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The magic of adjustments: ebitla-dee-

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APRIL 26, 2018
By: Jamie Powell


Yesterday, after a gleeful few hours running through the prospectus for
WeWork's $500m bond offering, we posted a summary of newly disclosed
financials for the free-beer toting office rental businesses. Spoiler: they aren't
the healthiest.
One financial metric that caught our eye was what WeWork called
“Community Adjusted Ebitda”, a rather quixotic take on the famous Ebitda
One of the most popular financial acronyms, standing for earnings before
interest, tax, depreciation and amortisation, it's often used as an easy
indication of a company's cash flow.
By adding back non-cash charges, such as a depreciation, to operating profit,
curious investors can get a handle on how cash generative a businesses core
operations are. The approach is particularly useful when figuring out the level
of interest payments a business can handle, for instance.
WeWork's metric of choice got us thinking -- what are our favourite adjusted
metrics from over the turbulent course of financial history? Here are four
which sprung to mind, starting with WeWork.
WeWork - Community Adjusted Ebitda
Here is the breakdown from the bond prospectus (right click and open in a
new tab to embiggen):
Quill Cloud
In effect WeWork are choosing to add back a swathe of costs, which it claims
are unrelated to the day-to-day operations of its office spaces, helpfully
moving the Ebtida figure from red to black. Hawk-eyed readers may notice
$139m, or 12 per cent, of this adjusted figure is from adding back sales and
marketing costs.
As total sales and marketing spend for 2017 was $143m, WeWork appears to
be telling potential bond investors that 97 per cent of this operating expense is
non-recurring. In other words, it is attributable solely to the opening of new
office sites.
Given occupancy rates in mature WeWork locations, defined as being open
eighteen months, are near-90 per cent, and overall occupancy is 81 per cent,
one would imagine a portion larger than 3 per cent of sales and marketing
might be attributable to maintaining occupancy.
For instance Kindred Group, who has 1,353 employees globally and occupied
a large portion of WeWork Southbank Central's second floor, churned to a
new office in Wimbledon after several months in the space last year. It must
cost something to let potential customers know there are desks available,
Sophos Group - Cash Ebitda
Sophos Group are a £2.3bn IT network security products business who seek
to “tackle security challenges with clarity and confidence”. A key metric for
Sophos, presented directly below revenue on page sixteen of its 2017 annual
report, is Cash Ebitda.
Here is how this metric breaks down (do the right-click-trick again to enlarge):

Quill Cloud
So, for the year ending March 2017, Sophos turned a $44.3m net income loss
into a $150m cash Ebitda gain. Quite a feat.
Adding back amortisation, depreciation, deferred revenue and share-based
payments is pretty standard. All of these charges arguably represent non-cash
costs, or in the case of deferred revenue, cash coming into the company
which has yet to be recognised on the income statement.
The striking add-back is 'Exceptional Items', particularly as this line has
cropped up every year since Sophos listed in 2015, contributing $90m, or 24
per cent, to the aggregate cash Ebitda total over the past three years.
When examining these exceptional items in detail, we find a recurring theme -
litigation costs.
In 2015 Sophos spent $7.5m on unspecified intellectual property litigation; in
2016, it spent $19.8m on similar litigation, including a payment to Fortinet to
settle allegations of both IP infringement and staff poaching; and in 2017
spent a further $24.6m on IP litigation, $15m of which was paid Finjin after a
Californian jury found Sophos had infringed five patents.
Exceptional items are one-offs, such as restructuring costs if you are selling
off part of a business. Three straight years of costs relating to lawsuits could
be viewed as a recurring cost of doing business.
RH - Adjusted Net Income
RH, or the artist previously known as Restoration Hardware, is a $1.9bn
market cap retailer who specialise in selling home furnishing products. Famed
for its colourful chief executive officer Gary Friedman, who once referred to
RH as a “ burning building” in an internal memo, the company last year spent
exactly $1bn buying back stock.
In the same year, RH reported $2m of net income.
Not to worry though, as as the luxury furnisher also reported $89m
of adjusted net income, a 4360 percent increase on the net income line:

Quill Cloud
Included in the smorgasboard of reconciled costs were goodwill impairment,
non-cash compensation, recall accrual, asset impairments, loss on
extinguishment (sic) of debt and so on and so on.
There is plenty to digest in the list. Notable is the non-cash compensation line,
including $23.9m payment of a fully-vested option grant to Mr Friedman. The
year before the option charge of $3.7m was made in connection with the
acquisition of Waterworks, a premier bathroom business, purchased by RH for
By the end of 2017, and Waterworks was not doing as well as RH may have
hoped. In fact, the $34m goodwill impairment cost, reconciled above, is
a write-down of Waterworks. According to the 10-K, the revenues and
EBITDA from the unit did not meet RH's projections.
Some investors might disagree with RH's categorisation of this write down as
non-cash cost, seeing as it shelled out $117m for the underperforming
business only a year before.
Groupon - Adjusted CSOI
Who doesn't love Groupon, which takes the effort of clipping offers from
magazines and replaces it with void day filling experiential spam.
Back in 2011, in preparation for what would become the largest technology
offering on the Nasdaq since Google, Groupon filed its S-1 form with the SEC.
One particular income metric stood out; “Adjusted CSOI”, or adjusted
consolidated segment operating income.
Groupon described the non-traditional figure as:
an important measure of the performance of our business as it excludes
expenses that are non-cash or otherwise not indicative of future operating
But how did it calculate this magical figure? See below:
Quill Cloud
In 2010, thanks to adding back various costs, Groupon swung a $420m
operating loss into a $61m adjusted operating profit.
Half the adjustments came from Groupon adding back online marketing costs,
which was a surprising move for a group whose business was marketing
offers online.
Fortunately, common sense prevailed. Under pressure from investors, media
and the SEC itself, Groupon removed the metric from its S-1 two months after
the first filing. Here's how the stock has fared since:

Quill Cloud
If you have any other examples of creative financial metrics, do let us know in
the comments below.