GAAP vs Non-GAAP

[Cosmacelf]

I was struck by Elon's statement that they won't be GAAP profitable until 2020, and then his explanation in the recent quarterly report Q&A session. On a GAAP basis, they can't immediately recognize full revenue for leased cars, and they also have an overhang for the residual value guarantee. What this means in practice is that as long as car sales continue to increase significantly, they will never hit GAAP profitability.

Two things could change that, one is dropping the residual value guarantee and the other is creating a leasing subsidiary which would allow them to fully recognize leased cars as sales up front.

Either of these things would boost GAAP profitability, but neither would change the true underlying business profitability (which is why non-GAAP numbers paint a much truer picture of the company's financial position).

To the extent that analysts focus on GAAP and ignore non-GAAP, this would undervalue the company.

So, the naysayers in the press will focus on GAAP, but the true metrics to follow are non-GAAP profitability, and cash.

 

[adiggs]

I was struck by Elon's statement that they won't be GAAP profitable until 2020, and then his explanation in the recent quarterly report Q&A session. On a GAAP basis, they can't immediately recognize full revenue for leased cars, and they also have an overhang for the residual value guarantee. What this means in practice is that as long as car sales continue to increase significantly, they will never hit GAAP profitability.

Two things could change that, one is dropping the residual value guarantee and the other is creating a leasing subsidiary which would allow them to fully recognize leased cars as sales up front.

Either of these things would boost GAAP profitability, but neither would change the true underlying business profitability (which is why non-GAAP numbers paint a much truer picture of the company's financial position).

To the extent that analysts focus on GAAP and ignore non-GAAP, this would undervalue the company.

So, the naysayers in the press will focus on GAAP, but the true metrics to follow are non-GAAP profitability, and cash.

Completely agree, with one proviso. The nature of the term non-GAAP gives some people heartburn, and in other contexts, with good reason. The proviso is that as an investor, you need to keep an eye on what Tesla throws into the non-GAAP numbers and what they don't. Something Tesla COULD do (but hasn't that I've seen), is to start throwing inconvenient stuff into non-GAAP for really any reason they choose.

Personally, I follow the non-GAAP numbers as what they represent is, I feel, a better representation of the actual business. The GAAP principles for the auto industry, applied to Tesla, create a skewed view of the company that is beneficial to me in an extremely long position. I'm also aware that I need to stay up with how Tesla defines the non-GAAP numbers, as changes in how that's defined could also change my understanding of the business.

I realize that it's typical to exclude the share based compensation from the non-GAAP numbers. Excluding that non-cash expense is I feel misleading in understanding the business (no cash leaves the business, but the business is still diluting at very low prices for the shares that are sold to employees). But that particular difference in opinion between me and Tesla management is also an eyes-wide-open situation for me; I don't like it, but it's steady quarter to quarter, it's small enough, and I can allow for it.

My point is that the nature of non-GAAP, if Tesla isn't very careful to keep it as comparable as possible from quarter to quarter, is that it can become meaningless as a point of comparison quarter to quarter. I don't expect Tesla to make those choices (it'd be foolish of them to do so when they've been consistent to-date), but as long term investors it's a point that might be an indicator of the investment going sideways.

 

[SR22pilot]

Including options can potentially be misleading. I hate what FASB did to options accounting. They were worried about east coast practices and instead put a dagger into the heart of the Silicon Valley model. When options are given they have no value. Once exercised they are fully accounted for via stock dilution. Basically a company gets hit twice. The result was that companies stopped giving options to large segments of their employees. All FASB did was to strengthen the individual contributor vs. management divide. In the old model I saw companies where there was no divide. Everyone was working to drive shareholder value. I miss those days. It was a great working environment. Back on topic, you are correct that you have to watch non-GAAP closely. However, GAAP has so much meaningless crap in it that it paints an inaccurate picture and is pretty much useless. Shareholders generally want to know simple things like how much money you really have (liquid assets not buildings), how much are you spending, and how much are you making. Add in margins and you can generally tell where things are.

 

[adiggs]

I'm not an accountant, so I'd be one of those "Shareholders generally .." people you're talking about @SR22pilot. I did have an undergrad Financial Management course that taught me the rudiments of reading the various financial statements. Both of us continue to make a particular point that I'm hoping readers of this thread will pick up on:
- GAAP is a particular set of rules that need to be applied consistently. That's both their strength and their weakness, as there are businesses where the GAAP rules results in a misleading understanding of the business. (Gross simplification - I realize that there are all sorts of management discretion choices, even in GAAP, and an ability to manipulate quarterly results even here).
- non-GAAP IS NOT a particular set of rules. Rather it is an indication that the business is making up their own (hopefully meaningful) modifications to GAAP to provide a better understanding of the business. The important element here though is that the company isn't constrained to make the same set of modifications each quarter. There are very good business reasons to keep them consistent (like not alienating your shareholders), but there isn't a rule that they do so.

My point here is that if you're investing in Tesla, and you agree with Tesla that their non-GAAP numbers better reflect the business, then you should understand what changes Tesla has made and why for non-GAAP, and you should keep an eye on future non-GAAP definitions. Tesla isn't constrained from changing the definition in the future, and if they do change the definition, you need to know it and you need to be able to assess whether the incremental changes are better or worse for understanding the business.

 

[Cosmacelf]

Yes, a lot of disclaimers here. That's why I said to also look at cash position.

As far as FASB and their idiotic options accounting, I still cannot fathom how an accounting organization could mix a balance sheet item in with the P/L. It completely pollutes the P/L. If you are worried about future dilution from options, that's what the fully diluted EPS is for.

Anyways, my point still stands, look at non-GAAP and cash. For a fast growing company, and one with lease accounting that Tesla has, GAAP is fairly meaningless.