Investorial

Earnings is the number that keeps CFOs awake at night. Nightmares of backlashing shareholders dance in their heads, in fear of a time when that number should ever prove dissappointing.

I’ll preface by saying that I’m not an accountant, and would welcome any comments by people commanding such expertise. Numbers can’t lie, but the game’s stakeholders may use them as tools to mislead and distract from the real issues. Here’s an example of a company creatively presenting earnings figures.

Earnings, EBITDA
But first, let’s get to know what earnings is all about. Simply put, earnings is a company’s total revenue less its total expenses. But following that strict rule can mean it becomes hard to compare companies because each company may have different influencing factors. As well, some expenses are not necessary reflective of operational costs — for example, taxes. And rather than repeating what has already been summarized excellently, I’d ask you to read this investopedia article on the good, the bad and the ugly of EBITDA (Earnings before Interest, Taxation, Depreciation and Amortization). Come back after the article to read about how some companies are creatively reporting earnings.

Vonage Digs Itself A Deeper Hole
It’s not easy being a struggling startup company. There isn’t much good news you can leverage to keep investor attention when you are burning capital, not generating profits, and fighting off the numerous competition out there that seek to undercut your position and market share.

The fallout from Vonage’s disasterous IPO may not have bottomed out yet, but they are certainly trying hard! So when its CEO and founder Jeff Citron made his first post-IPO public appearance at the Convergence 2.0 conference recently, he refused to answer audience questions and was the only speaker to take that stance.

But this story really focuses on how Jeff presented his company’s earnings. It seems that EBITDA was not a good enough measure to report to the public, Jeff used “pre-marketing” EBITDA numbers in a best-efforts attempt to present postive a positive earnings number. Vonage is currently spending approximately 90 cents on every dollar on marketing. Therefore, the convenience of taking that huge chunk of expense out of the earnings formula artificially inflates the number.

Pre-Marketing EBITDA??
Pre-marketing EBITDA is not something that Vonage has invented to distract from its disasterous IPO. Many recent subscriber-based business such as XM Satellite (PDF: 2006 Annual Shareholder Meeting) and Sirius Radio also key on this non-informative metric. It seems that many new subscriber-based companies like to emphasize this number because the majority of their expenses are geared towards marketing efforts to increase their subscriber base.

How relevant is this figure that executives are spinning these figures in the positive light? Can they truly disregard marketing costs as an operations expense? These companies could never hope to reduce marketing costs because they would start bleeding subscribers and marketshare to their competitors.

If I wanted to know how marketing costs is cutting into earnings, I’d rather have that information as a separate figure where I could clearly distinguish an upward / downward trend. Marketing costs as a ratio to total expenses makes better sense. Making marketing costs a relative figure to earnings only serves to convulate the issue.

What You Need To Know
The sneakiest thing that company executives can do in a financial statement is to put the word EBITDA in a paragraph, leading you to believe that they are following accounting conventions. But the number they are reporting may be customized by discounting other expenses chosen to best present a “likeable” earnings number. Be aware of this and make sure you scrutinize the origns of those figures!

Disclosure: I am not long or short on Vonage shares and have no plans to take any such actions in the future. This is neither a buy / sell recommendation on Vonage. I’m merely commenting on how such information delivered by executives through the media need to be taken with a grain of salt!

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