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Groupon Inc. (NASDAQ:GRPN)

Deutsche Bank dbAccess Media & Telecom Conference Transcript

March 5, 2013 2:05 PM ET

Executives

Jason Child - Chief Financial Officer

Analysts

Ross Sandler - Deutsche Bank

Ross Sandler - Deutsche Bank

We're good to go, okay. Okay, yeah we're going to get started here. Thanks for joining us, again Ross Sandler from Deutsche Bank Internet Research. We are very happy to have Jason Child, CFO of Groupon here with us today. It's been a pretty interesting week for you guys, to say at least, which is good (Inaudible). So what's the plan now, who would make a logical candidate for the CEO position and what business model changes if anything could we see or is it beyond this path and there isn't going to be that much changes.

Jason Child

Well, let me start by saying to sense the change was made last Thursday we went ahead and announced an interim Office of the CEO, which is a couple of people that are in perfect position to do this, because they both been with Groupon since early and Eric Lefkofsky, who's the Chairman of the Board and actually he was the first investor Co-Founder actually with Andrew. He's been there since day one.

And then Ted Leonsis who's been there since -- I think the first or second year of operation. And the combination of those two; Eric with incredible operational chops, really understands the culture well, since he was there helping the company from day one. And then Ted who really is a strong marketer, also a great operator, has a great internet background himself. We think we're in really good position to kind of (Inaudible) EBIT as we execute against the plan for 2013.

We actually just completed our first ever strategic and operating plan for the year, it was actually just finished over the last couple of weeks. And so we have a very strong vision and set of specific things that we want to execute and we're going to execute against those over the next couple of quarters.

In the meantime we'll be looking for the right long-term replacement but we'll take our time to make sure we find the exact life fit. I would not expect there to be any sort of business model changes or anything like that like I said the board approved our plan and is very much in favor of the stuff that we've been working on. You saw the strong growth that we saw in Q4 and we're going to keep executing across that same playbook.

Ross Sandler - Deutsche Bank

Okay. When we'll go into the details from the quarter but if you just take a step back and we look at the last call it 18 months, how do you feel about the stability of the business today from your standpoint, are we still in kind of a fluctuating mode or do you think that given the results in 4Q the business is stable to improving?

Jason Child

Our business, is really kind of two business, we have a north America business, which is roughly about half of the business, that business has been very stable all year long with solid growth at 50% plus year-on-year throughout the year. And very profitable and had solid profits throughout the year, as well as free cash flow.

Then you have the international business which is -- business, it's only about two and a half years old, it's gone from virtually nothing to $2.5 billion in gross billings and transaction volume over the past two and a half years. And that business has, we've had some struggles in trying to get the right infrastructure in place to be able to support growth across 46 countries outside of North America and in international particular, we actually saw growth slow throughout the year and profitability actually put to negative in Q4.

So the solution to that challenge is actually pretty clear and that is to basically take the same technology and processes that we implemented -- developed and implemented in North America and implement those in international. In fact there's actually a deck that we just posted on our website that's an update from last quarter and basically spells out exactly what the difference is between the processes and technology between North America and the international are, some of the highlights are we have, you know the SmartDeals technology which helps us personalize our deals to everyone of our individual customers and subscribers that's implemented in the UK and we're actually going to implementing that in the rest of the European countries throughout the next two quarters.

We also have the [DealBank] which is the technology that allows us to store virtual inventory where that inventory North for example is 37,000 deals that we featured in Q4 which is up from less than 10,000 a year ago. That's critical to being able to provide relevant deals for all of our customers. That's the technology that we're also just employing internationally.

And then lastly there's a number of automation tools regarding how we target deals and then how the deal actually goes from being sold to being featured and there's a bunch of support people that are doing that manually today. If you compare that to international - or compare that to North America we're actually do that in a much more automated fashion.

We're able to sign up about two times more deals and put get deals on the website with about half the people compared to international. So there's a lot of opportunity as we roll out that automation to be able to reduce our cost structure and just get a lot more leverage from our headcount.

Ross Sandler - Deutsche Bank

And if we see the Europe for a sec and this is kind of many underperforming business, can you describe what some of the problems where that were happening in that business got to scale and late '11 early '12 and then what changes were the kind of quick-fix changes, versus maybe some of the stuff you just mentioned which are back end technology overhaul those take a little bit more time?

Jason Child

Sure. So the way the international business has worked so far is very similar to the way that business in North America worked up until about a year ago. And that is it was mostly about featuring a deal a day and then we expanded from 1 to up to 10 or up to 20 deals per day in each market. And those deals are primarily distributed to subscribers and customers via their email. And so today in International that's still is the way the business works predominantly.

If you can track that to the U.S. where you actually have less than half of our transactions coming from email. We have about 40% of transactions coming from mobile and then another 10% that's come in from the pull or market place for the business, for people are searching either on our own site or they're searching on search engines through SEM or [SEO] activities.

And so that kind of distribution of channels to be able to help get customers to Groupon when they're looking for local goods or services that approach hasn't been implemented yet, internationally and so as we expand our [DealBank], implement our SmartDeals technology as we see mobile adoption increase, it is less penetrated than North America because the apps have not been out as long. It is growing about 1.5 times faster than the U.S. penetration rates, or adoption rates but it's just - it's just it needs more time.

So I think as we launch those technologies, you're going to see similar growth patterns internationally as you've seen in North America.

Ross Sandler - Deutsche Bank

And if we look at -- had I asked you 12-18 months ago about where kind of your systems the CFO systems were in terms of being able to kind of track day-to-day what's happening. You guys always had a very good sense of revenue or billings or gross profit, but some of the kind of cost items in rolling everything out to more this disparate content and different countries and markets was a challenge. Are we really now, what -- you can see pretty much what's happening in real time and does that give you more comfort around providing financial metric in [guiding], as you have?

Jason Child

Yeah I think the through, I think I agree that yes from a overall transaction volume perspective that has not been the primary challenge we'll forecast, and it's really mostly been around trying to understand some of the unique natures of some of the markets where in some countries -- where we're finding out about different taxes or social charges that are -- that were because of hitting profit levels in various countries that we're now subject to. And some of those things have been a bit of a surprise or unplanned.

I think in terms of where we are going forward we do -- we definitely have gotten our arms around each of the individual country nuances, the reality is there's going to continue to be probably some of those. I have -- having gone through this, at Amazon.com, where I was the CFO of international there.

We had a lot of the similar issues, it's just the international business, was what smaller as a percentage of total and therefore it was a smaller impact. For us with international being half the size of the business, and it being a two and a half year old business, there's just been some kind of growing pains that because of the size have been more material.

But I think with every quarter we get just a little bit tighter in terms of understanding some of those things. We went from a year ago where we had a material weakness because we weren't able to find everything before we close the books. This year we remediated material weakness. And so we were able to at least prove to ourselves we don't -- to get our arms around all these various challenges in various aspects as part of the closed process. You know the next step has now being able to find them as they occur and even prevent them as they occur.

Ross Sandler - Deutsche Bank

And so your guidance if we look at the comments from last week. It basically say -- just so we've got $30 million CSOI in 1Q and then you said it would grow throughout the year, so basically implies that (Inaudible) sequentially pick up in terms CSOI throughout the year in the first quarter into subsequent quarters. And our view, Deutsche Bank's view has been at the Europe business starts to get back on track by midyear and is that all what we're seeing in this guidance, is that fair characterization in terms of when the CSOI international starts to pick up again?

Jason Child

Yeah we didn't, we haven't specifically said when, I mean we just indicated all of the different efforts that we're going through. I think in Q4 you saw, the gross billings acceleration internationally where it went up about 30% quarter-over-quarter from Q3 to Q4 and so I think that's a positive sign. We did not get the flow through in margin dollars because of some unplanned charges as well as because early in Q4 we have made some investments in take rates to try to sign additional merchants.

A did more impact and we initially had expected and so that was actually I'd say leveled or adjusted by end of quarter to be at a healthier run rate. So going into Q1, we expect take rates overall, to look closer to what they were in Q3 than what you saw in Q4. What that means for overall international profitability, when you see the bottom or when you see stabilization. We do expect it in 2013 we just haven't take these back to our (Inaudible).

Ross Sandler - Deutsche Bank

True. Okay and if we drill then on the fourth quarter, the billings numbers were strong as you mentioned, both international and domestic look great. For those who got the expense think that Groupon cannot generate demand and sell product. I think you answered that question but there's all kinds of variability in these take rates and let's go through few of these and try to decompose and what's going on with the take rate so.

Well, first of all did the take rate come in largely where you thought it would, going into the quarter, you [hid] your revenue number, but you know you don't guide the billings, so we didn't know what you guys are thinking there but what was the take rate largely where you thought it would be when we talk about take rates?

Jason Child

No take rate came in lower than we had expected.

Ross Sandler - Deutsche Bank

Okay.

Jason Child

And so we did miss the our COSI or operating income less stock-based compensation range. You know part of it was there is some unplanned charges international. But the other part of it was the take rates did come in lower. And basically the way that happened is the complexity of the -- added complexity of the business is we started what's called the [DealBank] we look forward to it also as our marketplace, where we are now signing deals for a longer duration rather than just being an episodic one time deal, a merchant is basically signing for a six months or 12 months or what not. And so what happens is they sign at a specific rate.

Now at a certain take rate and that take rate or revenue margin is very consistent with what we see for the regular daily deal business, however as we went after what we identified as being the top merchants who have never run with Groupon in the past, this whole effort as about trying to expand the size of the market not just our share of us versus others, but they actually get merchants, I have never used our service. And so in that process we basically went after businesses that have never used Groupon and basically offered them a lower rate so that we can show them exactly what the positive ROI dynamics of the business are (Inaudible).

Ross Sandler - Deutsche Bank

The take rates back up a bit was that because you didn't need to offer the economics that you're offering these bigger guys or was it a mix issue, what was it that caused you to go back up?

Jason Child

I would say it's probably the approach was great, the actual execution on it was non-profit. You know when you have roughly 5000 sales people across 48 countries that are implementing this in a somewhat manual way, we didn't have the control mechanism to catch it right away. We did catch it by mid quarter, we did implement the mechanisms to see where specifically were that lower take rate was specifically necessary, because it was a very high quality merchant that in fact never run, there was a number of other merchants where maybe the take rate was a little lower than it needed to be.

At the end of the day the sales people are incented to sell as many deals as possible and to get as many merchants on the platform as possible. We just have to make sure that we provide the right incentives to make sure that they're not going lower than the need to. And so - so like I said we caught that mid quarter, we corrected it and we feel good about the trajectory we're on now.

Ross Sandler - Deutsche Bank

And if we (Inaudible) the local business for a second and we can talk about goods, but on the local side one thing has been happening in your numbers is you guys did lots of national and higher ASP, LASIK type deals where it generated lots of bookings and billings and gross profit but none of your base are going to repeat (Inaudible) won and done, so are we at the point where we've comped a lot of the larger won and done deals that were happening in 2011 and around the IPO process and what do you think when we have comped that, that the sustainable growth rate on that local -- is 20% 30%.

Jason Child

I think the so the relevant number of one-time large deals, it was probably less things like LASIK which are -- that's always been part of the offering and always will be. Like you said there's only so much LASIK any one person can have. Or at least that they probably should have. The reality is, the bigger issue was the national deals which are some time they've been historically subsidized or they're really about trying to just get customer acquisitions and a lot of those deals did drive a lot of won and done behavior.

And so we are through lapping the majority of that. I think you'll continue to see us experiment, we're trying to find the best ways to activate the customers. But generally we think the approach that we're now which is increasing selection to have a much larger population of deals, so that now instead of just us trying to predict what someone wants and emailing that to someone we now can have folks search on search engines and either try to capture that, purchase, [incent] via SEO or SEM or through mobile where we're now seeing actually a really nice pickup of folks that are searching for deals nearby which is formerly the Groupon Now! business where we now actually having a large local deal market place that's proximity based.

And some of those deals are actually based on certain times of the day. So we see a lot of traction in that business as well, so I think how that evolves we'll continue to see, but I think more deals with more ways that customers can interact is only going to benefit us.

Ross Sandler - Deutsche Bank

And if you look at -- if we just look at Goods, so if we would if we just kind of look out five years, right now the Goods business is at about at $2 billion annualized run rate in the fourth quarter, of the [zero effect] than what you call it by quarters ago where can that business be in five years and how does the model change as goods is substituted in more markets for the local business.

Jason Child

Yeah, we don't really think of it think but as a substitute and I guess as you said it's about a $2 billion run rate business which is about a third of our $6 billion run rate overall business. And we think that overall our job is to put the best deals in front of the customers and whether it's a local deal or whether it's a product, whatever the case is we've find that our customers consistently tell us they're looking for the unbeatable deals, deals that can't be matched anywhere else.

And so I expect to see a healthy growth across both Goods as well as Local. The Local business actually has a much larger opportunity I mean there's like $60 million merchants in the 48 countries that we operate in but the 18 million of those merchants operate in the core categories that we operate in.

And so our view is that you're going to -- we've only featured about 500,000 of those merchants to date. So we still have -- its only couple of percent of the total merchant population. And so you should expect to see us continue to grow the [DealBank] and grow the overall marketplace in deals featured. And you should expect to also see us continue to grow the goods businesses as well.

At this point we have not made any commitments to try to make it a more typical e-commerce I'm offering where our value is not about wide selection it's really about a smaller selection of [curated] and unbeatable deals. And so with that model we're not looking at warehouses or inventories so to speak we're looking mostly to work directly with manufactures and some distributors to really just to try to find great deals on being able to sale a large amount a volume at a very short period of time.

Ross Sandler - Deutsche Bank

Okay, one thing and we totally understand the concept of -- let's say you're I Boise, Idaho, for lack of a better example, where the density of the local deals isn't that high, you can provide goods that kind of broaden out the selection and that helps the consumer experience. But in markets where the local deal density is very high Chicago for instance and New York and you're putting goods in there, you're basically offering the consumer something that is a much lower take rate for you, much lower unit economics, and may be they would've bought a higher margin local deal if that was the one that was being advertised.

So is this -- do you see different -- is there a one plus one equals three going on where if you do put in goods, it really does invigorate that consumer experience in those high density market or we struggle to understand why you would do that in Chicago if some ones going to buy a (inaudible) Groupon at a 40% take rate versus a coffee machine a 15% to 20%, yeah how do you make those decisions I guess via is--.

Jason Child

Yeah, I mean that's where it gets to be -- I mean we try to do science but it's still art. And that is in classic merchandising there's always the you carry a certain amount of products to just keep -- people to come to the store and make sure that they're engaging with you. And then there are some products that are your core profitability and consumer stable items.

And the reality is as a four year old business, I think we're still trying to figure out exactly what the right purchase frequency of certain categories is you've seen us make a lot of focus specifically in prudent drink deals, in local in particular. Because that's the highest purchase frequency category that exist.

And so I think the notion that we're you should not assume that we're actually cautiously saying let's go give some in Boise, Idaho more goods because we have less local deals. We'd love to have a large amount of deals, we want the consumers make their own choice. And the way our personalization algorithms work is we try to pick what fits the person that the person has selected as well as based on what the [quick stream] behavior has been as well as we always want have some freshness because we don't want to keep showing people the same things that they've already bought, special when there is a up brought kind a group of categories.

So I would think of it as being something that yes the margin characteristics are different between Goods and Local, but in the long term we actually don't think they're necessarily that different. You've may seen on this the website slides that we had in the call last week that the long term operating margin for Goods is somewhere in the high single digit rate on the gross basis if you look at the Local business which is 25% to 30% is our long term target on a net business.

If you convert that to gross using the 30% to 40% take rate it works out to about 8% to 12% so that's actually not that the different -- the difference is the good business is very young and therefore you have we still haven't scaled a lot of the cost that that you typically see in e-commerce companies do you good job of lowering cost structures specifically on freight and fulfillment cost. And so from our perspective our job is to fix that and it's not really the consumer's job to work on that the consumer's job is basically just to find or to tell us which stuff base they want us to future.

Jason Child

And one thing you mentioned on your 4Q call was that certain -- I think it was just International but first party international goods units were being install at a negative gross profit, I mean that's how the accounting works I mean that's allocation or if that's actually the unit profitability, but is that a reflection of selling coffee machines or whatever might be at a loss to make sure that there is a [election] in the consumer experience or is it other things like you guys have like Groupon box and certain offers that are used to analyze before to buy Groupon is some of that happening is well which is above revenue both gross profit.

Jason Child

I'm sure -- are you talking about the international negative?

Ross Sandler - Deutsche Bank

Yeah, (Inaudible) why would you sell something at negative margin ever?

Jason Child

Yeah I would say we did it in a couple of instances; there's only $15 million of the total $225 million of the direct revenue. And it was a very small percentage; there was a couple of deals that around holiday period made sense for us to sell at a loss as traffic drivers for the store. I would not think of it as an ongoing strategy but more of something that was a onetime holiday strategy.

Ross Sandler - Deutsche Bank

Okay. But now (Inaudible) again, following lower first party margin business that's something I probably think.

Jason Child

Yes, there's many very popular brands that are sold at a loss at a lot of retailers, yes.

Ross Sandler - Deutsche Bank

Okay. And then can you shift to mobile for a sec, so this is a big party the longer term strategy and when you guys talk about 50% or say 40% for mobile. Does that include when someone opens their email on their mobile phone and then clicks through the app and then does the purchase, so how much of it is VAT versus more pull orientated I go to the app I want a local deal I know to search for it.

Jason Child

The vast majority is people that are going directly to the app, but also if you do click on an email and it takes you to the app there is - now automatically takes to the app, I think you just have to enable it the first time. And so the idea is just to make it as frictionless as possible, because at the end of the day we don't whatever it takes to get someone interested. If we do our jobs right on personalization every e-mail will include something that you want. And will - and by being able to access it on a mobile phone you can do it at the exact time of purchase it and rather than waiting till they get home and on your cash or whatever it is. But the vast majority is people that are going directly to the app.

Ross Sandler - Deutsche Bank

And kind of related to, that it's related to the overall pull strategy but how are you building out the [DealBank] or do you have metrics that following the take rate experiment would suggest that [DealBank] is staring to accelerate, I didn't see the slides that were posted recently but--

Jason Child

I think they were posted the minute we got up here, so that the answer that question not there. What we did say was that all the deals that were featured in Q4, 84% of those deals are still on the site today and so or at least as of last we were going to the call. And so the large percentage of our deals now are [DealBank] they're staying - they're basically remain on the platform indefinitely most of them are in 6 to 12 month deals but we're seeing high rates of re-signing up, does that answer your question?

Ross Sandler - Deutsche Bank

Yeah, let me trying to figure out, but is the merchant selection still improving, is it driven by the reduction in take rate for is - this is an attractive new area for them?

Jason Child

You should expect to see us continue to grow the absolute number merchant, and that's an ongoing strategy where we will continue to try to retain the merchants as I explained in Q4. We do a pretty good job when merchants are on they come back and so what we want to try to do is by offering a lower rate to get them on the platform when they see what, their overall economics are, we've had experienced that they are come for with that and so I think over time we're not afraid to flex are take rate I mean given long term take rate guidance September between 30% and 40%.

Over the past few quarters we've mostly been at the around 40% this quarter you show us test going down more towards the mid 35% I think in Q1 you will see go back to the high 30% range. But that's not that's the average that's our merchant we're very happy going down to the bottom end of that range when it's a quality merchant and it bringing someone on the platform that never work for us.

Ross Sandler - Deutsche Bank

Okay, I am hoping out question here. Anybody have a question, we'll take one comment. Please (inaudible) front.

Question-and-Answer Session

Unidentified Analyst

(Inaudible)

Ross Sandler - Deutsche Bank

The question was smartphone versus tablet which is gaining more attracting what is more popular one or the other?

Jason Child

Yeah, it current depends by country certainly in the U.S. IOS and kind of Apple platform I think, grew prevalence quicker. The more recent adoption and then sign upgrade of android and other smartphone platform is gaining quickly outside the U.S. even more so or IOS not as popular, it's been on the country. But overall like I said before we see the overall sign upgrades of the apps outside the country about 1.5 times faster than the U.S. and so we're very happy with the overall penetration rates that we see and the engagement of the users that are mobile which are at least 50% better than the average life time the IO or engagement of website only consumer. So overall mobile is core part of the long term strategy.

Ross Sandler - Deutsche Bank

I have one more over here. So if I go back like 12 to 6 months you probably didn't have the systems in place just in exactly what we're going on in real time from your perspective, from the CFO's seat, you can definitely see billings, you can see gross profit but probably not everything below. You guys are on the back end of a lot of system overhaul, incentive overhaul in Europe et cetera lot of heavy lifting there. [Cal] has come in and done a pretty good job.

So, we're sitting here in March, do you feel increasingly confident in your ability to forecast the business? I think some folks were surprised we were as well about in the full year of 2013 [CSOI] guidance. So, I guess what gives you the confidence and if we come back here next year, what do you think the likelihood of achieving our goal is, even though, do you see things right now that making us very confident that you can grow in '13 and that's why you made that statement?

Jason Child

Well, certainly, we wouldn't make that prediction unless we feel very confident. There is a couple of levers, big levers that help us with that confidence, but one of course growth, you saw the growth that we had in Q4. We think we had a lot of momentum going forward and we think that that's going to help us and that will certainly help, be able to fill letter of those CSI numbers as long as we continued to manage take rate appropriately and we're confident we have the controls to do that now.

But the second thing is also there is lot of cost actions. I explained all the different automation tools as well as personalization in [DealBank]. I think that actually will help us to be able to operate way more efficiently. So, I want to say one more time, international the deals closed per rep is half of that of North America and they used to be quite close. North America got a number of tools that Colin, his team have build and that just a lot of us to get way more targeted focused and just be more efficient, that's going to be rolling out internationally.

Also, the number of people that support getting the deal from all the way on to the website its two times more the number of people internationally that is in the U.S. and those also were similar back in time. So, the reality is those are kind of tactical execution items that we feel very confident because we've done it before and we've seen no reason why we should not be able to do that successfully across all of our international countries. I think the only real question is, is exactly which things will be implemented at what time and exactly when the impact will be felt. And so, we feel good about overall throughout 2013. I just had really to say specifically which quarter which impacts will be felt.

Ross Sandler - Deutsche Bank

I think we got out of time, is there any other questions in the audience that we don't hear yet?

Jason Child

Yeah.

Unidentified Analyst

Question was gross profit dollar prudently North America versus international and where can I go from here?

Jason Child

Yeah, so, consistent with the comment I just made the North America ratios are quite a bit higher than international with all the automation tools that we'd be launching, that's going to help us a bunch. Second, as we continued to increase our ability to actually help sell sign up deals, which is one of the things that's starting to also grow, those are effectively going to be deal. And then, revenue from those deals that are effectively coming with very little touch from our employees that's also going to help improved that number.

And then, lastly as we continued to just get better at tuning these tools and continuing to leverage them in my experience, I've spent a number of years at Amazon.com and what we've experienced every year, you could continually find in our productivity through automation on an annualized base as we did it for another 12 years added there. My expectation is the tools that we're implementing are not just one and done, they're implemented, they will get direct benefit initially and we'll continue to tune those tools and we will get productivity on those tools on an ongoing basis.

Ross Sandler - Deutsche Bank

And one last quick one and if we talked about this before but if you look at there is more kind of Panama is on Poesia Groupon and the five or so senior SVP levels folks are all like the [Amazon] so the fact that none of the ex-Amazon passed the arrest is telling to us and how this retention overall and would you say that the fact that you guys are just tighten at group that working together and have worked here for a number of years that actually that helping bring people in, is that potentially attracted to any CEO candidate?

Jason Child

Yeah, I think the reality is especially the Amazon analog I mean a bunch of that's went through times of being misunderstood, I think we still used to call it which certainly feel appropriate now for those of us in on Groupon. The reality is the inputs to the business and even the outputs of the growth that you saw in Q4, those are the things that get us very excited and you finish that back at the four, four and half year business, that's prior new not just create a business but create a category and we talked about that in the call. It's going to be hard and it's been hard so far but I also feel like we made a ton of progress.

So, from that perspective attrition rates at the management level have been very low and I think everyone is completely bought in to the mission, the vision and exactly what we need to accomplish. So, we feel very good about the prospects and hopefully we can talk about those this time last year.

Ross Sandler - Deutsche Bank

Okay, great. Thanks a lot.

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