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Comment by mbesto | Hacker News Reader

> Dropbox Inc.'s chief executive officer said the company is now generating a profit excluding interest, taxes, depreciation and amortization

FYI - it's very likely that Dropbox is depreciating a HUGE ($100's of millions) amount of data center cost.[0] Translated into a more common "AWS opex cost", might yield a company that isn't really profitable^. EBITDA can be very misleading (not saying it definitely is in this case) so it's always worth analyzing it with a grain of salt until you have all of the full granular details.

[0] - http://www.datacenterdynamics.com/content-tracks/colo-cloud/...

^EDIT - I should have said, "might not be profitable yet".

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> EBITDA can be very misleading

To illustrate, let's consider a company that buys a $100 data centre every 10 years. (To keep things simple, let's assume the data centre is worthless after 10 years.) The data centre generates $20 in revenues for each of those 10 years.

Instead of showing an $80 loss in year 1 and then a $20 profit in years 2 through 10 (with the expectation of another $80 loss in year 11), accountants smooth the numbers based on expectations. The $100 data centre cost is "depreciated" over the expected lifetime of the asset. So one might account $10 of the data centre's cost to each of its ten years, thereby producing $10 of profit each year. This better reflects economic reality.

Ebitda does not include depreciation. The aforementioned company's Ebitda would be $20 for years 2 through 10. This is a small problem in year 2. But if you're an investor in year 10, ignoring that depreciation is the flip side of capital expenditure, you're in for a nasty shock when year 11's predictable capital expenditure comes down the line.

This is correct - good explanation. It's also why good financial professionals/investors look at cash flow statement (follow the money) more so than the income statement.

Good thing Dropbox is free cash flow positive then!

https://techcrunch.com/2016/06/14/dropbox-says-it-is-cash-fl...

How about when they were buying those DCs?

The whole idea of depreciation is spreading large capital expenditures (free cash flow = cash flow from operations - cap. ex.) over many years.

Therefore, free cash flow in any single year does not say much, only when considered over many years.

The key question is, then, those large capital expenditures that are accounting for the large depreciation charges, were they truly one-off, or can we expect them to be recurring?

Having said that, I have made mucho dinero off of investing in companies that have negative earnings due to high depreciation charges from truly one-off expenses (infrastructure investment, foolish purchases by previous management, etc.). Eventually the depreciation tapers off and earnings fall in line with fcf, and I make money.

Great explanation. I was confused about all the financial terms in the article.

Maybe you can further explain the difference between cashflow positive and EBITDA?

Judging from mbesto's comment, back when they were on AWS, those costs would have been included in EBITDA?

So if AWS cost $10/year, would EBITDA be $10?

Yes, it is considered Opex (operational expenditure) with no asset to depreciate over time.

Sort of.

EBITDA is Earnings Before ITDA. Quick example, with super simple math:

Scenario A (AWS)

- Over 5 years, you bring in $1M per year in revenue

- Every year you pay $200k in AWS fees

- Your earnings (Net Income) are $800k per year, your EBITDA is $800k per year

Scenario B (Buy your own hardware)

- Over 5 years, you bring in $1M per year in revenue

- You pay $1M in year one for hardware and depreciate it over the next 10 years at $100k per year

- Your earnings (Net Income) are $800k per year, your EBITDA is $900k per year

There are a ton of nuances to this, but this is generally how it works. As you can see the depreciation schedule affects this a lot, as well as when you choose to make the investment. Hence why it's feasible that Dropbox took out it's largest operating expense, i.e. AWS storage, which literally overnight increased EBITDA. It just so happens to be that a year ago they switched over to their own data center, and now they are touted "EBITDA profitable".

Long story - these stories are kinda stupid unless you get to see the full income statement, balance sheet and cash flow statement.

Wow, I think I finally understand depreciation and you did it in three paragraphs. Kudos.

It's been a while since I researched this (accounting is not my strongest suit), but it always seemed like depreciation schedules for server/datacenter equipment were always super aggressive compared to usable life. For an expanding company, I would assume that for a high growth company with a high datacenter cost structure, this would mean that until growth slows down, net profit will always be "pessimistic" compared to the more abstract "health" of the company.

The aggressive depreciation schedules might be due to the more compute-intensive use cases. Most servers are replaced due to new technology, mainly power consumption improvements. Maybe for low power scenarios the ROI bar for replacement is a lot higher, meaning low power servers get used longer than average. I would expect that Dropbox mostly uses these (I would assume they are more IO bound than compute bound).

If the depreciation schedule is too aggressive, the solution isn't to ignore it but to rework it based on longer useful life assumptions.

That's true, but it's also really hard to do for a new company or new technologies. Dropbox started on AWS, so they don't have much experience running their own datacenters. They'll probably adjust their depreciation schedule in the future when they know better how long useful life really is.

Accelerated depreciation schedules often have tax benefits compared to linear depreciation schedules.

See here for more info: http://www.investopedia.com/walkthrough/corporate-finance/2/...

The depreciation recorded in the books may or may not be the one used to calculate taxes.

When I was working as an accountant, computers were depreciated with a three year life. It's important to understand that an assets useful life often exceeds it's depreciation schedule. If an asset is sold after it's fully depreciated, it's just recorded as a gain.

> Translated into a more common "AWS opex cost",

Weird tangent, but there are methods to classify AWS spend as CapEx; while your typical startup isn't going to bother with it, companies spending in the 8 figure and up range annually on AWS annually do tend to go down that path.

> The recent announcement of a German facility run on AWS to accommodate European data will not be affected but the ability to transfer data from the Dropbox data center at a terabyte per second should speed up the process of migration.

A terabyte per second, am I reading that right? It sounds... Insane?

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