Fitbit IPO’s earnings excludes the bad stuff

June 16, 2015, 1:56 PM UTC

Fitbit, the fitness device company that plans to go public on Thursday, has come up with its own way to track profits. The company is hoping investors will think it’s a better fit than generally accepted accounting rules.

For instance, according to Fitbit’s own profit metric, the fitness company earned a combined $270 million in 2014 and 2013. Based on generally accepted accounting practices, the company’s profit was only $80 million. The divergence has continued this year. The company earned $93 million by its measure in the first three months of 2015. Its actual profit, by standard accounting rules, was $47 million, or roughly half that.

Fitbit calls its measure of profits adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization), and it’s not the only company using this metric. More and more companies, especially a number of tech firms over the past few years, like Etsy and Twitter, are reporting their own version of adjusted EBITDA when highlighting their results to shareholders. And the gap between what companies report as their earnings and what they actually earned is growing, according to a recent study by the Associated Press.

Fitbit is actually in pretty good financial health. The company is profitable, even by standard accounting measures. That better than most other IPOs these days. Of the 37 companies that went public in the first three months of the year, just 10 had turned a profit in the past 12 months. That’s down from just over 43% in 2013.

And Fitbit’s gap between adjusted earnings and its actual profits is smaller than what many other companies are reporting. Last year, Fitbit’s adjusted earnings were $191 million, $59 million more than what it actually netted, by accounting standards. Twitter (TWTR), on the other hand, said its earnings as measured by its adjusted EBITDA metric were $300 million last year. Its actually bottom line profit was a loss of $578 million, a difference of nearly $900 million.

On Tuesday, Fitbit said that it had decided to sell more shares than originally planned, and it upped its price range for the offering, which suggests investors are excited about the IPO. Indeed, the biggest issue investors appear to have with the company is potential competition from Apple and its new watches. Rival Jawbone also sued Fitbit, essentially for corporate espionage.

But investors should take note of Fitbit’s use of adjusted EBITDA. It could signal issues for the company down the road.

The measure does not accord to any specific standard. Companies can exclude anything they want. Fitbit’s adjusted EBITDA, for example, excludes the cost of paying employees in stock options, long after accounting regulators have ruled that a no-no. Along with other things that companies typically exclude, like interest and taxes, Fitbit’s adjusted EBITDA excludes the $107 million the company spent on a product recall. In early 2014, the company recalled its Fitbit Force because some users were having an allergic reaction from the adhesives in the bracelet. The cost of the recall accounts for nearly 56% of the difference between adjusted EBITDA and the company’s actual bottom line.

Companies do regularly exclude one-time events when they report earnings, as it can give investors a better view of how much a firm’s earnings actually grew. For Fitbit, including the charge would have made this year’s earnings growth actually look better, as it would have depressed the company’s profits in 2013 and 2014.

But it’s rare for a company to exclude a one-time event in a metric they are likely to continue to report. And unlike other things that most companies exclude from adjusted EBITDA, a product recall is an operating expense. And it’s not clear how one time it is. In its IPO filing, Fitbit described recent reports that users of another one of its bracelets, the Fitbit Charge, have also had allergic reactions. Some have filed personal injury lawsuits against the company. As of now, Fitbit doesn’t say whether future recalls would be excluded from its adjusted earnings metric. But it seems likely.

Hopefully, Fitbit’s athletic tracking abilities are more reliable than its accounting.

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