Lesson 7 of 10
Segment reporting and non-GAAP
The segment note in Item 8 shows the business as management runs it. The non-GAAP reconciliation lists what management wants excluded.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A group margin that barely moves can hide one segment losing its entire margin while another carries it.
- A company re-cutting its segments restates the past, so two defensible series exist for the same years and they disagree.
- A non-GAAP reconciliation is a list, written by the company, of everything it would rather you ignored, and the list is worth more than the total.
Two disclosures take a company's consolidated figures apart. The segment note, inside Item 8, shows the business the way management runs it. The non-GAAP reconciliation, in the earnings release and often in Item 7, lists the adjustments management would rather you judged it by.
From the reported margin to the headline
- Reported, GAAP20.0%
- Litigation settlement, once+1.5%
- Restored, recurring costs counted= 21.5%
- Share-based pay, every year+6.0%
- Restructuring, every year+2.5%
- Acquired-intangible amortisation, every year+4.0%
- Headline, adjusted= 34.0%
Margins for each part
Under ASC 280, operating segments are reported the way the chief operating decision maker reviews them: the parts management actually uses to allocate resources and judge performance. It is the only place a reader gets a margin for part of a company. Since ASU 2023-07, effective for fiscal years beginning after 15 December 2023, the note also lists each segment's significant expenses. That lets a segment margin be taken apart line by line.
Which past do you use?
When a company re-cuts its segments, the current filing restates the comparative periods onto the new definition, leaving two defensible series that are different numbers. The first is the series as originally filed each year, discontinuous where the definition changed. The second is as restated in the latest filing, consistent but usually running back only two years. Neither is right in general. State which one you used, and never splice them, because a splice hides a definitional break inside what looks like a trend.
Segment profit is also measured the way the chief operating decision maker measures it. That need not match operating income as the income statement defines it, so segment profits do not always sum to the consolidated figure.
Non-GAAP: the reconciliation beats the total
Regulation G and Item 10(e) of Regulation S-K require a non-GAAP measure presented to the public to be reconciled to the most directly comparable GAAP (Generally accepted accounting principles: the US rulebook every filed statement follows.) measure, and forbid giving it greater prominence. The practical effect is the most useful table in an earnings release: a list, written by the company, of everything it would prefer you ignored.
A cost that appears every year is a cost. Share-based compensation is compensation whether or not a headline excludes it. Restructuring booked every year is a cost of running the business too. Amortisation of acquired intangibles is the write-off of a price somebody paid. Excluding it while keeping the acquired revenue reports the benefit of a deal without its cost.
Restore the three adjustments that appeared in each of the last three years and 34.0 percent falls to 21.5. That is 1.5 points above the 20.0 percent reported, because only the litigation settlement happened once.
Check yourself
A company's non-GAAP operating margin is 34 percent and its GAAP margin is 20 percent. What does the 14-point gap tell you on its own?
- That the company is manipulating earnings
- That the GAAP figure must be wrong
- Nothing, until you check whether the adjustments recur
Show the answer
Answer: C.
A gap is a list of adjustments, not a verdict. Checking which of them appeared in each of the last three years is what turns the list into information.A segment note restates last year's figures under a new definition. Which series is the correct one?
- The restated one, always
- The originally filed one, always
- Neither on its own; state which you used and never splice them
Show the answer
Answer: C.
Both are defensible and they disagree. Splicing them puts a definitional break in the middle of a series and calls it a trend.Under Regulation G, what must accompany a non-GAAP figure a company publishes?
- Nothing, disclosure is voluntary
- A footnote from the auditor confirming it
- A reconciliation to the most directly comparable GAAP measure
Show the answer
Answer: C.
Regulation G and Item 10(e) of Regulation S-K require the reconciliation and forbid giving the non-GAAP figure greater prominence than the GAAP one.Sources
- ASC 280, Segment Reporting: operating segments reported as the chief operating decision maker reviews them.
- ASU 2023-07, Segment Reporting (Topic 280), effective for fiscal years beginning after 15 December 2023: significant segment expense disclosures required, including for single-segment public entities.
- Regulation G and Item 10(e) of Regulation S-K: a non-GAAP measure reconciled to the most directly comparable GAAP measure, never given greater prominence.
What this leaves out
- A company with one reportable segment shows no margin for any part of itself. For fiscal years beginning after 15 December 2023, its segment note still lists the significant expenses its chief operating decision maker reviews.
- There is no standard definition of an adjusted earnings figure, so two companies in the same industry can adjust for different things and both comply.
- The worked examples use round invented numbers so the arithmetic can be checked by hand. Nothing here is advice about any security.