Explanatory Note to CVM Instruction 527

EXPLANATORY NOTE TO CVM INSTRUCTION NO. 527, OF OCTOBER 4, 2012 Ref: CVM Instruction No. 527, of October 4, 2012, which provides for the voluntary disclosure of non-accounting information known as EBITDA and EBIT.

I – INTRODUCTION
The frequent disclosure of information and measurements by publicly held companies based on adjusted accounting data and non-accounting data raises concerns that must be observed by the administrators of publicly held companies, with a view to preserving the quality of information directed to investors.

Non-accounting measurements and information comprise all information that is not a structured representation of accounting information as provided for in Pronouncements issued by the Accounting Pronouncements Committee – CPC and approved by the Securities and Exchange Commission (CVM), but which compete with the same purposes of so-called general purpose financial statements, in terms of item 9 of Technical Pronouncement CPC No. 26 – Presentation of Financial Statements.

The relevance of this topic is evident, as this information influences the economic decisions of users, adding elements not foreseen in the usual structure of financial statements based on its own regulation and audited by independent auditors.

An example of this information is that related to earnings before interest, income tax, depreciation and amortization – EBITDA, and earnings before interest and income tax – EBIT. Mention of these concepts may occur in the directors' comments in the reference form (CVM Instruction No. 480/09), in the management report, in prospectuses, press releases, communications, or other public documents.

The disclosure of these non-accounting information, in order to preserve the quality of information directed to the public, must receive the same treatment and care devoted to accounting information. In this sense, it was observed that the information on EBITDA and EBIT is being prepared and disclosed in a very particular way by publicly held companies and in a divergent manner among them.

This situation can make it difficult to understand both the formation of the number presented and its integration or reconciliation with the other numbers of the income statement. In many cases, it is relevant to observe that the reported numbers are not comparable with the information provided by other publicly held companies.

Thus, the concern of the CVM, which motivated the preparation of CVM Instruction No. 527/12, was based on the understandability and comparability of the indicator disclosed to the market, whose main commands are intended to be detailed in this explanatory note, for its better understanding and application.

II - EBITDA AND EBIT
If the intention is to reflect the administration's view on the company's gross cash generation potential, or at least an approximation of this generation, the adjustments made to EBITDA must establish a relationship with the measurements provided for in accounting standards, as does the statement of cash flows itself, by the direct method.

With this, the first conclusion is that values that do not appear in the financial statements, in this case, the income statement, should not enter into the composition of EBITDA or EBIT.

Adjustments that are not related only to interest, taxes on profit, depreciation, amortization, and depletion are usually introduced, extrapolating the very content of the title given to these indicators. Some of these adjustments concern non-recurring items, with the aim of trying to show the recurring gross cash generation potential of non-financial assets.

Initially, the most relevant is that the title given to the indicator does not exclude, by itself, any non-recurring, non-operational, and discontinued operations items. Thus, it is inferred that the first and simplest concept of EBITDA refers to the amount given by the addition, to the net income of the period, solely of taxes on profit, net financial expenses from financial revenues, and depreciation, amortization, and depletion. It is worth remembering that the concepts of depreciation, amortization, and depletion mentioned here refer to non-monetary items classified in non-current assets, in the investment groups (investment properties), fixed assets, and intangible assets.

Within this line, the concept of EBIT corresponds to that of EBITDA decreased by depreciation, amortization, and depletion.

However, the literature often refers to the figure of gross resource generation potential with the adjustment of some items that the administration understands do not contribute to this gross resource generation. It is important to ensure that these adjustments do not make the indicator incomprehensible and incomparable among the companies that disclose it.

III - ADJUSTED EBITDA AND EBIT
It is important to remember that Brazilian legislation no longer segregates, since 2008, from Law No. 11.941/08, the previously called "non-operating results", only referring to "other revenues" and "other expenses", leaving this characterization to specific accounting standards.

With the approval of Technical Pronouncement CPC 26 – Presentation of Financial Statements, the following minimum structure of the income statement is obtained:

“82. The income statement of the period must, at a minimum, include the following items, also complying with legal determinations:
(a) revenues;
(b) cost of products, merchandise, or services sold; (c) gross profit; (d) expenses with sales, general, administrative, and other expenses and operating revenues; (e) share of results of invested companies recognized through the equity method; (f) result before financial revenues and expenses; (g) financial expenses and revenues; (h) result before taxes on profit; (i) expense with taxes on profit; (j) net result of continuing operations; (k) net value of the following items:
(i) net result after taxes of discontinued operations; (ii) result after taxes resulting from measurement at fair value less selling expenses or on the derecognition of assets or groups of assets held for sale that constitute the discontinued operating unit; (l) net result of the period.”

Note that this structure, where the only revenues and expenses left aside concern the content in letter (k), covering the net result (including taxes) of discontinued operations, highlights in the structure of the income statement relevant information regarding the result arising from continuing activities and those arising from discontinued operations. This identification is fundamental for the current and future assessment of the entity's performance.

It is important to emphasize that the CPC Basic Conceptual Pronouncement that deals with the Conceptual Structure and Disclosure of Financial Reporting highlights this predictive power of the income statement when dealing with financial performance reflected by the accrual basis:

OB18. Information about the financial performance of the reporting entity that reports information during a period that are reflections of changes in its economic resources and claims, and not of the additional obtaining of resources directly from investors and creditors (see item OB21), are useful to assess the entity's past and future capacity to generate net cash flows. These information serve as indicators of the extent to which the reporting entity has increased its available economic resources, and thus its capacity to generate net cash flows through its operations and not by obtaining additional resources directly from investors and creditors. (emphasis added)

However, it is common practice in the capital market for publicly held companies to disclose an indicator that includes additional adjustments to the period's result in order to generate information regarding its future gross cash generation potential. These adjustments, added to those provided for in item II above, result in the determination of Adjusted EBITDA/EBIT and are derived from the administration's judgment regarding their representativeness in determining the specific future gross cash generation potential of the entity.

Thus, since these adjustments result from the administration's judgment regarding their effects on determining the entity's gross cash generation potential, nothing more relevant than the disclosure of the premises considered in their judgment when preparing the Adjusted EBITDA/EBIT.

Additionally, the motivation and nature of the adjustments made must be described, as well as a reconciliation between the period's result and the Adjusted EBITDA/EBIT, all for the adequate understanding of the indicator and its comparability with those from other peers, sectoral or not.

IV - PERMITTED DISCLOSURES AND RESTRICTIONS
In view of the content up to this point, it is verified that the company may disclose a value for EBITDA and one for EBIT of the period and also that relative to the Adjusted EBITDA or EBIT of the period.

Thus, the company may disclose exclusively the concept of EBITDA or EBIT provided for in item II, or the concept of Adjusted EBITDA/EBIT, provided for in item III, provided that the latter is presented together with the first. In the latter case, complete disclosure of the motivation, nature, and values of the adjustments introduced must be given, as well as its reconciliation with the EBITDA/EBIT provided for in item II and the period's result, without, under any circumstances, compromising the concepts of these measurements (EBIT and EBITDA) or the determinations of CVM Instruction No. 527/12 duly clarified in this explanatory note.

Furthermore, all disclosure related to EBITDA or EBIT must be done consistently and comparably with the presentation of previous periods and, in case of change, the justification must be presented, as well as the complete description of the change introduced.

The disclosure of EBITDA or EBIT values must also be done outside the complete set of financial statements provided for in items 10 to 14 of Technical Pronouncement CPC 26 – Presentation of Financial Statements, so that these measurements do not compete with information of an exclusively accounting nature presented therein.

V – AUDIT
Although EBIT and EBITDA do not integrate the complete set of Financial Statements contained in Technical Pronouncement CPC 26 – Presentation of Financial Statements, it must be submitted to verification work by the independent auditor.

This verification aims to provide adequate assurance regarding the origin of the values and their reliability, factors that are essential for the reliability of any information disclosed to the market.

Considering that all adjustments made in the calculation of EBIT and EBITDA originate from the company's accounting records and that these were subject to assurance by the independent auditor, there is no reason for the indicator not to be identified as verified, in accordance with standard NBC TA 720 (Auditor's Responsibility Regarding Other Information Included in Documents Containing Audited Financial Statements) issued by the Federal Council of Accounting.

Thus, it is the responsibility of the independent auditor to verify only whether the adjustment amount originates from the company's accounting records, and it is not necessary to validate the administration's judgment regarding the adjustments included in the calculation of the EBITDA/EBIT indicators.

VI – EFFECTIVE DATE AND SCOPE
CVM Instruction No. 527/12 must be applied to information related to EBITDA and EBIT disclosed from January 1, 2013, which includes disclosures about these indicators made in statements closed on December 31, 2012, duly supported by verification work by auditors as determined in this Instruction.

Original signed by
LUCIANA PIRES DIAS
Interim President