How EBITDA is supposed to be calculated under Regulation G
According to the S.E.C. Compliance & Disclosure Interpretations, EBITDA is defined under Regulation G as net income (not operating income) before net interest, taxes, depreciation, and amortization. See below:
Question: Exchange Act Release No. 47226 describes EBIT as "earnings before interest and taxes" and EBITDA as "earnings before interest, taxes, depreciation and amortization." What GAAP measure is intended by the term "earnings"? May measures other than those described in the release be characterized as "EBIT" or "EBITDA"? Does the exception for EBIT and EBITDA from the prohibition in Item 10(e)(1)(ii)(A) of Regulation S-K apply to these other measures?
Answer: "Earnings" means net income as presented in the statement of operations under GAAP. Measures that are calculated differently than those described as EBIT and EBITDA in Exchange Act Release No. 47226 should not be characterized as "EBIT" or "EBITDA" and their titles should be distinguished from "EBIT" or "EBITDA," such as "Adjusted EBITDA." These measures are not exempt from the prohibition in Item 10(e)(1)(ii)(A) of Regulation S-K, with the exception of measures addressed in Question 102.09. [Jan. 11, 2010]
Question: If EBIT or EBITDA is presented as a performance measure, to which GAAP financial measure should it be reconciled?
Answer: If a company presents EBIT or EBITDA as a performance measure, such measures should be reconciled to net income as presented in the statement of operations under GAAP. Operating income would not be considered the most directly comparable GAAP financial measure because EBIT and EBITDA make adjustments for items that are not included in operating income. [Jan. 11, 2010]
The proper way for a public company to compute EBITDA under Regulation G is by starting the calculation with net income (not operating income) and only adding back net interest, taxes, depreciation and amortization. A public company cannot add back other items such as stock-based compensation costs, impairments of fixed assets, or anything else to compute EBITDA. Such errors can materially overstate EBITDA and lead to potential regulatory sanctions. Any different calculation cannot be called EBITDA, but it can be called "Adjusted EBITDA" or some other appropriate name.
Examples of erroneous EBITDA calculations uncovered by the Securities and Exchange Commission
Reviews of public company financial reports by the S.E.C Division of Corporation Finance highlight how EBITDA is required to be computed under Regulation G.
In September 2007, the Division of Corporation Finance told CGG Veritas that its EBITDA calculation erroneously included an adjustment for stock-based compensation:
The acronym EBITDA refers specifically to earnings before interest, tax, depreciation and amortization. However, your measure also adjusts earnings for stock option expense. We will not object to your using such a measure as a liquidity measure but request that you rename it to avoid investor confusion.
In March 2010, the Division of Corporation Finance told Crown Crafts that its EBITDA calculation erroneously included an adjustment for asset impairment charges:
We note that your calculation of EBITDA in the press release furnished as an exhibit includes an adjustment for goodwill impairment charges. As such, the non-GAAP measure should not be characterized as EBITDA. When you include an adjustment that is not included in the definition of EBITDA as set forth in Item 10(e) of Regulation S-K, please revise the title of the non-GAAP measure to clearly identify the earnings measure being used and all adjustments. Refer to question 103.01 of the Division’s Compliance & Disclosure Interpretations on the use of non-GAAP measures available on our website http://sec.gov/divisions/corpfin/guidance/nongaapinterp.htm.
In March 2010, the SEC Division of Corporation Finance told General Finance Corporation that its EBITDA calculation improperly included an adjustment for foreign currency gains and losses:
We note that the measure you call EBITDA does not appear consistent with the definition of EBITDA since it excludes foreign currency exchange (gain) loss and other. Please revise the title of this non-GAAP measure in future filings to accurately reflect the items being excluded. For further guidance see Question 103.01 of our Compliance and Disclosure Interpretation on Non-GAAP Financial Measures, available on our website at www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm.
Below, I will detail how Nature's Sunshine, Willbros Group, Cal Div, and BSQUARE all used improper adjustments to EBITDA which enabled them to report a positive EBITDA instead of a properly calculated negative EBITDA.
In the quarter ended September 30, 2011, Nature’s Sunshine erroneously included share-based compensation expense, contract termination costs, and foreign exchange gains or losses in its EBITDA calculation. In the quarter ended September 30, 2010, it erroneously included loss from discontinued operations, share-based compensation expense, and foreign exchange gains or losses in its EBITDA calculation. See the yellow highlighted items below from its 8-K filing. (Click on image to enlarge):
Note: According to the company's 8-K report, “Other income (expense), net is primarily comprised of foreign exchange gains (losses), interest income, and interest expense.” As I detailed above, foreign currency gains or losses cannot be properly included in an EBITDA calculation.
Nation’s Sunshine should have reported a negative EBITDA in both the three months ended September 30, 2011 and 2010, rather than a positive EBITDA in each period. It erroneously claimed that its EBITDA had doubled to positive $11.505 million in its latest quarter compared to a positive $5.074 in the prior year’s comparable quarter.
Based on my calculations, it should have reported a negative EBITDA of $2.887 million in the quarter ended September 30, 2011 compared to a negative EBITDA of $2.5 million in the previous year's comparable quarter. In other words, its financial performance, as measured by EBITDA, seems like it got worse in 2011 compared to 2010, not better. See my calculations below. (Click on image to enlarge):
Note: The company did not specify the amount of foreign exchange gains or losses for the respective three month periods ended September 30, 2011 and 2010. I was able to calculate that amount by subtracting the totals for the respective six month periods ended June 30, 2011 and 2010 from the totals for the respective nine month periods ended September 30, 2011 and 2010. (See the Statement of Cash Flows in the June 30, 2011 10-Q and September 30, 2011 10-Q reports).
Willbros Group, Inc.
In both the quarters ended September 30, 2011 and 2010, Willbros erroneously started its EBITDA calculation with net income (loss) from continuing operations, rather than net income (loss). In addition, the company erroneously included goodwill impairment costs in its EBITDA calculation. See yellow highlighted items below from 8-K filing. (Click on image to enlarge):
Willbros should have reported a negative EBITDA of $113.640 million instead of a positive EBITDA of $32.186 million for the quarter ended September 30, 2011. In addition, it should have reported a positive EBITDA of $64.035 million instead of a positive EBITDA of $78.745 million for the quarter ended September 30, 2010. Its financial performance, as measured by a correct EBITDA calculation, got worse in latest quarter compared to the previous year. See my calculations below. (Click on image to enlarge):
Cal Drive International
In the quarter ended September 30, 2011, Cal Dive erroneously included non-cash stock compensation expense and non-cash fixed assets impairment charges in its EBITDA calculation. In the quarter ended September 30, 2010, Cal Dive erroneously included non-cash stock compensation expense, non-cash goodwill impairment charge, and non-cash fixed assets impairment charges in its EBITDA calculation. See the yellow highlighted items below from its 8-K filing. (Click on image to enlarge):
In the quarters ended September 30, 2011 and 2010, BSQUARE erroneously included stock-based compensation expense in its EBITDA calculation. See the yellow highlighted items below from its 8-K filing. (Click on image to enlarge):
In addition, BSQUARE disclosed that "Other income or expense consists of interest income on our cash, cash equivalents and investments, gains and/or losses recognized on our investments, as well as gains or losses on foreign exchange transactions." Investment gains or losses and foreign exchange gains or losses cannot be included in an EBITDA calculation. However, the company did not specify such amounts in its recent S.E.C. filings, though they seem to be minimal given the total amounts reported for other income (expense) in each quarter, detailed above.
Other companies identified by this blog using erroneous EBITDA calculations
In the past, this blog has identified eight other companies who used improper EBITDA calculations. Seven of them promptly corrected their EBITDA calculations after this blog reported them. The other company, Overstock.com, now known as O.co, led by Patrick Byrne defiantly refused to correct its improper EBITDA calculations for almost two years. Finally, under pressure, it complied with Regulation G. After this blog uncovered violations of Generally Accepted Accounting Principles (GAAP) which helped Overstock.com fabricate profits, the S.E.C. Enforcement Division opened an investigation of the company for violations of various securities laws. That investigation is ongoing.
The management and audit committees of Nature's Sunshine, Willbros Group, Cal Dive International, and BSQUARE need to study SEC rules governing the calculation of non-GAAP measures such as EBITDA and follow them in future filings. I will continue tracking future financial reports to see if they miscalculate EBITDA and violate Regulation G again.
Sam E. Antar
I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.
If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.
There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. Further, I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.
I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time. My past sins are unforgivable.
I do not own any securities of any of the public companies referred to in this blog post, long or short.