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August 18, 2008updated 19 Aug 2016 10:07am

Should you look at GAAP or non-GAAP?

Trend Micro accused us of writing a story that was “absolutely factually incorrect” because we said its second quarter profits dipped 40%. What’s irritating is that there was nothing wrong with our story whatsoever, but we pulled it down just in

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Trend Micro accused us of writing a story that was “absolutely factually incorrect” because we said its second quarter profits dipped 40%. What’s irritating is that there was nothing wrong with our story whatsoever, but we pulled it down just in case while we investigated. We’re in the process of putting it back up.

“Trend Micro doesn’t define net income as profit,” a spokesperson told me. “You said profit dropped 40% which is absolutely wrong: it was down only 4%.”

Well I’m sorry for being a spoil-sport, but CBR has always — and as far as I am concerned always will – gone on the net income figure when comparing profits. Trend Micro’s second quarter net income, in accordance with Japanese Generally Accepted Accounting Principles (GAAP) was down 39%, to be precise. Its CFO/COO Mahendra Negi even put the figure in his slide deck (see below)…[click continue reading for more on this story]…

Trend Micro’s quarterly operating income was down 4%. Operating income, of course, excludes little things like stock option expenses and the amortization of goodwill (usually related to acquisitions).

So why do we look at net income and not operating income, EBITDA or some other not Generally Accepted Accounting Principle measure? The biggest argument for comparing net income is for consistency. For the non-GAAP measures, companies can adopt their own little process to define what is and what is not included in their operating income or EBITDA figures. That makes comparison with other companies that may have a different approach to their non-GAAP metrics, unfair.

GAAP figures are comparable. The clue is in the phrase “Generally Accepted”.

The net income figure includes all the costs and charges incurred by the company in the period. Why should you not include the likes of stock option expenses and goodwill impairments in your analysis of a company’s net profits? A company can use acquisitions to bolster its revenue, and claim sales are up considerably as a result, but then it wants you to ignore the cost of that acquisition by not taking into account possible asset impairments related to goodwill?

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Taking that kind of approach benefits companies that make numerous or very large acquisitions because they get a sales benefit and gloss over the acquisitions costs where they can. That’s why, both US and Japanese Generally Accepted Accounting Principles (GAAP) insist that all costs are included in the final net income figure.

I don’t really like EBITDA, for that matter. Why not include interest, tax, depreciation and amortization in your analysis? By not including them you penalize companies that have not borrowed money and so are not hit by interest charges (the ‘I’ in EBITDA is for ‘interest’).

But the company that borrows money is able to include the fruits of that lending in its own sales figures? How is that fair and comparable? Depreciation and amortization (the ‘D’ and ‘A’ in EBITDA) likewise, are troublesome to companies that make large or numerous acquisitions. Why not include their impact in an analysis of earnings? They certainly include the effects of those acquisitions in their revenue figures.

Don’t just take my word for it – legalzoom.com explains quite well why you should look at GAAP figures and not just non-GAAP: “Without GAAP, companies would be free to decide for themselves what financial information to report and how to report it, making things quite difficult for investors and creditors who have a stake in that company.”

“Because financial statements prepared under GAAP are intended to reflect an economic reality,” the site added, “GAAP makes a company’s financials comparable and understandable so that investors, creditors and others can make rational investment, credit and other financial decisions. In order to be useful and helpful to users, GAAP requires information on financial statements to be relevant, reliable, comparable and consistent.”

I have no problem with shareholders or analysts wanting to compare operating income, as long as they know it is non-GAAP, which is why we often include this figure in our news, too. In fact in our Trend Micro story we said:

“Trend Micro Q2 Profit Dips 40% to $37m

Anti-virus software developer Trend Micro has reported a 39% decline in net profit to JPY 3.94bn ($37m) for the second quarter 2008, on revenue up 4% at JPY 26.12bn ($249m).

Operating income declined 4% to JPY 8.55bn ($81m) during the quarter. Cash and cash equivalents by the end of the quarter were JPY 67.30bn ($612m).

For the first half, the company reported a 26% decline in net profit to JPY 8.53bn ($78m) on revenue up 7% at 51.71bn ($470m). Operating income rose 4% to 16.89bn ($154m).”

If that is in any way misleading, then I fail to see how. But what is painfully clear, is that it is anything but “factually incorrect”.

Here’s the rest of our story: as you can see we gave the firm the chance to highlight the positive elements in the results:

“During the quarter, revenue from Japan rose 7% to JPY 9.89bn ($90m), while revenue from Asia Pacific declined 16% to JPY 2.33bn ($21m). North America sales grew 4% to JPY 6.57bn ($60m), revenue from Europe was up 9% at JPY 6.55bn ($60m), and Latin America sales declined 5% to JPY 772m ($7m). The company was awarded four US patents during the quarter.

Eva Chen, chief executive at Trend Micro, said: “It has been an exciting quarter for us. We recently announced our vision for fighting web threats with drastically new, in-the-cloud methods through the Trend Micro Smart Protection Network. Security vendors need to evolve alongside a changing threat landscape and Trend Micro is taking the lead in this evolution.”

Looking ahead to the third quarter, the company projects net revenue of JPY 26.40bn ($251m), and operating income and net income of JPY 7.6bn ($72m) and JPY 4.9bn ($46m), respectively.”

Below are Negi’s own figures: feel free to do your own comparison.

trendresults.jpg

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