 and other filings. Therefore, the GAAP earnings per share is actually a good measure of what earnings are being diverted to management and directors. The GAAP data is a better measure for outside investors such as you and me as to what our earnings or loss is. A long position taken by you may well be a purchase from an insider who is exercising his share incentives at a very low cost or basis and reaping the rewards.
This is not a criticism of the quality of Salesforce cloud operations or ability to turn a profit. I am giving you my perspective of the incentive and enrichment structure designed by insiders and provided to insiders. That is, the Salesforce operation is first and foremost to enrich the insiders. To enable this enrichment the stock must be pumped and your greed excited via the Non-GAAP financial results, which are not for the outside investors. The GAAP financial results more accurately report your position as an outside shareholder.
I have traded CRM stock in the past as a long and realized a gain. You may trade CRM stock now or in the future as a long and realize a gain. Just be aware that GAAP financial results are there for you to review and consider long-term plus reveal some risk. That is, the longer the GAAP losses persist, the higher the risk for outside investors as in no company financial resources left for you. The insiders' basis, their actual cost, in CRM stock is very, very low. They can survive a plunge in stock price. Can you?