Adjusted growth expense

What Is Adjusted Growth Expense?

Adjusted growth expense is a non-Generally Accepted Accounting Principles (non-GAAP) financial measure that modifies a company's reported operating expenses to provide an alternative view of its investment in future growth. This measure falls under the broader financial category of financial reporting. Companies typically exclude certain costs that they deem non-recurring, non-cash, or otherwise not representative of their ongoing operational spending directly related to revenue generation or core business activities. The intent behind presenting adjusted growth expense is to offer investors a clearer picture of the expenses that management believes are directly fueling strategic initiatives, research and development, or market expansion, distinct from everyday operational outlays. The use of adjusted growth expense aims to highlight the underlying profitability and the long-term growth potential of a business, particularly for companies in high-growth sectors or those undergoing significant transformation.

History and Origin

The concept of adjusting expenses to present a more favorable financial picture has existed for decades, but the formalization and widespread use of "adjusted" metrics, including adjusted growth expense, gained significant traction in the early 2000s, particularly following the dot-com bubble. As companies sought to emphasize their growth prospects and differentiate themselves from traditional industries, they increasingly relied on non-GAAP measures. This trend led to concerns from regulators about the potential for misleading investors. In response, the U.S. Securities and Exchange Commission (SEC) introduced Regulation G in 2003, which requires companies to reconcile non-GAAP financial measures to their most directly comparable GAAP measures and explain why management believes the non-GAAP measure is useful. The SEC has continued to update its guidance on non-GAAP financial measures, emphasizing that such adjustments should not remove normal, recurring cash operating expenses.⁹, ¹⁰ Despite regulatory oversight, academic research suggests that managers may still use discretion in defining non-GAAP earnings, sometimes to meet or beat analyst forecasts by excluding expenses.⁸

Key Takeaways

• Adjusted growth expense is a non-GAAP financial measure used to highlight investments in future growth.
• It typically excludes certain expenses deemed non-recurring or non-operational by management.
• The measure aims to provide a clearer view of a company's core profitability and growth-oriented spending.
• Regulatory bodies like the SEC provide guidance on the use and presentation of non-GAAP measures.
• Despite its potential utility, the subjective nature of adjustments can lead to concerns about transparency.

Formula and Calculation

The formula for adjusted growth expense is not standardized, as it is a non-GAAP measure. Companies define it based on their specific reporting objectives. However, it generally follows this structure:

Where:

• Total Operating Expenses: These are the expenses incurred in a company's ordinary course of business before non-operating items, as reported on the income statement according to GAAP. This typically includes cost of goods sold, selling, general, and administrative (SG&A) expenses, and research and development (R&D).
• Excluded Expenses: These are the specific costs that management chooses to remove to arrive at the adjusted growth expense. Common exclusions might include:
  • Amortization of acquired intangible assets.
  • Stock-based compensation.
  • Restructuring charges.
  • One-time legal settlements.
  • Impairment charges.

Companies are required to provide a reconciliation of their non-GAAP measures to the most directly comparable GAAP measure.

Interpreting the Adjusted Growth Expense

Interpreting adjusted growth expense requires careful consideration, as it offers a management-defined perspective on a company's financial performance. A lower adjusted growth expense relative to total operating expenses might suggest that a significant portion of a company's operational outlays are considered non-essential for future growth, or that the company is effectively streamlining its growth-related spending. Conversely, a higher adjusted growth expense, particularly in growing companies, could indicate aggressive investment in research and development, marketing, or expansion, which management believes will yield substantial future revenue growth.

When evaluating this metric, investors should scrutinize the specific expenses that are adjusted out. For instance, if a company consistently excludes certain "one-time" items that recur frequently, it could signal an attempt to present an overly optimistic view of its underlying profitability. It is crucial to compare the adjusted growth expense with the reported GAAP expenses to understand the magnitude of the adjustments and to assess whether the rationale provided by management for these exclusions is sound and consistent over time. Understanding the impact of these adjustments on a company's overall financial health requires a holistic view of the financial statements.

Hypothetical Example

Consider a hypothetical technology startup, "InnovateTech Inc.," that incurred the following expenses in a given quarter:

• Salaries and Wages: $500,000
• Rent and Utilities: $50,000
• Marketing and Advertising: $150,000
• Research and Development (R&D) Salaries: $200,000
• Stock-Based Compensation (R&D team): $75,000
• One-time acquisition integration costs: $100,000
• Depreciation and Amortization: $25,000

InnovateTech's management believes that the stock-based compensation for the R&D team and the one-time acquisition integration costs are not indicative of their ongoing, cash-based investments in growth. They want to present an adjusted growth expense that reflects only their core cash expenditures directly related to developing new products and expanding their market.

1. Identify Total Operating Expenses:
   Total Operating Expenses = $500,000 (Salaries) + $50,000 (Rent) + $150,000 (Marketing) + $200,000 (R&D Salaries) + $75,000 (Stock-Based Comp) + $100,000 (Acquisition Costs) + $25,000 (Depreciation/Amortization) = $1,100,000

2. Identify Excluded Expenses (for Adjusted Growth Expense):
   Excluded Expenses = $75,000 (Stock-Based Compensation) + $100,000 (One-time Acquisition Integration Costs) = $175,000

3. Calculate Adjusted Growth Expense:
   Adjusted Growth Expense = Total Operating Expenses - Excluded Expenses
   Adjusted Growth Expense = $1,100,000 - $175,000 = $925,000

In this example, InnovateTech would report an adjusted growth expense of $925,000. This figure aims to show investors their core, cash-based spending on growth initiatives, excluding specific non-cash or non-recurring items. Investors would then compare this to the GAAP operating expenses of $1,100,000, along with the detailed reconciliation provided by the company, to understand the full financial picture and the impact of these non-cash expenses.

Practical Applications

Adjusted growth expense is primarily used in financial analysis and reporting, particularly for companies that aim to emphasize their long-term strategic investments.

• Investor Relations and Equity Research: Companies use this metric to communicate their investment story to potential and existing investors. Equity analysts may also utilize it to compare the growth-oriented spending of different companies, especially within sectors where heavy investment in R&D or market expansion is crucial for future success, such as technology or biotechnology.⁷
• Internal Management and Strategic Planning: Management teams may use adjusted growth expense to track the effectiveness of their growth initiatives and allocate resources. It can help assess the impact of strategic investments on the core business, separate from temporary or non-operational costs. This allows for a clearer view of the efficiency of growth-driving expenditures and can inform future capital allocation decisions.
• Valuation Models: While not a GAAP measure, some valuation models, particularly those focused on growth stocks or early-stage companies, might consider adjusted growth expense to project future profitability, assuming that the excluded expenses are truly non-recurring or non-core. However, analysts must be cautious and rigorous in their assessment of the adjustments.
• Industry Benchmarking: In certain industries, companies may collectively adopt similar non-GAAP adjustments, making adjusted growth expense a more comparable metric for benchmarking performance against peers. This can be particularly true in fast-evolving sectors where innovation and market penetration require significant upfront investment. Companies like Intel, for example, have recently announced plans to streamline operations and reduce expenses by shedding non-core assets to focus on future growth.⁶

Limitations and Criticisms

While adjusted growth expense can offer additional insights, it is subject to significant limitations and criticisms. The primary concern revolves around its subjective nature, as companies have considerable discretion in determining which expenses to exclude. This flexibility can lead to a lack of comparability between companies and even within the same company over different periods, undermining the principle of comparability in financial reporting.

Critics argue that companies may use adjusted growth expense to present a more favorable financial picture by removing legitimate, recurring operational costs, thereby inflating perceived profitability or downplaying the true cost of their growth strategies. The SEC has repeatedly issued guidance and warnings about the potential for non-GAAP measures to mislead investors, particularly when they exclude what should be considered normal and recurring operating expenses.⁴, ⁵ For instance, an expense initially classified as "one-time" might recur, challenging the validity of its exclusion.

Furthermore, the exclusion of certain expenses, even if non-cash, can mask the true cash flow implications of a company's operations. For example, stock-based compensation, while non-cash in the accounting sense, represents a real cost to shareholders through dilution. Similarly, amortization of intangible assets, although a non-cash expense, reflects the consumption of valuable assets acquired for growth. Ignoring these can lead to an incomplete understanding of a company's economic performance. Academic research has explored how managers may opportunistically use non-GAAP earnings to meet analyst forecasts, sometimes by excluding recurring expenses.¹, ², ³

Adjusted Growth Expense vs. Research and Development (R&D) Expense

While both Adjusted Growth Expense and Research and Development (R&D) Expense relate to a company's investment in future innovation and expansion, they differ significantly in their scope and reporting standards.

The key distinction lies in R&D expense being a standardized, GAAP-compliant measure that specifically tracks innovation-related costs, whereas adjusted growth expense is a flexible, non-GAAP metric used by management to highlight a broader range of "growth" investments, subject to company-specific exclusions.

FAQs

What is the primary purpose of adjusted growth expense?

The primary purpose of adjusted growth expense is to present a company's investment in its future growth, excluding certain expenses that management considers non-recurring, non-cash, or otherwise not representative of ongoing growth-related spending. This aims to provide a clearer picture of the core operational costs associated with expansion.

Is adjusted growth expense a GAAP measure?

No, adjusted growth expense is a non-GAAP financial measure. Companies are required to reconcile it to the most directly comparable GAAP measure, typically total operating expenses, and explain its usefulness to investors.

Why do companies use non-GAAP measures like adjusted growth expense?

Companies use non-GAAP measures to provide what they believe is a more relevant or informative view of their underlying financial performance, often to highlight specific aspects of their business, such as core profitability or investment in future growth. It can help explain complex business strategies that may not be fully captured by traditional GAAP metrics.

What are the risks of relying solely on adjusted growth expense?

Relying solely on adjusted growth expense can be risky because its calculation is subjective and can vary significantly between companies. It may exclude actual cash expenses or recurring costs, potentially leading to an overestimation of a company's true profitability or an underestimation of its operational expenses. Always compare it to GAAP figures and review the financial disclosures.

How can investors verify the credibility of adjusted growth expense?

Investors should always review the company's detailed reconciliation of adjusted growth expense to its most comparable GAAP measure, typically found in the earnings release or SEC filings. It's crucial to understand the specific exclusions and the company's rationale for making those adjustments, assessing whether they are genuinely non-recurring or non-operational.