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Gap between GAAP and non GAAP Earnings

By CrossProfit

Lately more and more companies are reporting non GAAP earnings along with the standard required GAAP earnings. The trend is accompanied with statements like 'we provide non GAAP earnings to give a better picture of our operations' or 'management feels that the non GAAP figures better reflect our financial position'. A half truth is sometimes worse than a lie.

The reason GAAP (generally accepted accounting principles) is required is so that a true peer to peer comparison can be applied. Imagine for a moment, that every CFO decides on his or her own what goes into a P&L statement or balance sheet. Chaos would be a mild understatement. At first, non GAAP figures veered from GAAP figures by excluding only the true cost of issuing shares as a form of compensation. Now, some companies exclude acquisition expenses as well. This enables companies to produce figures that show revenue growth and EPS growth, without accounting for costs and how that growth was achieved.

Non GAAP = NAAP = Not Acceptable Accounting Philosophy

In the past, Enron hid expenses and we all know how that ended. Likewise today, companies are deluding themselves, or should we say - are misleading investors, claiming that the non GAAP figures give a clearer picture of the company. They do not.

As an investor, you do want to know how much the company pays out to top management. There is no difference between a salary paid to the cleaner and the salary / stock options or other compensation that was paid to the CEO or CFO. This is an expense, a cost, money and value that has left the company. Whether or not you agree with the compensation package is irrelevant and is a totally different issue that is facing investors.

Recently, one company in particular, posted a 56% increase in revenues YOY (year over year) yet their GAAP EPS was $0.13, the same as in the first quarter of 2006. The company stressed the non GAAP EPS increment! There was no mention in the non GAAP statement that a $600K increase YOY wasn't from ongoing operations but from interest on investments. The company insists that the non GAAP figures show a clearer picture of operations! With non GAAP, anyone can spin the figures anyway they want, there are no rules and the sky is the limit. As time goes on, CFOs' are testing the tolerance level and are showing more chutzpah.

Another company posted yesterday after the bell a GAAP loss. The company emphasized the minuscule non GAAP EPS profit. What is mind-boggling is that this particular company has not been profitable for eleven years. What the company left out was that they may have to issue more stock six months down the road to cover acquisition and other costs. Once again, the company will report an increase in non GAAP earnings while the GAAP earnings will remain flat. In order to maintain the façade, the company has to continuously acquire more assets. Here as well the company boasts a tremendous increase in revenue and client count, yet in reality the company is still losing money for shareholders. In this particular instance, there is no way that they will post a real profit in 2007.

For all intents and purposes, GAAP earnings are the true earnings, not the other way around.