Successful companies don't need to flatter their profits with generous adjustments to impress investors. Nvidia took longer to figure this out than it should have, but at least now it is taking the high road.
The chip maker last week said it would no longer exclude stock-based compensation expense from its nonstandard financial metrics, starting with the current quarter. The decision leaves Tesla as the only Magnificent Seven company still clinging to the practice.
Nvidia's decision is a welcome move, and means the adjusted profits that it highlights will be more in line with the results it reports under GAAP accounting. Coming from the world's most valuable company and the dominant leader in artificial-intelligence computing, Nvidia's move will add pressure on other stragglers to follow. But at other companies, especially specialized software makers, a change in direction won't be so easy. If investors stopped accepting their earnings adjustments, some would be revalued as loss-making businesses.
For Nvidia, the impact of including stock-based pay is relatively modest. Last fiscal year, it reported $120 billion of net income, which included just $6.4 billion of stock-based pay. But for the software sector, these costs are a much bigger deal.
Snowflake excluded $1.7 billion of stock-based pay last fiscal year from its nonstandard earnings measures. That helped transform its $1.3 billion net loss under generally accepted accounting principles into a $466 million non-GAAP profit.
CrowdStrike, the cybersecurity company, reported non-GAAP earnings of $957 million for the fiscal year ended Jan. 31. But that ignored $1.1 billion in stock-based pay and shifted attention from what was actually a $163 million net loss.
Much of the software sector is under threat from new tools by AI developers such as Anthropic, Google and OpenAI. When times get tough, more investors start demanding straight talk and less spin.
Broadcom, which reports earnings on Wednesday, still excludes stock-based pay from its non-GAAP results. The chip maker and software provider reported $23.1 billion of net income last year and $33.7 billion of non-GAAP earnings. The difference in large part came from excluding stock-based pay. Other software companies that boost their nonstandard earnings this way include Adobe, Intuit, Palantir, ServiceNow, Salesforce and Workday.
Nvidia's shift comes as public debate has turned to the cash costs of employee stock awards. While Nvidia reported $6.4 billion of stock-based pay for its income statement last year, it paid out $7.9 billion in cash withholding taxes that became due when employee shares vested.
To satisfy the taxes, Nvidia withholds a certain number of shares from the employee. But instead of selling the shares to raise cash for the tax bill, it pays the taxes from its own cash on hand, which limits dilution.
Nvidia has been paying a success tax, in essence. Stock-based compensation expense on the income statement is measured using grant-date values, while withholding taxes are determined using share values on the vesting date. Nvidia's stock price has soared in recent years, and so the vesting-date values were much higher.
None of those cash tax payments counted in earnings. They also weren't included in cash flow from operating activities or free cash flow, because the amount was classified on the cash-flow statement as a financing activity. The same was true for share repurchases.
Nvidia last year spent about $40 billion on stock buybacks. That included an estimated $15.5 billion on buybacks to offset dilution, which can be derived from Nvidia's equity statement even though it isn't expressly disclosed.
Last year Nvidia issued 160 million new shares of common stock, virtually all for employee stock programs, but withheld 51 million of them to cover employee taxes. That left a net increase of 109 million newly issued shares. All told, that means 39% of the total 282 million shares that Nvidia repurchased were needed merely to neutralize the dilution from the newly issued shares.
Nvidia reported about $97 billion of free cash flow last fiscal year, the result of $103 billion of operating cash flow minus $6 billion of capital expenditures. However, the cash costs tied to employee stock programs consumed about $23 billion, or 24%, of free cash flow.
The net effect: Nvidia can afford to dial back its earnings spin, because the expense on its income statement for stock-based pay is incidental compared with its true economic cost. Its booming revenue also helps, of course. But for many other tech companies, it would be a crushing blow if they had to abide by the same policy choice as Nvidia.
