Adjusted EBITDA is a measure of profitability without counting interest, tax, depreciation, and amortization. It can be used as a nice reference point for companies that are showing improved benefits from scaling their operations. That's why tech companies are quick to point to EBITDA profitability as an indication that their business will turn a GAAP profit in the future.
The issue with Blue Apron using adjusted EBITDA as a claim to profitability is that revenue is tanking. Fourth-quarter sales were down 25% year over year. Blue Apron isn't scaling; it's scaling back. And it's not showing any operational leverage, which is normally what's implied when a company announces EBITDA profitability.
Notes in the margins
A metric investors need to be keeping a closer eye on rather than EBITDA is Blue Apron's operating expenses as a percentage of revenue.
Blue Apron might point to improved operating margin in 2018 compared to 2017, but all of the efficiencies are a benefit of lower cost of goods sold. Decreasing cost of goods sold is a result of improved automation and capacity in the company's Linden facility.
But there's only so much the company can optimize its cost of goods sold. The benefits ought to continue into 2019 as Blue Apron reduces headcount in its Arlington facility and shifts more production to Linden. But there's not much room to improve cost of raw materials (i.e. food) or shipping expenses associated with the product.
Investors will get a better sense of the company's ability to show profitability at scale by looking at its operating expenses as a percentage of revenue. Unfortunately, that number is heading in the wrong direction.
In 2018, marketing and product, technology, general, and administrative expenses combined to account for 46.7% of revenue. They combined to account for just 45.7% in 2017. The gap was worse in the fourth quarter -- 46.7% in 2018 versus 41.8% in 2017.
Blue Apron's strategy of spending less on marketing but attracting a higher concentration of high-value customers isn't showing any progress. Indeed, the company's payback period has extended to over one year.
Don't discount depreciation
Another important factor about Blue Apron's focus on EBITDA profitability is that a lot of its cost-of-goods-sold improvements are tied to the equipment in its Linden facility. Operating that expensive equipment does come with a cost -- depreciation.
Depreciation and amortization expenses climbed 28.6% year over year in 2018. That rate of growth slowed significantly in the fourth quarter, however, up just 3.9%.
Investors shouldn't discount the depreciation of Blue Apron's equipment. While it's a noncash expense, the mechanical equipment is likely to require repairs and replacement over time.
To be fair, the improvements in gross margin more than offset the impact from higher depreciation and amortization. But investors need to pay attention to the expense since the equipment is tied so closely to producing Blue Apron's product.
Blue Apron's push to focus on EBITDA profitability may have some investors overlooking some troubling trends at the company. Investors shouldn't be so quick to get excited about the metric without looking more closely at how its operating and depreciation expenses are trending as a percentage of revenue.