Non-GAAP Income Statement
How do you guys deal with non-GAAP adjustments? A lot of TMT companies give good disclosure in-terms of non-GAAP adjustments like non-GAAP COGS, R&D, SG&A, etc. so you can pretty easily put together the non-GAAP Income statement.
For companies that only give you a GAAP to non-GAAP net income reconciliation and maybe a GAAP NI to EBITDA bridge, would you still build a non-GAAP IS as detailed? Sometimes the footnotes in the PR and Ks/Qs don't give much detail so you can't segregate out the adjustments into the different expense buckets. Would you just have a non-GAAP adjustments plug line for a non-GAAP IS or would you just project out the GAAP to non-GAAP reconciliation table?
Short answer is make sure you understand the line items, and it depends on what you're trying to solve for.
If a company is reporting adj. EPS because amortization is primarily related to intangibles from previous acquisitions and is stuff like customer lists or relationships, then your adjusted number is going to better reflect the true economics of the business (and is going to be added back to your CF and so better captures CF potential anyways). I'd like to know what that EPS number is more than the GAAP. Know what is driving the adjustments, look at the historicals, and try to understand what is truly one off vs. recurring.
For TMT, the biggest adjustments usually relate to SBC, which is a contentious item when it comes to valuation. My sense is that at the end of the day, if you're in a pod, it probably doesn't matter, and if the street is going off adjusted (and its mostly SBC), you're going to end up using adjusted; there's no time for useless academic debates over the impact of SBC here...Unless of course we get into an environment where that debate re-takes center stage, or perhaps its such a large item that investors often discuss it, in which case you're going to end up incorporating that in your analysis.
So I guess there are two elements, between 1) the pure modeling of GAAP vs. adj, and 2) how to interpret the numbers in your valuation/stock analysis process. But for the pure modeling aspect, it shouldn't be difficult to discern from historicals and commentary the size and recurring nature of some adj. figures. Generally, if it is likely to be recurring and is "estimatable" or there is guidance given off of it, it is worth including in your modeling because you'll be likely to get closer to the true company adj. EPS print. At the end of the day, if your adj. number is off, but your key driver beat/miss is right (topline + "cleanish" margin/"true" margin), you're probably going to be more right than wrong (rather than missing the bottom line adj. figure). For #2, it gets into what kind of fund / strategy you are in, investment philosophy, etc. For the most part, it always comes back to what is the cash flow power going to look like LT for a business, and these ST results are reinforcing a view one way or another, so you have to translate what GAAP + adj. figures say about this, more than any 1 quarter's line item.
Generally when you build the model, you build to non-GAAP if its going to be the "better" measure / what investors are looking at, and then have the GAAP reconciliation table below if its important to capture the individual adjustments, esp. if one-off items are different but still recurring in nature (if that makes sense?). There should be thoughtful reasoning behind every forecasted input.
Thanks for the detailed answer!
In terms of the purely mechanical part of the making the adjustments/building the model, if the company doesn't give non-GAAP adjustments for every line-item but just a reconciliation from GAAP to non-GAAP EPS and GAAP EPS to adj EBITDA, would you have two separate income statements, or would you just have the GAAP income statement with the added in non-GAAP EBITDA and EPS that feeds in from the reconciliation you continue to project out?
Some companies are obviously better at giving you granular adjustments, so you can construct a full non-GAAP income statement, but it seems like many just give you the reconciliation table and you can't always know which line items include which parts of the reconciliation.
There is always an explanation for the adjustments - maybe its because I primarily operate in mid-cap to large-cap space, but they should explain what the items are... Is the issue that you can't attribute it to like COGS vs. SG&A vs. R&D lines (whereas with TMT, they often bucket the SBC attributable to each line?)
Again, it depends on what you want to solve for, what numbers provide the most utility, and what stuff you want to look at. You can do Non-GAAP, and then below that, you can include a recon table where it just includes lines like "provision for xyz; restructuring exp; good will and intangible blah; income tax effects". A lot of those you're never going to be able to forecast, and it might be straightlined 0s, so there is room for the reported GAAP #s as you update each quarter, but you are primarily solving for an adj. figure because that's what mgmt. guides to and it better captures "recurring" or "cash" EPS or whatever.
Other times, you may want to do a full GAAP and full non-GAAP (potentially biz w/higher SBC like an INTU or ADBE)
Yeah, that's exactly the issue. SBC can't be split up between COGS, SG&A, and R&D and then a few other adjustments where some you can tell which cost line they belong to and some are in multiple lines or unclear, even after looking through the footnotes and filings.
In cases like the above, I'm guessing you would do what you mentioned in the first paragraph, and you just project everything GAAP, and then have the reconciliation below and project the lines that are recurring in there to get adjusted numbers?
Other way around. Project non-GAAP (remember, IF that is what we care about, and its what management is likely guiding to, and better captures the stuff I said before). Then below you recon to GAAP. If you notice line items are recurring more often than not, are significant, and are real cash expenses, that may lead you to question things about the usefulness of the adj. #s tho
You're no going to attribute some of these expenses to COGS or SG&A etc. in an adjustment because these are "non-operating" adjustments (maybe), but we want to model the underlying economics of the business so we can better look at the underlying/operating drivers in the past, and better forecast them going forward.
Doloribus aut maxime ea non. Qui et in eaque incidunt voluptatibus. Omnis ut animi assumenda. Rerum nobis maiores ut maxime.
Hic eaque dolorem ducimus voluptas enim laudantium. Rerum rem eum sit explicabo.
Ut veniam dolores rem. Praesentium laborum sapiente fugit voluptatum eveniet id. Ea minus ipsam maiores deserunt. Et itaque eius quia incidunt voluptatem dolorem. Molestiae quia qui voluptatum magni et reprehenderit et. Eligendi voluptatem et expedita quis explicabo sit enim.
Nemo consequatur qui ut quasi aut in. Fugit quis temporibus tenetur enim et. Sit molestias dolore dolorem pariatur reiciendis. Molestiae dolor consequatur architecto dignissimos nam nam enim.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...