Equifax: a quick accounting note on capitalizing expenses

It’s possible that Equifax is pulling on accounting levers to juice its earnings and the Adjusted EBITDA that it reports.  Capitalizing expenses (e.g. software development costs) creates profits now and losses later- it changes the timing of when expenses are recognized.

  1. On the balance sheets, capitalized internal-use software grew from 212.5M to 307.0M (an increase of 44% per year, or 94.5M).  This area of accounting is subjective- should software development costs be amortized over 3 years, 10 years, or somewhere in between?  What expenses should be considered capex?  Should these expenses even be capitalized?- some software companies don’t capitalize software development costs at all.  The answers are not clearcut.  However, accounting distortions can occur if a company were to suddenly aggressively capitalize expenses that it previously expensed.
  2. While capitalized internal-use software grew 94.5M, consolidated income before income taxes grew 91.6M in the same timeframe.  So it’s possible that Equifax’s growth is not as fast as it seems.

GAAP rules generally force software businesses to understate earnings initially- there is a lag between the cash spent on development and when the benefits of that spending hits a company’s bank account.  So I’m not opposed to the principle of capitalizing software development expenses.  However, in Equifax’s case, it seems a little aggressive for some of those expenses to be amortized over a 10-year period… I would be surprised if that software ages that well.  The latest 10-K states:

Capitalized internal-use software and systems costs are subsequently amortized on a straight-line basis over a three- to ten-year period after project completion and when the related software or system is ready for its intended use.

Additional points

  1. From 2014 to 2016, total capex more than doubled from 86.4M to 191.5M (an increase of 49% per year).
  2. Digging a little deeper, most of that increase occurred in “General Corporate” capex.  That capex grew from 32.3M to 87.6M (an increase of 65% per year).  It strikes me as weird this capex would rise so rapidly given that revenue growth at Equifax has been far below 65% per year.

In the last 3 reported quarters, capitalized internal-use software continued to grow from 307.0M to 388.0M.

*Disclosure:  No position.  (For whatever’s it worth, I would rather be long Equifax rather than short the stock if I were forced to choose.)  

2 thoughts on “Equifax: a quick accounting note on capitalizing expenses

  1. Interesting take. Given the issues around the security breach, I’m guessing accounting is not top of mind for most investors at the moment.

    • Originally I thought that the security breach is a one-time thing that Equifax would overcome. In the grand scheme of things, it doesn’t seem like the worst thing in the world because consumers would likely forget about the controversy.

      But even before the breach, I’m not sure if Equifax is a dynamic and high-growth company. I don’t know if I will be right about their growth, but I will be leaving that stock alone. Thanks for the comment!

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