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What is EBITDA?
E
B
=
=
Earnings
Before
I
T
=
=
Interest
Taxes
D
A
=
=
Depreciation and
Amortization
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The preferred time period is the latest twelve months (also known as LTM numbers) Projections are used only rarely in the high yield market Sometimes we adjust historical EBITDA to make it seem like a projection
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KAD
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Calculating EBITDA In most cases, the starting point is Earnings or net income
Step one: Normalize earnings to make historical earnings look more representative of future earnings
You should consider excluding various types of income or expense included in net income that are unusual or not reflective of cash flows
Exclude unusual or non-recurring items if they will not
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of business
Extraordinary items
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Calculating EBITDA (contd) Remember to focus on the difference between net income and operating income Consider whether each income/expense item below the operating income line should be included in EBITDA Keep in mind that the goal is to reflect recurring cash flow from operations available to service debt in the future
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Step two: Once the base-line has been established, we build up from there by adding back:
Interest Expense Income Tax Theoretically, income tax is not paid until after interest is serviced because interest expense is generally deductible for tax purposes (for corporate issuers)
Therefore, all dollars spent on taxes would be
RAZ
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Calculating EBITDA (contd) Step three: Add back: Depreciation and Amortization It is customary to add back the entire amount of depreciation and amortization, despite the cash cost of utilizing fixed assets
Theoretically, most capital expenditures can be delayed to service interest expense While this theory may be valid in the short term, many capital costs cannot be delayed forever
Most senior lenders will look at EBITDA minus capital expenditures as well. This is not the practice in the High Yield world.
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RAZ
NY_DOCS\560773.3 [PPT 97]
Calculating EBITDA (contd) However, since D and A do ultimately get plowed back into the business in the form of capital expenditures:
It is customary (and proper) to disclose historical
expenditure requirements (in the Liquidity discussion in the MD&A) and the source of financing of such capital expenditures
Regulation S-K requires disclosure of material
capital commitments, and most companies also disclose their capital expenditure budget for the next year or two
RAZ
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EBITDAR EBITDAR = Earnings Before Interest, Taxation, Depreciation, Amortization and Rent Expense In certain industries, operating leases are utilized interchangeably with capital leases and other traditional forms of indebtedness to finance fixed assets
In these industries, it is typical to add rent expense back to EBITDA (to make EBITDAR) and to include rent as a fixed charge Caveat: Unless your issuer is in an industry where analysts typically look at EBITDAR, try to avoid using EBITDAR because you may be distorting both cash flow and fixed charges
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Why do we care about EBITDA? Investors in corporate debt use EBITDA as a measure of the ability of a company to service its debt Two key credit ratios focus on EBITDA: 1. Ratio of EBITDA to Fixed Charges
Used to determine the ability of an issuer to service
interest on debt
The more times the companys EBITDA covers its
fixed charges, the more cushion the company has to withstand earnings pressure and still service its debt
A company with a 2.0x ratio theoretically has $2 of
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of their EBITDA. If you know what the typical multiple is for a company in your issuers industry, then you can assess the equity cushion that creditors of your issuer will enjoy. If the company is valued at 12x EBITDA and the total debt it is carrying is only 5x EBITDA, then the value of the enterprise can be cut in half and the company can still repay the debt in a meltdown scenario
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KAD
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Why adjust EBITDA? The financial community relies heavily on EBITDA as a measurement of a companys ability to leverage itself
There is typically pressure to adjust EBITDA to more accurately reflect a companys available ongoing operating cash flows
This is a backhanded way of using historical financial
Once traditional EBITDA is adjusted in one or more of the ways to be discussed, it is typically referred to as Adjusted EBITDA
This is a good disclosure since it alerts the investor that adjustments have been made
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RYL
NY_DOCS\560773.3 [PPT 97]
Non-cash adjustments It is customary to add back most non-cash charges to EBITDA (in addition to the non-cash charges for depreciation and amortization) However, not all non-cash adjustments are created equal:
Some non-cash adjustments are similar in nature to
depreciation and amortization charges, and can typically be added to EBITDA on the same theory
An example:
Charges for the write-off of goodwill or for a
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Other non-cash charges are simply reserves for future cash charges
expenditure will not be reflected in the income statement for the future period (and therefore will not reduce EBITDA for such period)
Typically, these charges should not be added to
EBITDA (unless you are comfortable that they are nonrecurring, as discussed below)
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charge, representing the amortization of the asset created in the prior period when the cash went out the door These types of non-cash charges should not typically be added to EBITDA (unless the expense is nonrecurring, as discussed below)
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Restructuring/relocation costs Start-up costs for new facilities or product lines Costs of mitigating the effect of natural disasters or terrorist strikes Costs of work stoppages at the companys plants or those of its customers or suppliers
The key question here is whether the expense is likely to recur in the future
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Non-recurring, unusual or extraordinary items (contd) Problem: These sorts of costs can, and in some cases absolutely will, recur
You and your client need to consider, on a case-by-case basis, whether a proposed adjustment can reasonably be described as non-recurring In the context of disclosure, you need to disclose the add-backs and explain what the add-backs are, explain why management thinks they are unusual or nonrecurring and then let the reader make up her own mind as to the appropriateness of managements view
See our standard form Adjusted EBITDA Rider attached as Annex 1 for an example of how to handle this disclosure
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RAZ
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Adjusted EBITDA: Summary and Selected Financials footnote disclosure template for high yield
(__) Adjusted EBITDA is calculated by adding to EBITDA certain items of expense that we believe are not [likely to recur][indicative of our future operating performance] consisting of: (i) [describe Adjustment 1]; (ii) [describe Adjustment 2]; and (iii) [describe Adjustment 3]. See Commission Review on page (____).1
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When you are including an Adjusted EBITDA presentation, consider including in the boilerplate following the cover page a legend such as: Commission Review In the course of the Securities and Exchange Commissions review of the registration statement for the exchange offer which we have agreed to make relating to the Notes, we may be required to make changes to the description of our business and other information and financial data included in this Offering Memorandum. The Commission has been closely reviewing the application of certain generally accepted accounting principles in disclosure documents, including those applicable to the impairment of long-lived assets and restructuring activities. [The Commission may not view certain pro forma adjustments or adjustments to EBITDA as complying with Article 11 of Regulation S-X.] While we believe that the pro forma financial data included herein have been prepared in a manner that complies, in all material respects, with generally accepted accounting principles and the regulations published by the Commission, comments by the Commission on our financial data in the registration statement for the exchange offer required by the Registration Rights Agreement may require modification or reformulation of the data we present in this Offering Memorandum.
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The following table summarizes the impact of these adjustments to EBITDA for the periods indicated (See notes to Unaudited Pro Forma Consolidated Statements of Income for additional detail): Twelve
Fiscal Year 1996 EBITDA ..................... Adjustments: Adjustment 1............... Adjustment 2............... Adjustment 3............... Adjusted EBITDA ...... $ $ $ $ $ $ $ $ 1997 1998 [ ] months ended [ ], [ ], 1998 1999 months ended [ ], 1999 $
(DOLLARS IN MILLIONS) $ $ $
Adjusted EBITDA represents EBITDA plus the additional adjustments noted in the table above. Adjusted EBITDA is presented because we believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. However, other companies in our industry may present Adjusted EBITDA differently than we do. Adjusted EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be considered as an alternative to cash flow from operating activities or as a measure of liquidity or an alternative to net income as indicators of our operating performance or any other measures of performance derived in accordance with generally accepted accounting principles. See the Statements of Cash Flow included in our financial statements.
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Non-recurring, unusual or extraordinary items (contd) Some factors to consider: The companys experience over the preceding 3-5 years
If the company has recorded similar charges every year over that time period, the item is clearly not nonrecurring
A work stoppage may be more likely to be nonrecurring in some industries than others
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Start-up, restructuring and design costs may be less non-recurring for some companies than others
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extraordinary items
under GAAP (hence you are trusting the companys CFO and not relying on an objective standard if you allow these sorts of add-backs)
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Future cost savings It may also be appropriate to adjust EBITDA for potentially significant savings (relative to historical costs) expected to result in the future from a transaction that the company is about to consummate Typical contexts include:
Acquisition Sale of business unit Costs savings program Build versus buy decisions
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Future cost savings (contd) Fundamentally, cost savings adjustments are forward looking statements
It is one thing to roll back cost savings that have
improvements or projected improvements in operating results expected to be achieved in the ordinary course
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Documented does not mean evidence that the cost saving was achieved. It means that:
The corporate initiative or transaction is itself
documented The adjustment is based upon identified actions with quantifiable results Also, be sure that the cost savings wont impact revenues
Downsizing the sales force may save costs but it
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The most common situation in which future cost savings are proposed to be added back to EBITDA is in connection with an acquisition
Parties to an acquisition context typically anticipate
significant cost synergies in areas such as: Elimination of duplicative SG&A Elimination of duplicative operations
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The SEC has promulgated standards (in Regulation S-X) for including costs savings in pro forma financial statements for acquisitions
The SEC has interpreted these standards narrowly Most cost savings adjustments would not typically be included in pro forma financial statements A deal team often looks to these standards as guidelines for including costs savings in Adjusted EBITDA
The market will tend to give full credit to adjustments that meet the S-X standard and will tend to discount other adjustments
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RAZ
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Typically does not include ordinary course cost improvements anticipated to result from an acquisition or divestiture Typically would include cost savings in the acquisition agreement itself
If youre not buying the other companys headquarters building, then you dont have to assume the costs associated with owning it
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terminated should have been specifically identified and the net cost of termination calculated
For improved purchasing power, there should be a new
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Revenue Adjustments It may be appropriate to adjust EBITDA for anticipated, substantial revenue improvements in the near term
This is most often seen in the context of an acquisition Generally, it is more problematic to include revenue adjustments because of the difficulty involved in documenting anticipated revenue amounts/synergies However, an adjustment may be includable if the company has new or amended contracts or similar documentation in place
Revenue adjustments are the most aggressive and are quite rare This sort of adjustment would not likely meet the Regulation S-X standard
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RYL
Certain types of proposed adjustments to EBITDA are less susceptible to quantification than others
Examples of difficult quantification issues:
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First, obtain from the Company a detailed breakdown of each proposed adjustment amount
This will flush out what, if any, estimates are baked into the amount of the proposed adjustments
Understand the extent to which each proposed adjustment is not derived from the companys historical books and records
Any such amounts should be scrutinized more thoroughly they will not be covered by the accountants comfort letter
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RYL
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Quantification of adjustments to EBITDA (contd) Also consider whether any of the cost savings will have a revenue impact Typical examples include:
Sales force cuts Reduced number of retail outlets Reduction in advertising budget
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Finally, consider the timing of the realization of the proposed cost savings Often full realization will not occur for the first 12 to 18 months or more after the acquisition. The timetable for the realization of these savings should be disclosed in the MD&A. The further out in time full realization will occur, the more difficult it is to quantify the adjustment The problem is that EBITDA and Adjusted EBITDA are typically presented on a historical or historical pro forma basis
Note: You also want to be very careful about the disclosure surrounding the adjustment
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RYL
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KAD
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Disclosure of EBITDA Remember three things: 1. Whenever EBITDA or Adjusted EBITDA is presented, it should be carefully defined
Describe what the base-line was (operating income, net income or something else)
Describe what got added back See our standard form Adjusted EBITDA Rider attached as Annex 1
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Disclosure of EBITDA (contd) Remember three things: (contd) 2. If non S-X-able adjustments are made, the adjusted number should be referred to as Adjusted EBITDA to put the reader on notice of the need to read the fine print
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Disclosure of EBITDA (contd) Remember three things: (contd) 3. Adjustments to EBITDA included in Adjusted EBITDA should be described and broken out separately in a footnote The key is to give enough information so that investors will be able to:
Make an informed judgment as to the reasonableness of your presentation of EBITDA Make adjustments to your presentation of EBITDA to conform to the investors own view of what is appropriate to include and exclude
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KAD
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When you need help with EBITDA call your friends at Latham & Watkins
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Annex 1
CORPORATE DEPARTMENT FORM ** STANDARD FORM DO NOT CHANGE ** Adjusted EBITDA: Summary and Selected Financials footnote disclosure template for high yield
The following is a suggested form template for footnote disclosure for the summary and selected financials on a high yield debt offering. Specifically, this form provides a template for describing and supporting any adjustments to pure EBITDA that bankers or issuers may request or require. In addition, this template provides standard templates for the discussion of pure EBITDA and the ratio of fixed charges to earnings. Feel free to hand this out as a proposed rider at drafting sessions.
Adjusted EBITDA: This template is designed to (1) allow an investor to identify and understand each item that is added back to EBITDA to reach Adjusted EBITDA and (2) provide a sound foundation for subsequent SEC attack on Adjusted EBITDA. This form contemplates that EBITDA and Adjusted EBITDA are both line items in the summary and selected financials. The Adjusted EBITDA footnote should be attached to the Adjusted EBITDA line item. If the descriptions of the adjustments are adequate, this disclosure will allow an investor to identify the individual adjustments and then independently gauge the appropriateness of each such adjustment. In addition, if the SEC forces the issuer to remove Adjusted EBITDA as a line item from the summary and selected financials, the Adjusted EBITDA footnote can be edited and appended to the EBITDA footnote. This middle ground seems to satisfy the SEC while leaving the issuer some disclosure they can point to that includes and describes adjustments to pure EBITDA.
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Adjusted EBITDA: Summary and Selected Financials footnote disclosure template for high yield
EBITDA: This template includes a standard footnote to discuss EBITDA in an SEC-friendly manner. Ratio of Earnings to Fixed Charges: This template includes a standard ratio of earnings to fixed charges footnote. In the plain English world, the SEC requires this ratio in the summary financials. (__) EBITDA represents earnings before interest, taxes, depreciation and amortization. EBITDA is presented because we believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. However, other companies in our industry may calculate EBITDA differently than we do. EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be considered as an alternative to cash flow from operating activities or as a measure of liquidity or an alternative to net income as indicators of our operating performance or any other measures of performance derived in accordance with generally accepted accounting principles. See the Statements of Cash Flow included in our financial statements.
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Adjusted EBITDA: Summary and Selected Financials footnote disclosure template for high yield
(__) Adjusted EBITDA is calculated by adding to EBITDA certain items of expense that we believe are not [likely to recur][indicative of our future operating performance] consisting of: (i) [describe Adjustment 1]; (ii) [describe Adjustment 2]; and (iii) [describe Adjustment 3]. See Commission Review on page (____).1
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When you are including an Adjusted EBITDA presentation, consider including in the boilerplate following the cover page a legend such as: Commission Review In the course of the Securities and Exchange Commissions review of the registration statement for the exchange offer which we have agreed to make relating to the Notes, we may be required to make changes to the description of our business and other information and financial data included in this Offering Memorandum. The Commission has been closely reviewing the application of certain generally accepted accounting principles in disclosure documents, including those applicable to the impairment of long-lived assets and restructuring activities. [The Commission may not view certain pro forma adjustments or adjustments to EBITDA as complying with Article 11 of Regulation S-X.] While we believe that the pro forma financial data included herein have been prepared in a manner that complies, in all material respects, with generally accepted accounting principles and the regulations published by the Commission, comments by the Commission on our financial data in the registration statement for the exchange offer required by the Registration Rights Agreement may require modification or reformulation of the data we present in this Offering Memorandum.
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The following table summarizes the impact of these adjustments to EBITDA for the periods indicated (See notes to Unaudited Pro Forma Consolidated Statements of Income for additional detail): Twelve
Fiscal Year 1996 EBITDA ..................... Adjustments: Adjustment 1............... Adjustment 2............... Adjustment 3............... Adjusted EBITDA ...... $ $ $ $ $ $ $ $ 1997 1998 [ ] months ended [ ], [ ], 1998 1999 months ended [ ], 1999 $
(DOLLARS IN MILLIONS) $ $ $
Adjusted EBITDA represents EBITDA plus the additional adjustments noted in the table above. Adjusted EBITDA is presented because we believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. However, other companies in our industry may present Adjusted EBITDA differently than we do. Adjusted EBITDA is not a measurement of financial performance under generally accepted accounting principles and should not be considered as an alternative to cash flow from operating activities or as a measure of liquidity or an alternative to net income as indicators of our operating performance or any other measures of performance derived in accordance with generally accepted accounting principles. See the Statements of Cash Flow included in our financial statements.
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(__) The ratio of earnings to fixed charges is computed by dividing earnings by fixed charges. For this purpose, earnings include net income (loss) before taxes and fixed charges (adjusted for interest capitalized during the period). Fixed charges include interest, whether expensed or capitalized, amortization of debt expense and the portion of rental expense that is representative of the interest factor in these rentals. For the year ended December 31, 199___, earnings before fixed charges were insufficient to cover fixed charges by approximately $ ____.2
Expand this section to include each period referenced on the financial table where the same is true, including pro forma periods. Each cell in the ratio of earnings to fixed charges line item should either indicate a positive ratio or reference to the footnote where dollar amount of the insufficiency for the relevant period should be discussed.
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CAVEAT
This outline sets forth principals, policies and procedures of general application. They are not absolute rules, but only guidelines. Consulting a form or outline is only one step in analysis. In any particular case, exceptions to guidelines may be appropriate or necessary. Please do not rely on this form as definitive legal advice; always consult an attorney at Latham & Watkins. Our practice areas are organic and evolving, and this outline is therefore necessarily a work in progress, subject to amendment and revisions as practice and circumstance dictate.
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