During earnings season, companies disclose a range of financial metrics, such as net income or net loss, revenue, gross margin, and operating profit or loss. Accurately interpreting this data requires experience and keen observation. Is the company performing well, or is it heading 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 uniform standards. Think of them as a digestive after a meal, or a supplement in one's diet.

An article by Deloitte notes: "Non-GAAP measures can serve as a useful supplement to GAAP figures for a comprehensive understanding of business operations and liquidity. Analysts and investors often focus on non-GAAP measures to obtain information needed for their modeling, which is not readily or clearly available from financial statements."

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

Among the many non-GAAP measures, one still dominates.

EBITDA—earnings before interest, taxes, depreciation, and amortization—and its various derivatives, such as adjusted EBITDA, are commonly used non-GAAP financial measures today. This metric allows brands to report profitability while excluding certain factors, such as depreciation. Adjusted EBITDA involves further adjustments on top of an already adjusted measure.

In the retail industry, it is nearly impossible to find a company that does not report some version 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 a company to show?

In theory, they allow companies to present profitability results while excluding certain factors they deem unrelated to overall performance or incidental. For example, a company might use EBITDA to calculate profitability without considering interest on certain debts or depreciation of hard assets like machinery.

But EBITDA has been criticized 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 this non-GAAP measure 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 every year—are looking for any means to report or even highlight 'adjusted earnings' that are higher than the company's GAAP earnings. Managements often try to avoid very real costs by emphasizing 'adjusted EPS,' which makes us nervous. Because bad behavior is contagious: CEOs who openly 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."

—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 tech companies in the market with absurdly 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 measure was "nonsense," adding that depreciation is a real cost and ignoring it does not adequately measure income.

EBITDA allows companies the freedom to choose which items to include or exclude. More importantly, companies can change these choices over time.

"Regarding EBITDA, of course, it's the Wild West," Higson told Retail Dive. "So, the rules on what you can include or exclude in that particular income measure are up to you."

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 measure, reporting only adjusted EBITDA including stock-based compensation expense. Stitch Fix did not respond to Retail Dive's request for comment at the time of publication. 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 have a significant impact on profitability results.

Alphabet—the parent company of Google—is one of a group of tech companies extending the expected useful lives of servers and other equipment, a move that can boost profits and reduce depreciation expenses, according to a May report by The Wall Street Journal. Alphabet in January extended the useful lives of servers and some network equipment from four and five years, respectively, to six years—a move that increased its net income by $770 million for the period ending March 31.

The importance of a company's EBITDA and adjusted EBITDA depends on the items added back or not, Abbie Zvejnieks, senior equity research analyst at Piper Sandler, told Retail Dive.

"I think it's really important to understand the add-backs," Zvejnieks said. "Some companies, you look back, and they added back pre-opening store costs or temporary costs in the supply chain. I think that's where 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, they naturally have more interest," Julian Yeo, clinical professor of accounting at NYU Stern School of Business, told Retail Dive. "Therefore, their net income would 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 retail, many of which are still startups and often not yet profitable, 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 equity research analyst at Wedbush.

"We also 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 companies that went public in 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, Warby Parker co-founder and co-CEO Neil Blumenthal told Retail Dive.

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

—Neil Blumenthal, Warby Parker co-founder and co-CEO

"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 judge long-term success."

For such companies that are loss-making and burning cash, Nikic said it's 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... a lot of times you hear companies somewhat interchangeably use EBITDA 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're profitable," Yeo said. "If net income is not positive, we may need to look at items above the net income line." For example, when valuing a company with net losses, Yeo said experts would next look at whether EBITDA is positive.

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

Among companies that went public in the past five years, Warby Parker is one. 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 yet achieved net income on an annual basis, although adjusted EBITDA remains positive. Its annual net revenue, adjusted EBITDA, and net loss/income for fiscal years 2018 to 2022 (in USD).

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 the measure.

"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 the idea that EBITDA or adjusted EBITDA is not a pure metric is almost irrelevant. What matters is what investors use to make investment or non-investment decisions."

Warby Parker reported in August that its second-quarter net revenue increased 11% year over year to $166.1 million, with net loss narrowing to $15.9 million. The brand highlighted that its adjusted EBITDA margin improved to 8.5%, with adjusted EBITDA rising 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 (which had hindered overall optical industry growth) continue to normalize. The executive expects e-commerce growth to return even as the brand 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 sports brand On, which reported in August that its second-quarter adjusted EBITDA nearly doubled from the same period last year 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 look at its financial filings shows that since 2018, the company has steadily increased its positive adjusted EBITDA (data since 2014 is not readily available), but recorded annual net losses between 2019 and 2021.

On turned from net loss to net income in fiscal 2022, as the sports brand's net revenue exceeded CHF 1 billion. Its annual net revenue, adjusted EBITDA, and net loss/income for fiscal years 2018 to 2022 (in CHF).

The costs On excludes when calculating adjusted EBITDA are also increasing. In fiscal 2022, depreciation and amortization costs excluded from On's 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, as 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, consistent with our strategy of achieving significant growth while improving profitability."

On turned to net income in 2022, with annual net income reaching CHF 57.7 million that year. But not all companies are so fortunate.

DTC brand Allbirds has been undergoing a transformation plan, which so far has included 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, while net loss improved 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, just like its net loss.

Since 2019, Allbirds' net loss and adjusted EBITDA loss have grown at similar rates. Its annual net revenue, adjusted EBITDA, and net loss/income for fiscal years 2019 to 2022 (in USD).

The brand's depreciation and amortization costs excluded from its 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 acknowledging they made operational mistakes and allowing the negative impact to show on the EBITDA line," Nikic added.

When asked how it measures profitability, Allbirds said it has historically "provided financial guidance on net income and adjusted EBITDA. We are in the midst of a strategic transformation, which has us even 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 are undoubtedly relying on it to showcase growth. Even when it sometimes differs significantly from a brand's net income or net 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 will achieve EBITDA profitability before net income or EPS profitability," Nikic said. "It's easier for a company at some point to point and say, 'Hey, look, we're going to be EBITDA profitable in two or three years.' That's a more compelling argument."