Adjusted long term revenue

What Is Adjusted Long-Term Revenue?

Adjusted Long-Term Revenue refers to a non-GAAP financial measure that modifies a company's reported revenue figures over an extended period to provide what management believes is a more accurate or insightful view of the underlying financial performance and sustainable growth. This metric falls under the broader category of financial reporting and financial analysis, offering investors and analysts a different lens through which to assess a company's long-term profitability and operational health. Unlike figures prepared strictly according to Generally Accepted Accounting Principles (GAAP), adjusted long-term revenue typically excludes or includes specific items deemed non-recurring, non-operational, or distorting to reflect a company's core, ongoing business activities.

History and Origin

The concept of adjusting reported financial figures, including revenue, stems from a desire by companies and analysts to present financial performance in a way that better reflects operational realities, often by removing the impact of one-time events or accounting anomalies. While not a formally standardized term like "net income" under GAAP, the practice of presenting non-GAAP measures gained significant traction in the late 20th and early 21st centuries, particularly as business models became more complex and volatile.

Regulators, notably the U.S. Securities and Exchange Commission (SEC), have long provided guidance on the use and disclosure of non-GAAP financial measures to ensure they do not mislead investors. The SEC's focus on these measures intensified due to their increased prominence and the growing divergence between GAAP and non-GAAP reported amounts. For example, the SEC staff has periodically updated its Compliance and Disclosure Interpretations (C&DIs) regarding non-GAAP financial measures, with significant updates occurring in 2003, 2010, 2016, 2018, and most recently in December 2022, to provide clarity on acceptable practices⁴. These updates have emphasized the need for clear reconciliation to GAAP measures and cautioned against misleading presentations.

Key Takeaways

• Non-GAAP Nature: Adjusted long-term revenue is a non-GAAP financial measure, meaning it is not prepared in accordance with standard accounting principles.
• Focus on Core Performance: It aims to provide a clearer view of a company's sustainable revenue generation by excluding or including specific items that management considers non-representative of ongoing operations.
• Management Discretion: The specific adjustments made can vary significantly between companies and industries, reflecting management's judgment on what constitutes "long-term" and "adjusted" revenue.
• Analytical Tool: It serves as an analytical tool for investors and analysts to assess a company's underlying growth strategy and potential for future earnings.
• Supplemental Information: It should always be viewed as supplementary to, rather than a replacement for, GAAP-compliant financial statements.

Formula and Calculation

Since Adjusted Long-Term Revenue is a non-GAAP measure, there is no universal formula. The calculation depends entirely on the specific adjustments a company chooses to make and disclose. However, it generally starts with a company's reported GAAP revenue and then adds back or subtracts items.

A generic representation could be:

Where:

• GAAP Revenue: The total revenue reported on the income statement in accordance with accounting principles.
• Adjustments: These can include a variety of items, such as:
  • Exclusion of revenue from divested businesses.
  • Exclusion of revenue from one-time contracts or significant, non-recurring sales events.
  • Inclusion of revenue from significant acquisitions as if they had occurred at the beginning of the period.
  • Normalization for impacts of foreign currency fluctuations that management considers temporary.
  • Adjustments related to significant changes in revenue recognition policies (though less common for "long-term revenue" adjustments after initial adoption of new standards like ASC 606).

Each adjustment should be clearly defined and reconciled to the most directly comparable GAAP measure.

Interpreting the Adjusted Long-Term Revenue

Interpreting Adjusted Long-Term Revenue requires careful consideration of the context and the nature of the adjustments made. Analysts use this metric to gauge a company's sustainable revenue-generating capacity, excluding factors that might obscure the true underlying business model or future trajectory. For example, if a company reports strong GAAP revenue growth primarily due to a large, one-time sale of assets, adjusting revenue to exclude this transaction provides a clearer picture of the growth from its ongoing operations.

Similarly, in sectors undergoing rapid transformation, companies might adjust revenue to account for discontinued product lines or significant strategic shifts, providing a more relevant base for future forecasting and valuation. The key is to understand why the adjustments are made and whether they truly enhance the clarity of the long-term trend, rather than merely making the numbers appear more favorable. It is crucial for users of financial information to scrutinize the rationale behind each adjustment and assess its consistency over time.

Hypothetical Example

Consider "TechInnovate Inc.," a software company reporting its annual results.

• Year 1 GAAP Revenue: $500 million
• Year 2 GAAP Revenue: $650 million

Upon closer inspection, TechInnovate's management believes the Year 2 GAAP Revenue was significantly boosted by a $100 million one-time licensing deal with a government entity, a type of contract not expected to recur annually. Additionally, during Year 2, TechInnovate acquired "DataSolutions Corp.," which contributed $20 million in revenue from the date of acquisition, but management wants to show pro forma revenue as if DataSolutions had been part of the company for the full year. DataSolutions' annual revenue before acquisition was $30 million.

To calculate Adjusted Long-Term Revenue for Year 2:

1. Start with GAAP Revenue: $650 million
2. Subtract non-recurring licensing deal: -$100 million
3. Add pro forma revenue from acquisition (difference between full-year and acquired period): +($30 million - $20 million) = +$10 million

In this scenario, while GAAP revenue grew from $500 million to $650 million, the Adjusted Long-Term Revenue suggests a more sustainable growth from $500 million to $560 million, excluding the one-off event and normalizing for the acquisition impact. This provides a different perspective for assessing the company's core growth trajectory.

Practical Applications

Adjusted Long-Term Revenue finds several practical applications in the financial world, particularly in corporate finance and investment analysis:

1. Strategic Planning and Goal Setting: Companies often use adjusted revenue figures internally to set realistic long-term growth targets and evaluate the effectiveness of their strategic initiatives, such as research and development investments or shifts in market focus.
2. Performance Evaluation: It helps management and boards assess the underlying performance of core operations, distinguishing it from transient gains or losses. This can influence decisions on resource allocation, capital expenditures, and executive compensation.
3. Investor Relations: Companies present adjusted long-term revenue to the investment community to articulate their growth story and provide a clearer picture of sustainable performance, especially when GAAP figures might be distorted by unique events. This is often accompanied by detailed reconciliations to GAAP measures.
4. Mergers and Acquisitions (M&A) Analysis: In M&A, pro forma adjusted revenue is crucial for understanding the combined entity's historical performance as if the acquisition had occurred earlier, aiding in integration planning and synergy assessment.
5. Benchmarking: Analysts use adjusted revenue to compare companies within the same industry, especially when different firms experience varying levels of non-recurring items or adopt different business model evolutions.

McKinsey & Company, for instance, highlights how strong performers achieve sustained growth by continually innovating in their core businesses and expanding into related areas, suggesting a focus on underlying, enduring revenue streams that adjusted revenue aims to capture³.

Limitations and Criticisms

While Adjusted Long-Term Revenue can offer valuable insights, it is subject to several limitations and criticisms:

1. Lack of Standardization: The primary criticism is the absence of a universal definition or standard for "adjusted" revenue. Each company can define its adjustments, leading to inconsistencies and making direct comparisons between companies challenging.
2. Potential for Manipulation: The flexibility in defining adjustments can be exploited to present a more favorable financial picture than reality, potentially obscuring declining core performance or recurring "one-time" expenses that are, in fact, integral to operations. The SEC has repeatedly expressed concerns over "misleading measures" and adjustments that exclude "normal, recurring, cash operating expenses" from non-GAAP performance metrics².
3. Reconciliation Complexity: While companies are required to reconcile non-GAAP measures to GAAP, the complexity of these reconciliations can sometimes make it difficult for investors to fully understand the differences and their implications for the underlying cash flow and shareholder value.
4. Auditor Scrutiny: Unlike GAAP figures, non-GAAP measures are not subject to the same level of independent audit scrutiny, though auditors typically review the consistency of their application and the adequacy of their reconciliation.

Therefore, relying solely on Adjusted Long-Term Revenue without a thorough understanding of the adjustments and a comparison to GAAP figures can lead to misinformed investment decisions.

Adjusted Long-Term Revenue vs. GAAP Revenue

The fundamental difference between Adjusted Long-Term Revenue and GAAP Revenue lies in their underlying principles and purpose.

While GAAP Revenue provides a standardized baseline for financial reporting, Adjusted Long-Term Revenue aims to offer a more insightful view of a company's ongoing operational trends. The confusion often arises when companies emphasize adjusted figures over GAAP, potentially leading investors to overlook important factors captured only by the standardized GAAP numbers. Both serve distinct but complementary roles in comprehensive financial analysis.

FAQs

What kind of adjustments are typically made to calculate Adjusted Long-Term Revenue?

Adjustments often include removing the impact of one-time events like asset sales, restructuring charges, significant legal settlements, or the pro forma inclusion of revenue from recent acquisitions as if they occurred earlier. The goal is to isolate the revenue generated from core, recurring business activities over an extended period.

Why do companies report Adjusted Long-Term Revenue if it's not GAAP?

Companies report adjusted figures to provide what they believe is a clearer picture of their underlying operational performance and sustainable growth trajectory. They might argue that GAAP figures, while standardized, can sometimes be distorted by non-recurring events that don't reflect the company's long-term potential or core business model.

Can Adjusted Long-Term Revenue be misleading?

Yes, it can be. Because there's no universal standard for calculating adjusted revenue, companies have discretion over what adjustments to make. This flexibility can potentially be used to portray a more favorable financial performance than warranted, especially if "non-recurring" items become regular occurrences or if core operating expenses are excluded. It's crucial for investors to carefully review the accompanying GAAP reconciliation and the rationale for each adjustment.

How does revenue recognition under GAAP influence Adjusted Long-Term Revenue?

Generally Accepted Accounting Principles (GAAP) provide the foundation for how revenue is initially recorded. For example, revenue recognition under ASC 606 (Topic 606), issued by the Financial Accounting Standards Board (FASB), dictates when and how revenue from contracts with customers should be recognized on the income statement¹. Adjusted Long-Term Revenue then takes these GAAP-reported figures as a starting point and applies further non-GAAP adjustments based on management's specific objectives for presenting long-term trends.