Companies in the course of the business will build up tax assets that can be used to offset GAAP income. These can be loss carry-forwards, R&D credits and book/tax timing differences, such as accrued liabilities etc. Now, these “assets” don’t have an infinite shelf life. If you do not produce GAAP profits, you lose them ((case in point salesforce.com, inc. (NYSE:CRM)).
From the earnings call (emphasis mine):
Turning to earnings. Our GAAP results this quarter include the impact of a onetime, noncash charge of $149 million to establish a valuation allowance against our federal and state deferred tax assets. As a result, we posted a third quarter GAAP loss per share of $1.55. While this is a noncash item and excluded from non-GAAP results, I just want to provide some context.
Deferred tax assets on the balance sheet represent the value of tax deductions and credits to offset future tax liabilities. These assets include net operating loss carry-forwards, R&D credits and book/tax timing differences, such as accrued liabilities. U.S. GAAP requires companies to regularly assess the realizability of deferred tax assets by evaluating certain criteria. These criteria include whether the company has a cumulative 3-year historical pretax GAAP loss, as well as the timing and likelihood of near-term GAAP profitability.
After performing this analysis in Q3, we determined that a valuation allowance was required as near-term realization of these assets is unlikely. But just to be clear, our deferred tax assets have expiry dates many years into the future. And so we do anticipate being able to use these assets at some point to offset perspective tax liabilities.
The 10Q said it just a bit differently (pg 28):
The Company regularly assesses the need for a valuation allowance against its deferred tax assets. In making that assessment, the Company considers both positive and negative evidence related to the likelihood of realization of the deferred tax assets to determine, based on the weight of available evidence, whether it ismore-likely-than-not that some or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, the Company considers its cumulative loss in recent years as a significant piece of negative evidence. As a result, in the third quarter the Company determined that the negative evidence outweighed the positive evidence as of October 31, 2012 and recorded a one-time, non-cash charge to income tax expense in the third quarter of fiscal 2013 in the amount of $149.1 million to establish a valuation allowance against a significant portion of its July 31, 2012 deferred tax assets balance. Additionally, the Company recorded $25.9 million related to the quarterly change in the valuation allowance for the three months ended October 31, 2012.
Salesforce is telling investors not to expect a GAAP profit in the near future (I’ll say at least two years). This is essentially due to the massive stock options/awards they grant management and the fact they are barely profitable ignoring this. But that is a post for another day. As they rush to cash the option/grants in (in many cases now 4 years before expiration), it is a cost to shareholders. CRM would prefer to pretend it isn’t an expense to shareholders and omit it by focusing on “non-GAAP”. We should note here that it was not always that way. When the company was reporting increasing GAAP EPS they were more than happy to report GAAP income and made no mention of non-GAAP (from 2009). It was only when earnings began falling on a GAAP basis (the next earnings release when the gave FY2011 guidance) they decided they’d better find another way to report EPS. Thus the birth of their non-GAAP metrics. It is often referred to by the technical term “putting lipstick on a pig”.
I’ll let Buffett explain: “If stock options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And, if expenses shouldn’t go into the calculation of earnings, where in the world do they go?”
Now, GAAP disagrees with salesforce.com, inc. (NYSE:CRM and says they are an expense and this is why salesforce.com, inc. (NYSE:CRM has not turned a profit since June 2011 and according to what they say above, has no plans to anytime soon. If they did think they would, there would be no reason for the “substantial” (their words) deferred tax asset write down.
Here is their reasoning:
Salesforce on the use of “non-GAAP” measure in net income (pg 50 10Q): (click to open 10Q)
We define non-GAAP net income as our total net income excluding the following components, which we believe are not reflective of our ongoing operational expenses. In each case, for the reasons set forth below, we believe that excluding the component provides useful information to investors and others in understanding and evaluating the impact of certain non-cash items to our operating results and future prospects in the same manner as us, in comparing financial results across accounting periods and to those of peer companies and to better understand the impact of these non-cash items on our gross margin and operating performance. Additionally, as significant, unusual or discrete events occur, the results may be excluded in the period in which the