During earnings season, companies disclose a range of financial metrics, such as net income or loss, revenue, gross margin, and operating income or loss. Interpreting these metrics accurately requires an experienced observer. Is the company performing well and moving toward profitability? Earnings reports can provide clues.

However, complicating matters is the existence of non-GAAP (Generally Accepted Accounting Principles) financial metrics, which are unaudited and lack standardization. Think of them as a digestive after a meal, or a supplement to one's diet.

An article by Deloitte notes: "Non-GAAP measures can serve as a useful complement to GAAP figures for a comprehensive understanding of business operations and liquidity. Analysts and investors often focus on non-GAAP measures to obtain information for their models that is not readily clear from financial statements."

Due to the increasing use of non-GAAP metrics, their potentially misleading nature, and the widening gap from GAAP figures, the U.S. Securities and Exchange Commission (SEC) has shown increased interest in such metrics. The SEC even updated its webpage of frequently asked questions about non-GAAP metrics in December.

Among non-GAAP metrics, one still holds a dominant position.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and its various derivatives, such as adjusted EBITDA, are commonly used non-GAAP financial metrics today. This metric allows brands to report profitability while excluding certain factors, such as depreciation. Adjusted EBITDA involves further adjustments on top of the already adjusted metric.

In the retail industry, it is difficult to find a company that does not report some form of EBITDA. Brands such as Warby Parker, On, Purple Innovation, Peloton, and Allbirds all report adjusted EBITDA.

EBITDA has both supporters and critics. So, what exactly is it, and why do brands focus on it so much?

The 'Wild West' of Metrics

What exactly can EBITDA and adjusted EBITDA allow companies to show? In theory, they allow companies to report profitability while excluding certain factors they deem irrelevant to overall performance or incidental. For example, a company might use EBITDA to calculate earnings without considering interest on certain debts or depreciation of hard assets like machinery.

But EBITDA has faced criticism for its lack of standardization. Its most famous critic is Warren Buffett, Chairman and CEO of Berkshire Hathaway, who has publicly expressed his views on non-GAAP metrics for years. In his 2001 letter to shareholders, he mentioned that references to EBITDA "make us shiver."

Buffett added in his 2017 letter to shareholders: "Too many managements - and the number seems to grow yearly - are looking for any means to report, or even highlight, 'adjusted earnings' that are higher than the company's GAAP earnings. Managements that regularly attempt to erase real costs by emphasizing 'adjusted EPS' make us uneasy. Because bad behavior is contagious: CEOs who publicly seek to report high numbers often cultivate a culture where subordinates also strive to 'help.'"

The battle against reporting EBITDA has objectively been lost, but Buffett is not the only critic.

"Regarding EBITDA, of course, it's the Wild West."

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Chris Higson

Professor of Accounting Practice at London Business School

In 2013, Chris Higson, Professor of Accounting Practice at London Business School, wrote that EBITDA's popularity began in the 1990s when "there were many loss-making technology companies in the market with extremely high valuations. Since EBITDA is more likely to be positive than EBIT, it provided a useful basis for valuation multiples."

Higson wrote at the time that the view of EBITDA as a better profit metric was "nonsense," adding that depreciation is a real cost and ignoring it does not adequately measure income.

EBITDA allows companies the freedom to choose what to include or exclude. Moreover, companies can change these choices over time.

"Regarding EBITDA, of course, it's the Wild West," Higson told Retail Dive, a sister publication of Industry Dive. "So, you can freely decide the rules for what is included or excluded in that income metric."

Online retailer Stitch Fix reported both adjusted EBITDA and adjusted EBITDA excluding stock-based compensation expense in its fiscal 2020 annual report, with the latter defined by the company as "a significant recurring expense in our business."

But in its fiscal 2021 annual report, Stitch Fix stopped reporting the second metric, reporting only adjusted EBITDA including stock-based compensation expense. As of publication, Stitch Fix had not responded to Retail Dive's request for comment on the change. The company's stock-based compensation expense increased from $67.5 million in fiscal 2020 to $127.4 million in 2022.

Depreciation costs related to assets can significantly impact earnings results. Alphabet - Google's parent company - is one of the tech companies extending the estimated useful lives of servers and other equipment, a move that can increase profits and reduce depreciation expenses, according to a May report from The Wall Street Journal. Alphabet adjusted the useful lives of servers and certain network equipment from four and five years, respectively, to six years in January - a move that increased its net income by $770 million for the quarter ending March 31.

The importance of a company's EBITDA and adjusted EBITDA depends on what is added back, Abbie Zvejnieks, senior equity research analyst at Piper Sandler, told Retail Dive.

"I think it's very important to understand the add-backs," Zvejnieks said. "Some companies, when you look back, they're adding back pre-opening store expenses or temporary costs in the supply chain. I think it gets a bit tricky because those are real expenses. Like, should we really be adding those back?"

However, EBITDA can be useful as an internal metric if companies are trying to pressure managers to improve profit margins, Higson said. The metric is also sometimes used to compare the performance of a group of similar companies within an industry.

"If you have two companies, one with a lot of debt naturally has more interest," Julian Yeo, clinical professor of accounting at New York University's Leonard N. Stern School of Business, told Retail Dive. "Therefore, their net income will be lower, so the two companies are no longer comparable."

So, what does EBITDA look like in practice in the direct-to-consumer (DTC) market?

Show Me the Money

Discussions about EBITDA and profitability can vary depending on a company's age. DTC brands in the retail space, many of which are still startups, often are not yet profitable and may use EBITDA as an indicator of potential.

From an analyst's perspective - especially those covering recently established companies - earnings per share is often the primary profitability metric, said Tom Nikic, senior vice president and head of equity research at Wedbush.

"We also do look at the company's enterprise value to EBITDA ratio for valuation purposes," Nikic told Retail Dive. "I think one reason it has gained more attention recently is that most of the batch of companies that went public over the past five years or so have not achieved net income profitability."

EBITDA as a metric has a lot to do with the stage a company is in, Neil Blumenthal, co-founder and co-CEO of Warby Parker, told Retail Dive.

"At the end of the day, as an entrepreneur and executive, I manage the business based on the real world."

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Neil Blumenthal

Co-founder and Co-CEO of Warby Parker

"It really depends on how investors view the business," Blumenthal said. "For growth companies, EBITDA and adjusted EBITDA seem to be the best metrics many investors use to measure long-term success."

For such loss-making and cash-burning companies, Nikic said it is important to understand how long a brand's cash can last.

"There's a sense that EBITDA tends to be closer to cash flow than net income," he said. "Because you add back some non-cash expenses... Many times you hear companies almost use EBITDA interchangeably with cash flow."

However, ultimately, a company's bottom line is the primary indicator of profitability, Yeo said.

"We always look at the bottom line. If net income is positive, we are profitable," Yeo said. "If net income is not positive, we may look at items above the net income line." For example, when valuing a company with net losses, Yeo said experts next look at whether EBITDA is positive.

According to the SEC, net income is the GAAP metric most comparable to EBITDA and adjusted EBITDA. But looking at these numbers side by side can sometimes tell two very different stories. Observing various DTC brands reveals that there can be significant differences between these metrics.

Among companies that went public in the past five years, Warby Parker went public in 2021 through a direct listing. The company is in a growth stage, and investors view it that way, Blumenthal said, which determines which metrics Warby Parker and its shareholders focus on.

Warby Parker Has Not Achieved Annual Net Profit, But Adjusted EBITDA Remains Positive

Warby Parker's annual net revenue, adjusted EBITDA, and net loss/income (USD) for fiscal years 2018 to 2022.

The fact that investors are interested in adjusted EBITDA is enough for this eyewear company to continue reporting the metric, Blumenthal said, despite criticism of it.

"At the end of the day, as an entrepreneur and executive, I manage the business based on the real world," Blumenthal said. "So I always start from the investor's perspective... I think it almost doesn't matter that EBITDA or adjusted EBITDA is not such a pure metric. What matters is what investors use to make investment or non-investment decisions."

Warby Parker reported in August that second-quarter net revenue increased 11% year over year to $166.1 million, with net loss narrowing to $15.9 million. The brand touted its adjusted EBITDA margin improving to 8.5%, with adjusted EBITDA increasing to $14.2 million.

Warby Parker's fiscal 2022 adjusted EBITDA excluded $31.9 million in depreciation and amortization expenses, up 47% from the previous year.

Looking ahead, Blumenthal is optimistic about Warby Parker's future as COVID-19 pandemic trends that hindered the overall eyewear industry continue to normalize. The executive expects e-commerce growth to return even as the company continues to invest in its physical store strategy.

"I remain very bullish on e-commerce; it will continue to grow, it just needs to normalize," Blumenthal said.

One of the current DTC success stories is sportswear brand On, which reported in August that second-quarter adjusted EBITDA nearly doubled to CHF 62.7 million (approximately $70 million at the time of publication). Meanwhile, net income fell 93.3% to CHF 3.3 million. On's net sales increased 52.3% year over year to CHF 444.3 million.

The brand previously told Retail Dive in January that it has been profitable since 2014. A review of its financial documents shows the company has steadily improved adjusted EBITDA since 2018 (2014 data is not readily available), but recorded annual net losses between 2019 and 2021.

On Turned from Net Loss to Net Profit in Fiscal 2022, with Net Revenue Exceeding CHF 1 Billion

On's annual net revenue, adjusted EBITDA, and net loss/income (CHF) for fiscal years 2018 to 2022.

The costs On excludes when calculating adjusted EBITDA are also increasing. Depreciation and amortization expenses excluded from fiscal 2022 adjusted EBITDA reached CHF 46.4 million, up from CHF 31.4 million the previous year.

"Adjusted EBITDA will continue to be an important metric for us because it is the best comparable way to measure our profitability," On told Retail Dive via email. "Since 2014, we have consistently improved our adjusted EBITDA margin each year, which aligns with our strategy of achieving significant growth while improving profitability."

On achieved net profit in 2022, with annual net income reaching CHF 57.7 million. But not all companies are so fortunate.

DTC brand Allbirds has been undergoing a transformation plan, including executive changes and layoffs, to focus on a path to profitability. The company's latest second-quarter earnings beat expectations, with net revenue declining only 9.8% year over year to $70.5 million, and net loss improving 1.5% year over year to $28.9 million. Allbirds' quarterly adjusted EBITDA loss improved year over year from $20.8 million to $18.3 million.

Since fiscal 2019, Allbirds' annual adjusted EBITDA has been negative, accompanied by net losses.

Allbirds' Net Loss and Adjusted EBITDA Loss Have Grown at a Similar Rate Since 2019

Allbirds' annual net revenue, adjusted EBITDA, and net loss/income (USD) for fiscal years 2019 to 2022.

The depreciation and amortization expenses excluded from the brand's fiscal 2022 adjusted EBITDA loss increased 61% year over year to approximately $15.8 million. But the retailer also made another significant change in 2022. When calculating adjusted EBITDA, Allbirds chose to include costs related to its discontinued apparel business, which increased its loss by approximately $17.1 million. Previously, the retailer had excluded these costs, which "made their adjusted EBITDA look better because it allowed them to show a smaller operating loss," Nikic told Retail Dive via email.

"The change they made is a more conservative stance, essentially admitting they made operational mistakes and letting the negative impact show on the EBITDA line," Nikic added.

When asked how it measures profitability, Allbirds said it has historically "provided financial guidance on net revenue and adjusted EBITDA. We are in the midst of a strategic transformation, which has made us more focused on reaccelerating growth, with the goal of achieving positive free cash flow and positive adjusted EBITDA by 2025."

Whether EBITDA or adjusted EBITDA is an adequate measure of profitability, brands undoubtedly rely on it to demonstrate growth. Even when it sometimes differs significantly from a brand's net income or loss. Despite the differences in how brands report EBITDA and the mixed opinions on its usefulness as a metric, it is likely to remain a key part of brand earnings reports.

"Naturally, you first achieve EBITDA profitability, and then net income or EPS profitability," Nikic said. "It's easier for a company to point and say, 'Hey, look, we're going to be EBITDA profitable in two or three years.' That's a more compelling argument."