Decoding Complex Footnotes To Get Ford’s True Earnings
This report details how my firm handle the very complex disclosure of unusual items from Ford’s (F) 2006 10-K and underscores the importance of rigorous analysis of footnotes to understanding true core earnings.
I chose these disclosures because the authors of Core Earnings: New Data and Evidence recently asked me about them as part of preparing to submit the paper to a peer-reviewed journal. Specifically, they wanted details about the location of the unusual items in the filings because S&P Global (SPGI) was unable to provide the location of these unusual items in any of its datasets.
This report highlights the advantages and expertise of the Robo-Analyst, which enables me to find non-recurring items like the ones featured in this report, across thousands of companies in a matter of seconds. Investors using legacy data providers, or worse yet, using only reported numbers, in their fundamental analysis are in the Danger Zone this week.
While this example is from 2006, I scale this diligence across ~2,900 actively traded stocks with historical data going back to 1998. During this year’s filing season (February 17-March 31) alone, the Robo-Analyst parsed and analyzed 2,522 10-Ks and 10-Qs and collected over 254,000 data points. The analyst team used this data to make 40,617 core earnings and balance sheet adjustments with a dollar value of $19 trillion.
Impact of Unusual Items: Net $4.9 Billion Impact on Reported Results
In 2006, Ford’s earnings distortion, or the unusual gains/losses that must be stripped out to calculate true core earnings totaled -$4.9 billion (3% of revenue) in 2006, or -$2.61/share. Ford’s true core earnings in 2006 were -$4.10/share compared to -$6.72/share in reported GAAP EPS.
Below is my firm’s core earnings to GAAP net income reconciliation, which I provide for all stocks under coverage.
Core Earnings: -$7,705
+ Earnings Distortion from Hidden Total Restructuring Expenses, Net: -$8,698
+ Earnings Distortion from Hidden Legal, Regulatory, and Insurance Related Expenses, Net: $110
+ Earnings Distortion from Hidden Derivative Related Expenses, Net: $43
+ Earnings Distortion from Hidden Non-Recurring Pension Expenses, Net: $815
+ Earnings Distortion from Reported Other Financing Expenses, Net: $1,478
+ Income Tax Distortion: $1,612
+ Earnings Distortion from Reported Loss/(Gain) from Discontinued Operations After-tax, Net: $2
= GAAP Net Income: -$12,613
Why Footnotes Matter: $8 Billion in Hidden Unusual Items
I know from Operating Lease Disclosures: Best & Worst Practices, that companies do not always comply with FASB standards or disclose financial data in a consistent manner.
Investors looking only at reported GAAP net income would be led to believe that Ford’s 2006 results were significantly worse than the true recurring profits of the business. As noted above, and shown in Figure 1, Ford reported GAAP net income of -$12.6 billion in 2006, which included multiple write-downs in what could be described as a “kitchen-sink year.”
In the same year, core earnings, while still negative, were just -$7.7 billion. Earnings distortion from hidden items alone totaled -$8 billion, or -$4.26/share.
Figure 1: Ford’s Core Earnings Vs. GAAP Net Income: 2004-2008
Discerning Duplicate Disclosures in MD&A and Footnotes
In many cases, companies bury unusual and non-operating items that impact reported profits in both the management discussion & analysis (MD&A) and footnotes, thereby making it more difficult for analysts to figure out which charges should affect earnings. Ford discloses many unusual items, i.e. “special items,” in a table on page 41 of its 2006 10-K, in the MD&A.
This table, seen in Figure 2, provides a list of the items included in “Income/(loss) before income taxes” that Ford does not consider indicative of the ongoing operations of the business. Highlighted in Figure 2 are ten non-operating items that must be analyzed in more detail and accounted for to calculate Ford’s core earnings.
Figure 2: Ford’s “Special Items” Table on Page 41 of 2006 10-K
Three of the unusual items are found only within this table, as detailed below:
- $4.8 billion non-operating expense related to Jobs Bank Benefits and personnel-reduction programs
- $281 million in asset write-downs related to U.S. plant idlings
- $110 million in non-operating income related to a legal settlement relating to social welfare tax liability
These non-operating items increased GAAP net losses by $4.9 billion, or $2.63/share.
Footnotes Provide Necessary Context When Building My Valuation Models
The seven other non-operating items in Figure 2 are missing key context needed to discern their impact on NOPAT and invested capital and ensure I am not double-counting any items. I have to go to the footnotes to get the necessary context.
Below, I’ll detail where I found each of these items and how I adjust for them to calculate core earnings.
- Pension curtailment charges of $2.741 billion
I determined this charge is already included within “interest income and other non-operating income/(expense), net” reported on the income statement. During 2006, companies could report pension curtailment charges within either operating or non-operating items, so the disclosure is very inconsistent between companies.
When making any adjustment, I first try to find specific disclosures in the financial statements before analyzing the MD&A and footnotes. When there is no additional information to be found in the MD&A or footnotes, as in this case, I have to make a judgment call as to whether this item is captured in an operating or non-operating item on the income statement. In this situation, I assume this item is bundled in a non-operating item on the income statement for two reasons: (1) the non-operating item on the income statement increased by an amount close to the pension curtailment charge over the prior period and (2) counting this non-recurring pension charge as hidden in another operating item, e.g. SG&A, causes an unusually large change in the operating line item. In other words, my model shows that including the charge in the non-operating income statement item results in a more normal trend in the values of non-operating and operating items on the income statement.
- Fixed asset impairment charges of $2.2 billion
Critical context for this asset impairment charge is found on page FS-21 (page 103 overall). The charge, equal to $1.17/share, was recorded in Automotive cost of sales and represented the amount by which the carrying value of the assets exceeded the fair value. I remove this non-operating expense from COGS.
Figure 3: $2.2 Billion Fixed Asset Impairment Charge: Page FS-21 of Ford’s 2006 10-K
- Jaguar and Land Rover fixed asset impairment charges of $1.6 billion
Additional information on this asset impairment charge can also be found on page FS-21 (page 103 overall). This charge ($0.85/share) is also recorded in Automotive cost of sales and artificially increased Ford’s cost of sales. I also remove this charge from COGS.
Figure 4: $1.6 Billion Jaguar & Land Rover Asset Impairment Charge: Page FS-21 of Ford’s 2006 10-K
The last four items are all pension related and accounted for in my model with information collected from the pension section of Ford’s footnotes (begins on Page FS-44, page 126 overall).
- Personnel-reduction programs/Other of $378 million
- Mazda pension transfer income of $115 million
- Personnel-reduction programs of $103 million
- Personnel-reduction programs of $84 million
Even though each individual value doesn’t specifically match a value on the pension section, I know that pension expenses have to be included within the Net Period Benefit Costs table. For instance, the personnel-reduction program charges are included in the Separation Programs items on Page FS-47 (page 129 overall).
In general, I avoid collecting pension charges from locations other than the pension section of a firm’s footnotes because the footnotes consistently provide the best disclosure. Doing so would double count these charges and provide an inaccurate assessment of Ford’s true core earnings.
Figure 5: Pension Charges: Page FS-47 of Ford’s 2006 10-K
Diligence Scaled Across ~5600 Companies
As shown above, investors cannot always rely on tables in the MD&A to get an accurate assessment of core earnings, even when it appears a company discloses unusual items in a useful table. Further investigation of footnotes is often required.
It is important to note that I’ve spent over 15 years endowing the Robo-analyst technology with the insights and expertise of a sophisticated analyst. Unlike the legacy data providers, I am not blindly collecting data for the sake of collecting data. Instead, my focus is on providing the most comprehensive and accurate models for clients. As a result, I bring a much higher level of attention and expertise to the data collection process.
By leveraging the Robo-Analyst technology, I’m able to provide the rigorous footnotes & MD&A analysis above across ~2,900 actively traded stocks and ~2,700 inactive stocks. This unmatched diligence shines a light in the dark corners of financial filings (i.e. footnotes) and provides clients with more accurate measures of earnings and valuation.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.