Acquired core eps

What Is Acquired Core EPS?

Acquired Core EPS refers to a non-GAAP financial measure used by companies to present their earnings per share after adjusting for certain expenses and impacts specifically related to mergers and acquisitions (M&A). As a metric within financial reporting, it aims to provide a clearer picture of the acquiring company's ongoing operational profitability, excluding one-time or non-recurring costs associated with integrating a new business. Companies often disclose Acquired Core EPS in their financial statements alongside their Generally Accepted Accounting Principles (GAAP) Earnings Per Share (EPS), believing it better reflects the true performance of the combined entity. These adjustments typically remove the immediate accounting complexities and non-cash charges that arise from a Business Combination.

History and Origin

The concept of "core" or "adjusted" earnings gained prominence as companies sought to present financial results that they believed more accurately reflected their underlying operating performance, often distinguishing it from the strict application of Generally Accepted Accounting Principles. Following a significant Mergers and Acquisitions (M&A) wave, particularly from the late 20th century onwards, the financial impact of business combinations on reported GAAP earnings became increasingly complex. Accounting standards, such as ASC 805 in the U.S. (covered in detail by resources like Deloitte's overview of Business Combination.⁶), mandate specific treatments for acquired assets and liabilities, often leading to charges like Amortization of Intangible Assets or contingent consideration adjustments that do not represent ongoing operational cash outflows.

This led companies to introduce supplemental, or Non-GAAP Financial Measures, like Acquired Core EPS, to articulate what they considered their "true" earnings power post-acquisition. Regulators, including the U.S. Securities and Exchange Commission (SEC), have since issued guidance to ensure that these non-GAAP measures are not misleading and are reconciled to their most directly comparable GAAP counterparts. The SEC's final rule release on non-GAAP financial measures outlines these conditions for public disclosure.⁵

Key Takeaways

• Acquired Core EPS is a non-GAAP metric that adjusts reported earnings to exclude specific items related to mergers and acquisitions.
• It aims to provide insights into the recurring profitability of the combined business by removing one-time or non-cash acquisition-related charges.
• Common adjustments include the Amortization of acquired Intangible Assets, integration costs, and changes in the value of contingent liabilities.
• Companies present Acquired Core EPS to help investors assess the operational performance of the core business, separate from acquisition accounting complexities.
• While offering a different perspective, it requires careful scrutiny as management has discretion over which items to exclude.

Formula and Calculation

Acquired Core EPS is not a universally standardized formula but rather a customized calculation derived by adjusting GAAP Earnings Per Share. The general approach involves starting with GAAP net income and adding back expenses or impacts that management deems non-recurring or non-operational due to an acquisition, then dividing by the diluted share count.

A typical adjustment might look like this:

Where "Acquisition Adjustments" commonly include:

• Amortization of acquired Intangible Assets: When a company acquires another, it often records identifiable intangible assets like customer relationships, patents, or brand names. These assets are then amortized over their useful lives, creating a non-cash expense on the Income Statement. Companies often exclude this to show earnings without the impact of acquisition-related amortization.
• Acquisition-related costs: These are direct costs incurred during the acquisition process, such as legal fees, advisory fees, and integration expenses. These are typically one-time costs.
• Fair value adjustments: Revaluation of acquired assets and liabilities to fair value under purchase accounting (ASC 805) can create non-recurring gains or losses.
• Restructuring charges: Costs associated with integrating operations, such as facility closures or severance payments, which are directly attributable to the acquisition.
• Changes in contingent consideration: Adjustments to the fair value of earn-out payments or other contingent liabilities related to the acquisition.

These adjustments are added back to GAAP net income because they are considered not reflective of the ongoing core business operations post-integration.

Interpreting the Acquired Core EPS

Interpreting Acquired Core EPS involves understanding the story a company is trying to tell about its post-acquisition performance. Management typically presents this metric to highlight the underlying profitability and growth potential of the combined business, discounting the temporary distortions caused by acquisition accounting. For instance, by removing the Amortization of acquired Intangible Assets or one-off integration costs, the Acquired Core EPS might appear higher than the reported GAAP EPS.

Investors and analysts use Acquired Core EPS to gauge the operational success of a Business Combination and its contribution to future Shareholder Value. It can help in forecasting future earnings more accurately, as the excluded items are often non-recurring or non-cash. However, it is crucial to examine the specific adjustments made and understand why management deems them "non-core." Overly aggressive or inconsistent adjustments can mask underlying issues or inflate perceived profitability, making a thorough Due Diligence of the adjustments essential.

Hypothetical Example

Consider "TechInnovate Inc." (a software company) acquiring "DataFlow Solutions" (a data analytics firm).
Pre-acquisition:

• TechInnovate GAAP Net Income: $50 million
• TechInnovate Diluted Shares Outstanding: 100 million
• TechInnovate GAAP EPS: $0.50

Post-acquisition (Year 1):
TechInnovate acquires DataFlow for $500 million. Under purchase accounting, they identify $100 million in customer relationship Intangible Assets, which will be amortized over 5 years. They also incur $10 million in one-time integration costs and legal fees.

• GAAP Net Income (Year 1, combined entity): $55 million (includes DataFlow's contribution, but also new acquisition-related expenses).
  • Amortization of acquired intangible assets: $20 million ($100 million / 5 years)
  • Acquisition-related costs: $10 million
• New Diluted Shares Outstanding: 110 million (due to shares issued for acquisition or increased employee stock options).

Calculation of Acquired Core EPS:
Start with GAAP Net Income and add back the specific acquisition adjustments:

• GAAP Net Income: $55 million
• Add back Amortization: +$20 million
• Add back Acquisition-related costs: +$10 million

Adjusted Net Income = $55 million + $20 million + $10 million = $85 million

Acquired Core EPS = (\frac{\text{$85 million}}{\text{110 million shares}} = \text{$0.77})

In this scenario, TechInnovate's GAAP EPS would be (\frac{\text{$55 million}}{\text{110 million shares}} = \text{$0.50}). However, by presenting an Acquired Core EPS of $0.77, TechInnovate aims to show investors that, excluding the temporary acquisition-related charges, the combined entity's underlying profitability per share is significantly higher, potentially demonstrating the expected long-term Synergy from the Mergers and Acquisitions.

Practical Applications

Acquired Core EPS is primarily used by management, investors, and analysts to assess the underlying profitability of a company following significant Mergers and Acquisitions (M&A) activity. It helps in:

• Performance Evaluation: Companies use Acquired Core EPS to showcase the operational performance of the combined entity, stripping out the non-recurring or non-cash accounting impacts of a Business Combination. This can be particularly useful in industries where M&A is frequent, such as technology or pharmaceuticals.
• Valuation Models: Analysts often incorporate Acquired Core EPS into their financial models when valuing companies, as it may provide a more stable and predictable earnings stream for forecasting future performance.
• Investor Communications: Management frequently highlights Acquired Core EPS in earnings calls and investor presentations to explain the financial impact of acquisitions and articulate the company's long-term Shareholder Value proposition.
• Strategic Decision-Making: Internally, this metric can help executives evaluate the success of an acquisition based on its contribution to core earnings, separate from the initial accounting treatments.

For example, a company might use Acquired Core EPS to demonstrate the improved operational efficiency after consolidating two entities, arguing that costs like redundant administrative functions, once streamlined, will lead to higher sustained earnings. The accounting profession itself sees significant M&A activity, with firms merging to expand services or manage succession, which underscores the importance of clear financial reporting post-deal.⁴

Limitations and Criticisms

While Acquired Core EPS can offer a useful perspective on a company's post-acquisition operational performance, it comes with notable limitations and criticisms. A primary concern is that, as a Non-GAAP Financial Measure, its calculation is at the discretion of management. This discretion means there is no standardized definition or uniform set of adjustments, allowing companies to choose which items to exclude. This lack of standardization can make it difficult for investors to compare Acquired Core EPS across different companies or even for the same company over different periods if the adjustments change.

Critics argue that companies may use Acquired Core EPS to artificially inflate perceived profitability by excluding "normal, recurring" expenses that are genuinely part of the business operations, even if they relate to past acquisitions. The Securities and Exchange Commission (SEC) has provided guidance warning against such practices, particularly when non-GAAP measures exclude expenses necessary for the company's operations.³ For instance, the Amortization of acquired Intangible Assets, while non-cash, represents the consumption of valuable assets purchased during a Business Combination and should arguably be considered part of the cost of doing business. Some academic research suggests that firms reporting non-GAAP earnings tend to pursue more acquisitions and may allocate purchase prices in ways that benefit non-GAAP presentations.²,¹ This could potentially influence management's GAAP accounting choices to align with their non-GAAP disclosures, raising questions about the objectivity of the metric.

Ultimately, users of Financial Statements should exercise caution and always reconcile Acquired Core EPS back to its most directly comparable GAAP measure, analyzing the nature and materiality of each adjustment to understand its true implications.

Acquired Core EPS vs. GAAP EPS

The core difference between Acquired Core EPS and GAAP EPS lies in the adjustments made for acquisition-related items. GAAP EPS is a standardized measure calculated directly from a company's reported net income under Generally Accepted Accounting Principles (GAAP). It includes all revenues and expenses recognized according to established accounting rules, providing a comprehensive view of a company's profitability.

Acquired Core EPS, conversely, is a Non-GAAP Financial Measure. It starts with GAAP net income but then excludes certain expenses or adds back certain items that management identifies as specific to a Mergers and Acquisitions (M&A) transaction and not reflective of ongoing core operations. Common exclusions include the Amortization of acquired Intangible Assets, one-time integration costs, and changes in the fair value of contingent consideration. The primary source of confusion arises because Acquired Core EPS often presents a higher, and arguably more favorable, earnings figure than GAAP EPS by removing these "unusual" or "non-recurring" charges. While companies contend this offers a clearer operational picture, critics argue it can obscure the full cost of an acquisition and the actual profitability available to shareholders.

FAQs

Q1: Why do companies report Acquired Core EPS?

Companies report Acquired Core EPS to give investors a clearer view of their ongoing operational profitability following a Business Combination. They believe it removes the temporary accounting distortions and one-time costs associated with acquisitions, helping to highlight the performance of the core business.

Q2: What kind of adjustments are typically made in Acquired Core EPS?

Typical adjustments include adding back the Amortization expense of acquired Intangible Assets, one-time integration costs (like severance or facility consolidation), legal and advisory fees related to the acquisition, and certain fair value adjustments mandated by purchase accounting.

Q3: Is Acquired Core EPS audited?

While the underlying GAAP Financial Statements are audited, the specific non-GAAP adjustments that lead to Acquired Core EPS are generally not subject to the same level of independent audit scrutiny as GAAP figures. However, public companies are required to reconcile non-GAAP measures to their most directly comparable GAAP measure in their SEC filings, which are subject to audit review.

Q4: Should investors rely solely on Acquired Core EPS?

No, investors should not rely solely on Acquired Core EPS. It is a supplemental metric that provides an additional perspective. It is crucial to always compare it with the company's reported GAAP EPS and carefully review the reconciliation provided by the company to understand the nature and impact of all adjustments. This balanced view is essential for a complete financial analysis.