PayPal And The Rewards Of Non-GAAP Accounting

When it comes to earnings, a bit of accounting can make all the difference.

The way Wall Street looks at earnings, and the way the average person might count earnings, though, are two different things. Let’s take the second scenario — what an individual might consider when examining the bottom line: money comes in, expenses are paid and what is left over is what is earned.

Not so on the Street, and especially not so with technology companies. The New York Times reported PayPal offers a prime example of how earnings can be presented in a positive light using selective counting of expenses, helping to keep shares on an uptrend.

The headline numbers show revenues were up 18 percent year-over-year, with $3.1 billion reported in the second quarter. The earnings, adjusted, came in at 46 cents per share, three pennies better than Street estimates. That “adjusted” figure is what makes all the difference.

On Wall Street, it seems, you can adjust numbers in a variety of ways to get things to look, well, positive, and “beating the Street” is often a management priority when it comes to publicly-traded companies.

The key element deserving of scrutiny here, the Times pointed out, comes with the way PayPal — and, to be fair, other tech companies — account for employee stock-based compensation. Stock grants are a key lure for employees, who dream of helping take a company public — and seeing their vested options grow in value with the ultimate aim of cashing out. If PayPal omits this item from its income statement, reported profits are higher than otherwise might be calculated.

The Times shared companies have been required to include such compensation as a way of doing business “for years,” and that such activity should be expensed. The implication here is that doing so would lower corporate profits. Nowadays, companies report for both generally accepted accounting principles (GAAP) and non-GAAP numbers, as mandated by the Securities and Exchange Commission.

Ostensibly, the onus is on the investor to choose which type of accounting they prefer to use — and which earnings — when assessing the financial snapshot of a company.

For PayPal, the impact is stark. The operating income line gets a big boost or a big hit, depending on how the aforementioned compensation is included. If GAAP is used, operating income came in at $430 million for the latest quarter, up 16 percent from a year ago. Not too shabby.

If using non-GAAP measures, the numbers shift to a more eye-popping $659 million, representing a 25 percent jump from last year. Stock compensation was an impressive $192 million this past quarter, up 57 percent from a year ago.

All of this comes against a backdrop where other tech firms are abandoning the GAAP/non-GAAP bifurcation. Among those firms are Alphabet and Facebook. As the New York Times put it, those two firms have said stock compensation represents a very real cost of operating a tech-centered business. PayPal stands in stark contrast to the duo, and to Visa and Mastercard, which do not take stock-based compensation out of their earnings equations.

One observer, Craig Maurer, a partner at investment research outfit Autonomous, estimated that the three cents more than Wall Street estimates may have had two cents of contribution by backing out stock-based compensation.

In addition, non-GAAP income includes calculating how payments for performance — bonuses — are calculated for employees and their managers. This means that the higher the non-GAAP income, the higher the rewards and, eventually, the higher the rewards, the higher the non-GAAP income. According to the Times, the circle is a virtuous one for the PayPal crew.