1 Crucial Thing to Know About Micron's Guidance

Image source: Micron Technology.

After three consecutive quarters of reporting losses, memory chip manufacturer Micron Technology (NASDAQ: MU) expects to return to non-GAAP profitability next quarter. In October, the company reported results that were substantially above analyst estimates, driven by an improving market for memory chips. Micron's guidance for the fiscal first quarter calls for sequential revenue growth of 10% to 20%, reflecting continued improvements.

Micron expects to report non-GAAP EPS between $0.13 and $0.21 during the first quarter, down from $0.24 during the first quarter of last year, but still a major improvement over the losses of the past three quarters. Revenue will be higher on a year-over-year basis, which raises an important question: Why are earnings still set to slump? Investors should certainly be wondering why improving conditions aren't leading to higher profits.

This expected earnings decline despite higher revenue, while an important observation, isn't the key thing to know about Micron's guidance.

Accounting games

The thing about non-GAAP numbers is that companies have the freedom to define them any way they choose. How a company comes up with its non-GAAP figures needs to be disclosed, of course, but this fact can make comparisons difficult. Different companies may define the same number differently, or in Micron's case, a company may change the definition entirely.

Beginning in the first quarter, Micron is making two key changes to how it calculates non-GAAP earnings. First, Micron will begin excluding stock-based compensation and the amortization of acquisition-related intangibles from the calculation. This is pretty standard, especially among technology companies, but up until this point Micron has always included these expenses. On average, this change will reduce Micron's non-GAAP expenses by about $50 million per quarter.

I'm a big proponent of treating stock-based compensation as an expense in all situations, so this change is a bit of a disappointment. It makes Micron's non-GAAP numbers less meaningful, at least for those who agree with me on this point. Excluding the amortization of acquisition-related intangibles is a more reasonable move, as a strong argument can be made that it isn't a real expense.

Second, Micron is changing how it depreciates DRAM capital equipment. Going forward, the depreciable life will be extended from five years to seven years, which will reduce Micron's depreciation expense by approximately $100 million per quarter.

There's nothing wrong with making this adjustment. Micron claims that longer intervals between technology transitions is the driver behind the change, and I don't doubt that that's the case. This change will affect both GAAP and non-GAAP numbers, since depreciation is an expense in both cases.

Unfortunately for investors, these two changes make comparing Micron's guidance for the first quarter to its results from the first quarter of last year difficult. That modest earnings decline that Micron predicted is actually a lot bigger if these changes are backed out. Adjusting for the roughly $150 million that will now be backed out of Micron's non-GAAP expenses, guidance for first-quarter non-GAAP EPS would be between breakeven and $0.08, depending on the tax rate.

In other words, on a comparable basis, Micron expects its non-GAAP earnings to decline year over year by between 67% and 100% during the first quarter. That's despite an expected increase in revenue and an improving market for memory chips. For the next four quarters, until Micron laps these accounting changes, year-over-year comparisons will be similarly muddled.

Making sure that all comparisons are apples-to-apples is important.

In this case, Micron was able to provide what seemed like acceptable, albeit still disappointing, earnings guidance only by moving the goalposts. Investors should always make sure they move the goalposts back.

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Timothy Green has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.