4.14 Credit Agreement Covenants
Credit agreements often require registrants to comply with certain
financial or non-financial covenants. The financial covenants, which may be based on
GAAP or on non-GAAP measures such as EBITDA or adjusted EBITDA, are often material
to an investor’s understanding of the registrant’s financial condition and
liquidity. Accordingly, disclosure of information about covenants may be required in
the MD&A section of a filing.
C&DIs — Non-GAAP Financial Measures
Question: Item
10(e)(1)(ii)(A) of Regulation S-K prohibits “excluding
charges or liabilities that required, or will require, cash
settlement, or would have required cash settlement absent an
ability to settle in another manner, from non-GAAP liquidity
measures, other than the measures earnings before interest
and taxes (EBIT) and earnings before interest, taxes,
depreciation and amortization (EBITDA).” A company’s credit
agreement contains a material covenant regarding the
non-GAAP financial measure “Adjusted EBITDA.” If disclosed
in a filing, the non-GAAP financial measure “Adjusted
EBITDA” would violate Item 10(e), as it excludes charges
that are required to be cash settled. May a company
nonetheless disclose this non-GAAP financial measure?
Answer: Yes. The
prohibition in Item 10(e) notwithstanding, because MD&A
requires disclosure of material items affecting liquidity,
if management believes that the credit agreement is a
material agreement, that the covenant is a material term of
the credit agreement and that information about the covenant
is material to an investor’s understanding of the company’s
financial condition and/or liquidity, then the company may
be required to disclose the measure as calculated by the
debt covenant as part of its MD&A. In disclosing the
non-GAAP financial measure in this situation, a company
should consider also disclosing the following:
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the material terms of the credit agreement including the covenant;
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the amount or limit required for compliance with the covenant; and
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the actual or reasonably likely effects of compliance or non-compliance with the covenant on the company’s financial condition and liquidity. [Jan. 11, 2010]
As indicated in C&DI Question 102.09, a registrant must disclose
in its MD&A material items affecting its financial condition or liquidity. The
C&DI emphasizes that a registrant should disclose a measure that is calculated
in accordance with a credit agreement when (1) the credit agreement is a material
agreement, (2) the covenant is a material term of the credit agreement, and (3)
information about the covenant is “material to an investor’s understanding of [its]
financial condition and/or liquidity” (e.g., when the registrant is at risk of
violating the covenant). Disclosure of the measure may be required even if the
measure would otherwise be prohibited under Item 10(e) (see Section 4.1).
In addition to providing the non-GAAP disclosures required by Item
10(e), a registrant should consider the other disclosures described in C&DI
Question 102.09.