Good day everyone and welcome to the Groupon first quarter 2012 financial results conference call. At this time, all participants are in a listen-only mode A questin-and-answer session will follow the company's formal remarks. (Operator instructions)
For opening remarks, I’d like to turn the call over to the Vice President of Investor Relations and Corporate Development Finance, Kartik Ramachandran. Please go ahead, sir.
Hello, and welcome to our first quarter 2012 financial results conference call. Joining us today are Andrew Mason, our CEO; and Jason Child, our CFO.
The following discussion and responses to your questions reflect management's views as of today, May 14, 2012, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and in our filings with the SEC including our Form 10-K.
During this call, we will discuss certain non-GAAP financial measures. In our press release and our filings with the SEC, each of which is posted on our IR website, you'll find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with GAAP measures. Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2011.
Now, I will turn the call over to Andrew.
Thanks, Kartik, and thank you all for joining us today. Q1 was a strong quarter for Groupon, our core local deals business continues to grow while also creating opportunities for growth in other channels.
This quarter our revenues grew 89% year over year, and 14% versus Q4. Operating margins extended about 10 percentage points from negative 3% in the fourth quarter to positive 7% in the first quarter, and we continue to drive significant free cash flow, strengthening our balance sheet, which now shows $1.2 billion in cash.
I’d like to take a moment and highlight what’s happening in North America. This is our longest served market, operating almost twice as long as the average country for Groupon, and we’re still seeing some great results.
In Q1 2012, North America saw 75% year-over-year revenue growth and 33% quarter-over-quarter revenue growth. That’s the strongest quarterly revenue growth we’ve seen in years.
Marketing efficiency also continues to improve. In fact, we added more gross new customers in Q1 than we did in Q4, while at the same time reducing our marketing spend. And although most of our R&D and overhead expenses hit the North American P&L, we’re still seeing 16.8% segment operating margins in North America.
We’ve also begun to see the benefits of technology and personalization initiatives in North America. Smart Deals, for example, applies sophisticated algorithms to help give our customers more of what they want, high quality deals close to where they live and work.
It’s still in its early days, but we’re excited by the progress we’re making with Smart Deals and other technology and product innovations in North America, and we believe that the gains are replicable elsewhere in our operations and open further upside opportunities as we roll them out globally.
We look to North America as the example of what Groupon markets could look like over time, healthy profits and strong growth, and this is despite having a larger percentage of the internet population as customers in North America than most of our other countries, as well as larger and more aggressively funded competitors.
So why the big difference between North America and international? Some of it is time and some of it is the result of the way that we’ve grown overseas. For example, our international operation is run on different technology platforms, which has prevented us from easily deploying the technology innovations we’ve developed in North America across a broader footprint.
We’re just starting to deploy features like Smart Deals internationally. The same is true with the marketing technologies that have helped us increase our subscriber activation rate, and even many of the operational tools we provide to our salespeople to help them close deals.
At the beginning of this month we kicked off our first major global technology integration initiative. Though there will be some foundational rebuilding in the short term, we believe that over the long term this project will allow us to move much faster and more easily apply technology to unlock globally.
There are a few more things I’d like to highlight about the last quarter. First, our customer and merchant reach continues to grow. For the first time, we’ve served more than 100,000 unique merchants in a quarter, ending Q1 with 36.9 million active customers.
Second, our customer and merchant satisfaction continues to be strong, which I believe is the most important leading indicator of our long term success.
Groupon’s customer satisfaction score in the US in March was 83 on a leading market research firm call 4C’s 100 point scale. That’s within approximately two points of 4C’s five-year average number one satisfaction score for online retailers. Our US merchant satisfaction score was 79 compared to the B2B benchmark of 64. We’re very proud of these scores. They provide empirical evidence of the value that Groupon provides to our millions of customers and hundreds of thousands of merchant partners.
Third, we are seeing solid early results in our roll out of enhanced merchant support products and services that are part of the Groupon operating system initiative. During the past two months over 30% of eligible Daily Deal merchants in our pilot cities signed up for Groupon Rewards, our new loyalty program for merchants and their consumers.
Though the preliminary data set is small, pilot results show that these customers are more loyal to merchants than other customers. To highlight another example, Groupon Scheduler has also seen early success with over 2500 merchants signed up to date.
Fourth, more customers are buying through mobile. In April 2012, nearly 30% of our North American transactions were completed on mobile devices, compared with 25% just four months ago. We’ve seen our mobile users drive more incremental revenue and purchase activity than our web only customers, with each mobile customer spending over 50% more.
Our growth in this very important area has created momentum for our Groupon Now service that offers real time deals for whenever you’re hungry or bored. Groupon Now recently surpassed 1.5 million purchases, doing so in less time and with a smaller footprint than what we achieved when launching Groupon Daily Deals.
Granted, our grant has grown significantly in the last three years, helping pave the way for Now’s growth within its footprint, however, this milestone is significant for a service of its type and a start of what we hope are many more milestones we expect now to deliver.
Finally, I would like to update you on the governance front. We recently announced the addition of two exceptional board members to see us through the next stage of our growth. First, Dan Henry has spent more than 20 years at American Express, where he has been CFO since October of 2007. Prior to joining American Express, he was a partner to Ernst and Young. Dan joined the board on April 26.
Next, Bob Bass has been a partner at Deloitte since 1982, where he has been Vice Chairman since 2006. Bob has been nominated to join the board following the stockholder benefit at our annual meeting on June 19, following his retirement from Deloitte. Dan and Bob bring deep financial accounting and operational experience that will be invaluable to our board and audit committee.
We also recently added two very accomplished executives to round out our management team. Veit Dengler joined us in April as our new SVP of International. Veit most recently led Dell’s Eastern European and Russian operations and has prior executive experience at T-Mobile, McKenzie and Company, and Proctor & Gamble.
Veit is working closely with Marc Samwer, who remains deeply committed to and invested in Groupon’s success as he transitions out of the international leadership role.
We also announced the addition of Kal Raman as SVP of Americas. Kal has a wealth of experience in technology and retail. He served as CEO of Drugstore.com in addition to having held executive positions at Amazon.com and Walmart. Kal brings expertise in both technology and operations, and has already proven to be a strong addition to our team.
Both Veit and Kal play central roles in our continued growth and evolution as a public company. Before I turn it over to Jason, I’d like to encourage you all to read my recently published letter to stockholders, in which I describe Groupon’s long term opportunity to become the operating system for local commerce. The services we are deploying are a natural progression from our current offerings and build upon Groupon’s core value proposition for consumers and merchants.
If you think about the evolution of Groupon, our first phase was all about local daily deals, both domestically and abroad. To that end, we expanded to well over 500 markets in 48 countries and have hired more than 12,000 people to help us connect with both consumers and merchants worldwide.
Our second phase involves the expansion of Groupon both in terms of categories, like product and travel, and in terms of the expansion of our platform to mobile. Our third phase is all about making our platform smarter.
We intend to infuse a series of technology services and enhancements that make our emails, our mobile products, and our marketplaces more personalized, more convenient, and more relevant to our customers and merchant partners.
This should yield significant lift across our entire ecosystem. From there, we will work to bring all of these elements together in one operating system for local commerce. If we’re successful, I believe the day will come when millions of local merchants rely on Groupon as the primary means by which they reach customers through the internet. That’s the ultimate vision towards which we are working.
I’m very proud of what we’ve achieved and excited about our future. With that, I’ll hand it over to Jason.
Thanks, Andrew. With our detailed results available in this afternoon’s press release, I’m going to provide a short summary of our performance, and then provide some additional color on the key levers in our business. I’ll also provide our outlook for the second quarter.
Some of my comments here will be on a non-GAAP basis. Note that reconciliation of GAAP to non-GAAP metrics can be found in this afternoon’s press release, as well as in our 10-Q, both of which can be found on our website.
Overall, we had a strong quarter. Here are some of the highlights on the year over year basis. Gross billings on the total amount spent by customers on Groupon were $1.35 billion, up 103% or 108% excluding changes in foreign exchange or FX.
Revenue grew 89%, or 95% excluding FX. North American revenues grew 75% and international grew 102%, or 112% excluding FX. Our Q1 GAAP operating income on a consolidated basis was $39.6 million, which included $28 million in non-cash stock based compensation.
Excluding these non-cash charges, operating income would have been $67.6 million compared to a loss of $98.3 million in the first quarter of 2011, and an income of $18 million last quarter.
FX changes did not have a material impact on profitability in the quarter. North American segment operating income margin reached 16.8%, and continues to make progress towards our long term target of 25-30%. International segment operating income margin became positive and 8.5%. International operating margin continues to lag North America’s due to our continued aggressive investment in early stage markets.
Non-GAAP EPS for the quarter was $0.2 compared, with the loss of $0.41 in the first quarter of 2011. GAAP EPS was negative $0.2, compared with the loss of $0.48 in the first quarter of 2011. This loss includes $28 million of stock-based compensation and $34.6 million of tax expense, or $0.10 per share in total on both a GAAP and a non-GAAP basis.
And finally, operating cash flow increased 367% to $83.7 million. Free cash flow in Q1 was $70.6 million growing our trailing 12 month free cash flow to $310 million as of March 31, 2012. I’ll talk more about Q1 free cash flow compositions shortly.
Consistent with last quarter, we were profitable in many countries and subject to tax. For the time being we remain unable to offset tax charges from profitable countries within a loss from unprofitable countries.
Primarily as a result of these tax charges and our international headquarters initiative, our effective tax rate for the quarter remains well above our current average statutory rate of approximately 33%. We do expect our effective tax rate to decline over time.
Q1 EPS also included the reduction of approximately $0.1 on both GAAP and a non-GAAP basis related to a $7.2 million reduction of earnings available to common shareholders as a result of our decision to purchase the remaining minority interest in certain consolidated subsidiaries. Going forward, we may elect to purchase additional minority interests related to other acquisitions.
Now I’ll touch on our accounting revisions filed March 30, which was primarily related to an increase in our refund reserve as of December 31, 2011. Customer refund activity in the first quarter of 2012 was consistent with the assumptions we made. We have not seen material changes in our overall category mix, price point, or customer refund behavior.
Also, as this pertains to the material weakness designation that arose in connection with our year end audit, we are implementing a comprehensive remediation plan that includes the hiring of additional staff at all levels of our finance department.
We are also in the process of implementing the controls necessary to insure that our internal controls over financial reporting are effective. As required by (SOCS), we will evaluate and report on the effectiveness of our internal controls at year end, and our evaluation will be reviewed by our auditors as part of our 2012 year end audit.
Now I’ll move on to review some of the key operating fundamentals from the quarter. I’ll frame my review of the financial fundamentals from Q1 these three sections.
First revenue leverage, or the interplay between customer growth and revenue for customer expansion, are two key levers for driving growth. Second, operating leverage, or the yield we realize on our core operating expenses. Our primary leverage point is our largest bucket of variable expense marketing.
In Q1, consistent with our execution over the past 12 months, we saw significant operating leverage from improved marketing efficiency. And third, strong free flow cash generation and the leverage we get from our balance sheet. Our business model possesses the benefits of a negative operating cycle that are not unusual in online retail and which continue to drive healthy cash flow dynamics that further strengthen our balance sheet.
Let’s start with revenue leverage. Our growth is primarily driven by two factors, new customers and how much these customers spend. Our growth in the quarter reflects our success in both of these areas.
Our active customer count grew 36.9 million in the quarter, an increase in 140% year over year. Spend per customer was consistent with Q4, with both Groupons per customer and average price per Groupon holding about steady quarter over quarter on a worldwide basis.
Another way to look at customer spend behavior is to look at trailing 12 month gross billings per average active customer, which was $179 in the first quarter, compared to $169 a year ago, and $187 last quarter.
North American Groupons per customer and average price point per Groupon both increased slightly, along with the growth in customers to result in strong sequential evidence of growth recorded in Q1.
While Groupons per customer and price per Groupon both declined marginally in our international segment in Q1, this is in line with the business opportunity Andrew highlighted earlier for us to evolve our technology platforms and deploy improved personalization overseas.
We also benefited from improvements in our deals inventory and quality. Deal selection continues to expand as we secure more and more merchant partners located with closer proximity and in denser concentration around our current and potential customer base.
We surpassed 100,000 unique merchants featured for the first time in Q1, and our sales and sale support organization of over 5000 people worldwide continues to form new merchant relationships that expand our reach on a daily basis.
Getting more merchants in all markets and increasing deal relevance will be a key focal area for us as we continue to look at the ways to address the importance of proximity in our customers’ decision making process.
In our local deals business, proximity is the number one driver of purchase behavior. Our date suggests that deals that are within five miles of the use have more than a 5 times conversion rate compared to deals that are more than 20 miles away.
As Andrew mentioned, we’ve begun to roll out features like Smart Deals that not only provide a considerable improvement to the customer experience through relevance, but also give densely populated markets like Chicago a 50% lift through emails.
Smart Deals is a key piece of the equation, but you’ll also see us driving deeper into the surrounding areas of major metropolitan areas. We’re pleased to see the core local deals business grow, but we’re also happy with the progress of our new channels.
Our results within our getaway business in Q1 is a great example. Getaways continued to grow last quarter with 45% sequential increase in the number of deals offered in a period to more than 540 deals. 30% of our Getaways purchases in North America in Q1 were from first time Groupon customers.
These are customers we might not have gained access to had it not been for our expansion into Getaways. And we now have the opportunity to sell them products and services from across our entire suite.
We also saw strong acceleration coming out of the fourth quarter in our North American goods business. Our continued expansion into these new channels should further increase wallet share.
The second point I’ll highlight from Q1 is our continued demonstration of operating leverage. Our largest variable expense bucket, marketing, is also our expense line of greatest leverage in the near to mid term.
In Q1 about $39 million of the operating income improvement quarter over quarter was related to our increased efficiency of customer acquisition efforts. Marketing expense, as a percent of revenue decreased from 78% in Q1 of last year, to 34% in Q4 and further to 21% this quarter, despite roughly the same number of paid and organic customer additions in each quarter.
In Q1, repeat purchases also grew more than 50% faster than first time purchasers. These improvements came while lapping the highest trade of marketing spent in the company’s history, which included large one-time deal promotions and broad base marketing that ultimately came with lower value customers.
As a result, net active customer additions declined versus Q4, as we attrited some of those customers acquired in Q1 2011. At the same time, we added approximately the same number of customers in Q1 as we did last quarter on 25% lower marketing spend.
Our Q1 marketing performance reflects continued execution against our plan to move from subscriber acquisition marketing to custom activation. We do not believe that this reduced level of spend is reflective of our normalized run rate. As we proceed, we believe that our long-term target marketing expense at 20% of revenue is still appropriate.
Finally, the third point I’ll highlight is our strong cash flow generation and the leverage we get from our balance sheet. The powerful free cash flow dynamics of our business afford us great flexibility to invest in key talent and initiatives. At the end of March, we had $1.2 billion in cash and no long-term debt.
Free cash flow, a non-GAAP measure, was $71 million for the quarter, and $310 million in the trailing 12 months.
In Q1, we realized contribution to free capital from earnings, and from the working capital benefit related to the natural spread between our receivables and merchant payables.
This quarter, the timing of other AP and AR accounts, along with cash tax payments, led to a lower overall benefit from working capital accounts than we’ve seen in prior quarters.
Cash taxes alone, all of which related to 2011, reduced free cash flow by approximately $35 million in Q1. We do expect additional cash tax payments while we complete the implementation of our international headquarters.
In summary, we’re pleased with our financial performance in the first quarter, and we feel very good about the progress we’re making with our key initiatives.
Turning now to our outlook for the second quarter, as always, our results are inherently unpredictable and may be materially affected by many factors, including a high level of uncertainty surrounding the global economy and consumer spending, as well as exchange rate fluctuations. It is not possible to accurately predict demand, and therefore actual results could differ materially from our guidance.
Our outlook further assumes that we do not make any acquisitions or investments and it assumes no material changes in foreign exchange rates.
For Q2 2012, we expect revenue of between $550 million and $590 million or between 40% and 50% year-over-year growth. We expect second quarter GAAP operating income of between $25 million and $45 million. That’s compared to an operating loss of $101 million in the second quarter of 2011.
This outlook includes approximately $35 million in stock-based compensation. We do not anticipate any significant acquisition-related expenses in the second quarter.
This guidance reflects Andrew’s commentary on our commitment to rolling out technology and process improvements internationally in a deliberate manner. The opportunity in front of us is significant and we have built a foundation that continues to prove difficult for our competitors to match.
We intend to continue to deepen the competitive modes around our business and to continue building for the long term, even though that may mean that we invest aggressively into our operational improvement initiatives in the short run, so that we are well positioned for continued growth.
With that, I’m going to turn it back to Andrew for some closing comments.
Thanks, Jason. In closing, I want to thank our employees for doing their part to continue to drive Groupon’s strong performance. I would also like to thank our stockholders for supporting us as we continue on this journey. Thanks for your time today. Operator, let's take some questions.
(Operator instructions) Our first question in our queue is Ralph Schackart with William Blair.
Ralph Schackart - William Blair
Good afternoon. I was wondering if you could provide some more color on the marketing leverage that you had in the quarter in terms of efficiencies? I think you added about 1 million plus more customers than we (inaudible) model with a 25 decrease in the spend. Was it primarily a shift from customer marketing away from subscriber acquisitions? I was hoping for some more color on that.
Thanks for the question. So we continue to gain marketing leverage as a result of investments in technology and deeper analytics to better understand how to efficiently deploy our marketing spend. Some of the results have come from a shift towards transactional marketing, but it’s still the early days there and we think there’s a lot of headroom remaining.
Ralph Schackart - William Blair
Great, one more Andrew, if I could. What was driving the strong revenue acceleration in North America and the quarter that was up I think 33% sequentially? I think you talked about the tech innovations such as personalization, was that the sole factor? Maybe you could give a little more color on that as well.
Thanks. So the performance we saw in North America was partly due to technology but it was also due to increases in deal density that we saw through operational efforts. Proximity of deals is the number one driver of purchase behavior by customers.
So by getting more dense deals we were able to use our technology in order to provide better targeting to customers, give them deals that were more relevant to them, and thus deliver performance improvements.
These are all, I should mention, improvements that are at this point limited to North America where our technology platform has this technology. We’re now in the process of rolling it out globally and expect to see summer’s all-term personalization in the quarters to come, globally.
Thank you. The next questioner in the cue is Ross Sandler with RBC Capital Markets.
Ross Sandler - RBC Capital Markets
Thanks. Guys, I’ve just got two questions. Andrew, first, you’re experimenting with the new onboarding path for new subscribers in certain markets. Can you talk about how that might be helping your ability to target user preferences and is this having a positive impact on Groupon’s per customer?
And then second question for Jason, you mentioned some new hires for the finance team. How do you feel overall about the financial control today, can you tell what’s going on in the business in real time? What else needs to happen from here to remove that material weakness clause in the 10-K by year-end? Thanks, guys.
Thanks Rob. So we’re constantly experimenting with our onboarding process for new subscribers. The effect of that is not only do we drive down our cost of acquiring a new subscriber, but we also more effectively collect information about the subscriber during the onboarding process, whether its gender or location or preferences.
We can then use that information to better target deals and increase the percentage of subscribers that are likely to convert into customers and these are all the drivers, the types of experiments that we’re doing, that have resulted in several subsequent quarters of steady paid customer growth while reducing our overall marketing spend.
Hey Ross. So on the question of controls, I guess the material weakness, can I go back to the- what we disclosed on March 30. The material weakness was in particular related to the financial statement close process. So there’s some very specific tasks that we’ve implemented and some that we’re still going to implement. So in particular, as you mentioned, there’s a number of people, we’ve certainly added some, we have still some more work to do there.
We do, I think as you know, we have 48 countries and so we do have accounting personnel and controllers in every single country and there’s certainly work we’re continuing to take on in terms of just kind of ramping up resource there.
Also in terms of process, there’s a number of procedures that we’ve actually already implemented. The most specific would be on refunds. Last quarter we did change our refund methodology to get much more granular into using actual statistical model that is actually now mapping on really a weekly basis to exactly what is going on in the business. So from a process standpoint we’re in very good shape.
And there is some technology that we’re implementing that is especially helpful with a large company like ours where you have to really try to get a good eye into reconciliations and try to be able to look at the status of where all 48 countries are when you’re going through a relatively tight close process.
So the answer would be, this quarter. We’ll probably make a lot of progress next quarter and hopefully within the next quarter or two, we will have done all the steps necessary. However, as you stated, this is a- a material weakness is something that is not reviewed by the auditors until year-end. And so, the actual removal of the label of material weakness will not disappear until we get to the year-end audit. But we feel very, very good about the progress that we’re- that we’ve made thus far.
Ross Sandler - RBC Capital Markets
Great, thanks guys.
Thank you, sir. Next questioner in the queue is Jason Maynard with Wells Fargo.
Jason Maynard - Wells Fargo
Hey guys, I have two questions on some of the drivers for your growth in North America. So first, it’s interesting. Not many companies have figured out a way to capture mobile ad or commerce dollars, so I’m curious if you can expand a bit more on the type of customer engagement you’re experiencing on the mobile devices? And then, specifically, how merchants are using the technology?
And the second point would be, on the personalization front. It was interesting in your shareholder letter, you sighted the improving purchase success in the Chicago market because of Smart Deals. So what type of long-term improvement do you think is achievable in terms of increasing repeat purchases? And what’s your expectation on that, say once you get past the international rollouts in the next year or so? Thank you.
Thanks for the questions. So Groupon, as a product, is uniquely well suited for mobile devices, we believe. We believe that mobile commerce will evolve into becoming one of the essential and fundamental use-cases of mobile.
It's enabled by the ability to have a computing device and internet connection with you at all times. We think that mobile is an equal enabler to local commerce as for example, broadband is for online video.
On top of that, Groupon is not a marketplace commerce model where we are focused on massive selection and allowing the user to compare and contrast products. We’re curated commerce where we make a bet on one or a handful of products or services and we make a recommendation to our customer which makes the buying process easy and painless.
So for those -- and that process is also uniquely well suited to a mobile device where you have less screen real estate, where its more difficult to type, and making a purchase decision is much simpler.
So all of that has contributed to the mobile growth that we’ve seen, as well as our mobile customers being more valuable, significantly more valuable to Groupon than web-only customers. Especially in products like Groupon Now! where over half of our transactions are completed from a mobile device.
We have big plans for Groupon Now! We continue to believe it’s a big part of the long-term future of our business. We’re releasing a new mobile application in the coming months that we think has a fantastic Groupon Now! browsing experience, so we’re excited for more of that to come.
On the merchant side of mobile, we’re just getting started there and you’ll see a lot more in the quarters to come. But it begins with our merchant center application on the mobile devices, which merchants can use to ease the process of redemption, turn Groupon Now! deals on and off, and a number of other factors to manage there, to manage their Groupon campaigns.
Jason Maynard - Wells Fargo
And then on the personalization side?
So on the personalization side, we’ve seen some great results and we still think that it’s the early innings. We’ve started experimenting with technologies such as one we call Deal Bank, which allows us to take our deals and put them in inventory for an extended period of time and expose those through search campaigns, as well as through activation campaigns that we send via email to our customers.
And early results look good with these things and we think that personalization will drive engagement and allow us to maintain the type of cohort behavior we’ve seen from our customers in the past.
Jason Maynard - Wells Fargo
Okay. Thank you very much.
Next questioner in our queue is Dave Perry with Goldman Sachs.
Dave Perry - Goldman Sachs
Great, thanks. Andrew, on the technology work that you’ve been doing, what kind of penetration does Smart Deals have in the US so far, and is that different by website, email, mobile? And what kind of adoption are you seeing for the merchant and reward tools that are needed for you to be able to measure ROI on specific deals?
Thanks, Steve. So on personalization we have gender and location information on over 80% of our active subscribers, which allows us to provide targeting and enables Smart Deals. Results vary from market to market on the effectiveness of Smart Deals.
Markets where we have more deals running per day tend to do better, in markets where we have more field proximity to available to users. So for example, in a market like Chicago, where we’re running well over a dozen deals, new deals per day, we see north of 50% conversion rate improvement for Smart Deals.
We’re seeing similar results with our merchant tools. The vast majority of our active merchants are logging into our merchant center application every single week and that creates a good foundation for us to upsell merchants into our other marketing solutions, such as Groupon Now! and Groupon Rewards.
If you’re interested, I’d encourage you to check out a demo of the merchant center application that we have available at Merchants.groupon.com/demo, it’s a pretty fantastic experience that merchants get.
Dave Perry - Goldman Sachs
Great, thanks. And with the take rate improving this quarter, what does that say about the individual segment take rates versus growth in some of your lower take rate businesses like getaways and goods?
Hey, this is Jason. So, in terms of take rate, I think it’s a little early to look at the total mix impact of these new categories. While we’re- we’re very happy with the progress of goods and getaways and now, they do- they’re not material enough for us to break out and therefore I would say there’s some impact but not significant.
If you go back over the past quarter, we actually had a 40% take rate in Q4, after the revision for the refunds. Before that it was 40.6%. So, if you adjust for that one-time step up in the refunds, we’re looking at 40.6% versus 41.3% this quarter so a relatively small difference.
Next questioner in our queue is Mark May with Barclays.
Mark May – Barclays
Thanks for taking my questions. One second, sorry. First one has to do with- as you and your merchant partners go down this experience curve, I wonder if you could give us a sense of how the deal terms and contract structure with your merchant partners is evolving?
Seems like payment days, deal discounts, redemption terms, those sorts of things - could you give us a sense of how, if at all, some of the major deal facets and contract facets are evolving?
And then second question is, a customer subscriber cohort, have some of the more recently acquired customers in Q1 and Q4 - how are they behaving versus previously acquired customers? Thanks.
Thanks for the question. So in terms of how our relationships with merchants have been evolving, with some of the contract structure it’s pretty much the same. It changes to some degree as we have a better understanding of risk, have a better understanding of predicted refund rates of merchants.
In certain cases we will invoke a holdback from the merchants final payment that is meant to cover predicted refund rates. Or in some high price points, deal categories, we will move to payment upon redemption, which is not uncommon. We’ve been doing that in- overseas, for our entire life overseas.
Our relationship- the most profound way in which our relationship with merchants has evolved is as we introduce new opportunities to partner with them to provide new ways to reach customers, to re-engage with our customers, as well as just generally run their business.
So as we’ve introduced tools such like Groupon Now! which is about yield management for businesses, in addition to the customer acquisition benefits of the core daily deals channel.
Or as we’ve introduced Groupon Rewards, which is a powerful retention and re-engagement tool that we offer for merchants. And our early results are showing that Groupon Reward customers are actually coming back more frequently than non-Groupon Rewards customers.
As well as tools like Groupon Scheduler, which solve a fundamental problem for many businesses that need to accept bookings online, all these tools eventually will tie together and complement each other and reinforce each other.
For example, integrating Groupon Now! into Groupon Scheduler will allow us to help merchants automatically yield manage their business, which is quite powerful and exciting to those (inaudible) members and partners.
And regarding the cohort question, so the first thing I’d say is the Q2 2010 cohort that we’ve talked about for a couple quarters now continues- and I think that- we think that’s the best example of how to think about our model.
So to refresh, in Q2 2010, we spent about $18 million to acquire a couple million customers that have been continually spending on a very dependable basis. So they spent $6 million in the first quarter after they were acquired, in terms of contribution profit dollars, sorry.
$6 million in Q2, $7 million, $6 million, $8 million, so it’s been consistent between $6 million and $8 million every quarter and this most recent quarter, Q1, was no exception where it was $7 million again. So, we’re now up to a 305% ROI on that Q2 2010 cohort when you include the Q1 numbers.
So, and again, that’s against the $18 million investment, so the total that I just mentioned in contribution profit would be about $55 million, so $305%.
Mark May – Barclays
Any comment on how more recently acquired customers are behaving relative to that cohort?
Yes, so the more recent cohorts are also consistent. All the cohorts are relatively consistent in terms of- there’s a first-month acquisition, and then every kind of- the purchase frequency that we see beyond that continues to be very steady. So the Q4 and the Q1 cohorts thus, so far, look to be very consistent with what we’ve seen in previous cohorts like the Q2 2010 cohort.
Our next questioner in queue is Jeff Houston with Barrington Research.
Jeff Houston - Barrington Research
Hi, thanks for taking my questions. Since international represented about 57% of revenue in the quarter, had a couple of questions there; to begin with, could you update us on your efforts in China?
Then separately, I understand that international markets are less mature and not on the same technology platform as their domestic counterparts. But when do you expect international and domestic profitability to be roughly in line with each other? Is that likely to be two to three years out?
Sure. So first on China. I think, as you may know, China is -- we have a joint venture with Tencent, one of the largest internet companies in China. And that is a joint venture where we own 49% so it’s not consolidated and it’s not included in our consolidated financials, it’s a below the line equity method investment.
In terms of how things are going in China, I would say as we- I would say no real change to what we’ve said in the past, and that is China is a market that continues to look very different than all other markets, both in terms of very, very strong competition and generally in lower take rates than we see in other countries around the world.
But we’re very happy with our partnership and we plan to continue to invest and have a lot of confidence in a long-term opportunity in China.
Second, regarding international profitability -- so, if you look at the segment operating profit, North America today is at 16.8%. International is at 8.5%. In particular, if you look at marketing, North America is at 14.3%, that’s marketing as a percentage of revenue, and international is at about 25.5%.
So what that basically means is that if we spent the same level of marketing in international as we did in North America, as a percentage of revenue, we would actually have roughly the same profit, it would actually be slightly higher in internationals.
So the reason they’re not the same, is because we have a much larger amount of traffic -- I think Andrew said earlier, we have significant organic customer growth in North America because of our brand reach and we’re able to grow through our organic efforts, and paid, but then also through some of the technology.
Internationally, as we roll out more technology, as we also get stronger adoption throughout all the countries, in terms of just brand recognition and stronger organic growth, you’ll see the marketing expense go down over time and there’s no structural reason why the profitability between North America and international should be any different.
Regarding the time bounding, it’s hard to say if that’s going to be within the next year or two and at this point I’m just not ready to say.
Jeff Houston - Barrington Research
That’s good detail, thank you.
Our next questioner in queue is Lloyd Walmsley with Deutsche Bank.
Lloyd Walmsley - Deutsche Bank
Great, thanks for taking the question. Just wondering, in markets where you’ve integrated more tools for merchants, such as this Groupon Scheduler, are you seeing any signs that end-user and merchant satisfaction is improving in a way that, over time, can reduce your refund rates?
And then, kind of relatedly, do you think that refund rates on Smart Deals are lower than aggregate deals and can drive a lower refund rate over time?
Thanks for the question, Lloyd. So what the introduction of these new tools allow us to do is solve different problems for different merchants and give every merchant a reason to join the Groupon family.
So we’ve seen that for some merchants who haven’t embraced our Daily Deal product in the past, they decide that Groupon now is right for them and Groupon Rewards, or Groupon Rewards, and then subsequently decide to experiment with other forms of our marketing services.
Once you’ve trained your staff on the processes necessary to accept a Groupon voucher that’s part of Groupon Rewards, then it’s very easy to experiment with something like Groupon Now or Daily Deals and we’ve definitely seen that process manifest itself in every direction.
Merchant satisfaction- I think our numbers speak for themselves, that I mentioned earlier. We have a 79 merchant satisfaction score from ForeSee, which is remarkably high, comparatively to others, the B2B sector.
Whether or not these things will affect refund rates, we think that there’s a healthy level of refunds for any given category, as our price points and categories evolve, so will our refund rates. We haven’t seen any changes in consumer behavior that lead us to believe there is an inherent problem with the refund rates as they are.
Lloyd Walmsley - Deutsche Bank
Do you think they could get better as Smart Deals proliferate and you’re getting better targeting, just, you’ll see that refund rates actually decline over time?
We think that products like Groupon Scheduler that allow- that address issues like a customer’s ability to book an appointment at the exact date and time that they want and know that they’re doing that as part of their purchase process, should in theory, reduce the likelihood that they’ll have a change of heart. But it’s too early to tell how exactly it’ll impact refund rates.
Our next questioner in the queue is Ken Sena with Evercore Partners.
Ken Sena - Evercore Partners
Thank you. On Groupon Now! you mentioned the $1.5 million Groupons sold, can you say how that number compares to the total number of Groupons sold in your core business? And then also, are there factors such as how the deals are structured, that make the two less comparable? Thank you.
Thanks, Ken. So Groupon Now! is still a small part of our overall business as we’ve said in the past we think it’s a long-term bet. We’re- everything is growing according to expectations but again it’s still quite small.
Nothing significant about the deal structure that leads to the difference, it’s a different use case, however, for customers and merchants, which is why we’ve seen even stronger repeat purchase behavior from our most active Now! customers than we have from our Daily Deal customers.
Daily Deals for our customers are more about surprise and delight, demand generation, often giving them an idea to do something that they wouldn’t otherwise want to do and offering it at a 50%+ discount. That makes them say, “why not.”
As for Groupon Now!, it’s more about- I already know that I’m hungry or I’m bored, I’m out looking for something to do, I check Groupon Now! because getting something at a great price is better than getting something at full price. And that’s more demand fulfillment that already exists.
So it takes more time to lodge that concept into the minds of our customers in a sticky way. It’s also gated to some degree on knowable penetration. But again, long-term we think it’s a big part of where Groupon is going.
Ken Sena - Evercore Partners
Great. And any comment on the number of Groupons sold in the core business?
That’s not something that we’ve disclosed. We think that our net revenue growth is a great indicator of where- of how Groupon is shaping up.
Ken Sena - Evercore Partners
Great, thank you.
Our next questioner in queue is Daniel Ernst with Hudson Square.
Daniel Ernst - Hudson Square Research
Yes, good evening, thanks for taking my call. I have two questions, if I might. First, I heard in the discussion this evening so far, a lot of positive commentary on the technology development at Groupon, things like Rewards and Scheduler and certainly mobile and then this great merchant dashboard I’m looking at here on the demo.
Those are things that sound like they’re driving both revenues and retention. Cost of goods, percentage of revenue, has gone from 13% to 20% over the last year. It sounds like you’re getting some positive reaction from what I would call R&D spending that's embedded in there.
Can you talk about where that's going as a percentage or revenue and maybe talk about breaking out the R&D portion of that as expensed or is capitalized in your balance sheet?
And then second question, given the obvious relationship between deal density and the likelihood to buy said deal, you had 100,000 merchants that you were sort of seeing in the quarter.
What's the capacity within Groupon to double that, triple that so that you have not too many deals that are 20 miles away but a lot more deals that are within five miles? Thanks.
So regarding the first question on the R&D expense as a percentage of revenue, so just the way it works is all of our general technology expense starts in SG&A and then to the extent that once tools are built and things are actually driving revenue, we basically capitalize that and then we amortize that into cost of revenue.
So think of the R&D expense as mostly an SG&A historically. It's now moving to cost of revenue and will continue to move into cost of revenue as we get greater adoption and roll out new tools based on the examples that you just mentioned.
In terms of what kind of percentage, we haven't given out that kind of guidance. We feel like the total tech expense in terms of kind of fits within our long-term targets of cost of revenue which we expect somewhere in the 10% to 15% of revenue over time.
So this is Andrew. On our ability to continue to increase deal density, just to give you an idea of where it stands right now, at a market like Chicago, I think roughly 20% to 25% of our subscribers are seeing their feature deal within five miles of their house right now.
And we think that there's a big opportunity to increase that. We're doing that by adding more frontline sales force. We think that will start to come into play in probably not in Q2 but beyond as we get these sales people ramped up.
And then there's further technology innovations as well as new products that we can offer merchants that will allow them to run deals on a more persistent basis.
Next questioner in queue is Douglas Anmuth with JPMorgan.
Douglas Anmuth – JPMorgan
Thanks for taking the question. Andrew, I think you talked earlier about how Getaways is adding some new customers here. Can you talk about how you're seeing some of these new customers move into local deals in the last few months?
And then also if you could just help us understand the investment that might be required for the international platform and then the timeframe over which you'll get on par with North America, thanks.
Sure. Thanks for the questions. In general, we've seen that the new channels that we've been experimenting in, whether it's Groupon Getaways or Groupon Goods, attracts customers into our platform that we wouldn't have first attracted through the local business.
But many of them then go on to buy local deals as well. So so far the customers appear to be just as strong and healthy as locally acquired customers. And your second question was about just – remind me again what your second question was.
Douglas Anmuth - JPMorgan
Just helping us understand the investment that's required to bring international platform to rebuild there and over what timeframe it'll take to get it more on par with North America.
So we held an international technology integration summit earlier this month to kick off the process. We're not expecting to make any unusual additional headcount adds in order to get it done.
I think it's an iterative process that will really get better and better over many, many quarters. But we're hopeful to start seeing some results in the Q3 timeframe as we start to roll out Smart Deals internationally.
Douglas Anmuth - JPMorgan
Great, thank you.
Thank you, sir. (Operator Instructions) Our final question comes from Clay Moran with Benchmark Company.
Clay Moran – Benchmark Company
Thanks, good afternoon. Just seems to me like you must be gaining significant market share, so I'm just wondering if you could comment on where you're strongest in regards to market share and do you think you're gaining – are those gains accelerating in any sense as to particular strength geographically?
Thanks, Clay. It's a huge market and we feel like we're just getting started. The market still continues to grow. We're happy with the progress that we've made with the revenue growth that we've seen this quarter and year-over-year.
And the real market opportunity is going to be the one that we start to unlock as we offer more services for merchants and customers to improve the experience of buying and selling things locally and that's a massive market and one that we intend to unlock over the years to come.
Clay Moran – Benchmark Company
Thank you. We do have time for one additional question. Mark Mahaney with Citigroup, your line is now open.
Mark Mahaney – Citigroup
You keep referring to this marketing leverage in the model. You clearly had a sequential material decline in marketing spend. If you look at the number of new customers, however, it seemed like it was 4.8 million in Q4 and 3.1 million in Q1.
What's the reference that you're making when you say that the number of new customers was relatively similar in both quarters? Are you cutting it geographically? Are you cutting it somehow differently than those numbers? Thanks a lot.
Thanks, Mark. The number I was speaking of was the gross number of new customer adds. What we saw – the number you're referring to includes attrited customers over last year.
Remember, we defined active customers as customers who purchased in the last year. The reason we've seen some of those customers attrit is that we are lapping the largest marketing spend period in our history as a company, which included a number of activation deals that were low margin and didn't attract customers who stayed with us. They're what we call one and done customers. But the gross number of new customers added was consistent with prior quarters.
Mark Mahaney - Citigroup
Thank you, Andrew.
Thank you. And now I'll turn the program back over to management for any additional or closing remarks.
Thank you very much. That's all.
Thank you again, gentlemen. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may log off at this time.
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