Groupon’s (GRPN) CEO Eric Lefkofsky on Q2 2014 Results – Earnings Call Transcript

That number has now been stable for the majority of 2014, which leads us to believe that we’ve seen the bottom.

As redemptions stabilize and other improvements we’ve put in place take hold, we expect local growth to continue to accelerate. The acceleration of our local business continued to grow robustly in July, which we believe is another sign that we’re on track to deliver double digit year over year billings growth in North America local by year-end.

That said, our take rates in North America local decreased by roughly 300 basis points compared to last quarter, predominantly driven by an increased proportion of sales for high-quality, lower take rate merchants in the quarter. In addition, we’ve increased site-wide sales and order discounts over the past few quarters in an effort to drive adoption of our marketplace.

Until now, we’ve absorbed the impact of these discounts ourselves. Going forward, we intend to pass on a portion of these promotional discounts to our merchants. As these efforts unfold, we believe that take rates in local will improve and remain within the range we’ve seen over the last couple of years going forward.

Our second priority is to improve our goods margins, particularly in North America. Our costs have historically been almost 2x that of other comparable ecommerce companies. To address this, we’ve made some significant changes, including shifting more of our business to drop ship, moving more fulfillment to our own distribution center in Kentucky, and increasing units per order.

We’re pleased with the progress we’ve made to date, with gross margins in North America increasing over 400 basis points quarter over quarter, from 5% in Q1 to 9% in Q2, and we believe we’re well on track to achieve our goal of double digit gross margins in North America by year-end.

Our third priority is to continue to improve our international operations and reduce our losses in rest of world. We made significant progress in the quarter, reducing our total segment operating loss from $25 million in Q1 to $18 million this quarter.

As we continue our regionalization efforts, and as APAC growth gains momentum, we expect continued improvement in Q3. Given our progress to date, we expect to generate positive segment operating income by Q4, excluding TMON.

As we shared last quarter, we define long term success as both gross billings and gross profit growing at least 20% annually over the next five years. We’re focused on the operating objectives I’ve highlighted, because we believe they are the purest drivers of gross profit dollar growth over the long term.

We also advanced our strategic objectives in the quarter. First, mobile. Mobile remains over half our business worldwide. Mobile mix as measured by transactions continued to increase in Q2, reaching yet another all-time high. As we said last quarter, we are no longer becoming a predominantly mobile business, we now are a predominantly mobile business.

Nearly 92 million people have now downloaded our app, and by most reports, we are now the most mobile large-scale ecommerce company in the world. Yet activations remain behind web, so while people are engaging with Groupon through their mobile devices, we have yet to optimize the customer experience. Each quarter, we make progress, and we’re inching our way closer to parity over time.

Second, local. Local and mobile are converging. Local is all about geography, and mobile is all about proximity. Both are intertwined, which is why our mobile business has grown so fast. That said, we have yet to truly deliver on the vision of Groupon, the vision of a world where all merchants and consumers are connected in real time, through a network that allows every merchant to attract the very best customers and allows every customer to find the very best deals.

What we’ve learned over the past year is that in order to win, we need Groupon to become an integral part of our customers’ lives, a daily habit. To achieve that, we need to make the experience of buying and redeeming a Groupon as easy as pulling out your credit card or buying an app on your phone.

When people use their Groupons, they buy more. When they don’t, they buy less. To close the loop and get more people using their Groupons, we need to connect merchants to our customers in real time, making the Groupon experience seamless, frictionless, and fun.

After years of work and significant investment, the tools we’ve built to close this loop are starting to hit the market with the rollout of our local commerce platform, which I’ll discuss in a minute.

Third, marketplace. When we began, our reps only had one product to sell, a daily deal email featuring one business at a time in a given city. When we built the first version of our marketplace, we needed a new product that would allow merchants to be on Groupon more regularly, so we created an inventory system allowing merchants to reduce the number of units sold on the first day and instead sell a designated number of units every month.

Today, over 75% of our North American merchants opt to be in our marketplace on an ongoing basis. Recently, we enhanced our product, allowing merchants the ability to offer deals that vary, based on both time of day and day of week, which allows us to attract a whole new range of merchants that historically couldn’t work with Groupon, because they have times when they’re just too busy to take on more customers.

They can now block those times off, or reduce the discount rate to more tightly control the flow of customers that Groupon delivers. But even with these enhancements, we still only offer a little over 105,000 deals in North America, out of a pool of nearly 7 million targeted merchants. Even with all of our effort, our marketplace is still only covering a small slice of the market.

But what if virtually every local business had a presence on Groupon? What if this was a customizable, and more importantly, transactable space where merchants could not only put up deals on our site, but also post their specials directly to our customers? And what if customers could search these sites and find a wealth of other relevant information including tips and reviews in addition to amazing deals, offers and specials?

As our marketplaces evolve, we’ve come to realize that despite the gains we’ve made, and continue to make in expanding our supply, having less than 5% of the available merchants on our platform is insufficient. We need a solution for the other 95% of merchants that don’t work with us today.

To address this, we’re launching two new products, Pages and Genome, that together, enhance our local offerings and allow us to connect the last mile of local commerce. Pages create a web and mobile presence for every local merchant, filled with useful information for our users, including contact information, maps, time of service, recommendations, tips, and most importantly, a wider variety of discounts. We’ve already built pages for millions of merchants in North America, and expect to begin rolling them out in the coming quarters.

Genome is our new operating system for merchants, whether they’re running a deal or just looking to claim their merchant page. We believe Genome bridges a critical gap for us, putting us right inside our merchants. Wrapped inside an iPad Mini with a credit card swiper, Genome offers merchants seamless redemption, enabling customers to redeem their Groupons without ever taking their phone out of their pocket.

It also offers a digital cash register that vastly improves workflows, a lightweight and elegant point of sale system that captures item-level detail, and full payment processing at some of the best rates in the market. In addition, customers can leave tips and reviews right on Genome. We’ve now deployed Genome in over 75 cities in North America and expect to continue the rollout throughout the rest of this year.

When you combine Genome with the nearly 92 million people that have downloaded our apps, you can begin to see the foundation of a true local commerce network unfold, a network where users and merchants are continuously connected, allowing consumers to explore the world around them and save money while they’re at it, and allowing merchants to offer real-time discounts and incentives to get the right customers coming in their doors at the right times.

While these new products are ramping up, we’ll continue to build additional supply and demand to accelerate adoption of our marketplace. Searchers accounted for 10% of our overall traffic in North America in June, with customers who searched continuing to spend materially more than those that did not.

Our marketplace is doing well, but with Pages and Genome, we believe we can take it to an entirely new level. Overall, we’re pleased with the progress we’ve made across all of our initiatives this quarter. We remain focused on execution, both in North America and in our international markets via our One Playbook initiative that is entering its most exciting stage through the final unification of our American and European technology stack.

With that, I’ll now turn the call over to Jason to discuss our financial progress in the quarter.

Jason Child – Chief Financial Officer

Thanks, Eric. With the details available in this afternoon’s press release, I’m going to run through the highlights of our performance and then provide our outlook. Note that all comparisons, unless otherwise stated, refer to year over year growth.

Let me run you through the numbers. Gross billings increased 29% to $1.82 billion. North America grew 12%, EMEA was about flat, and rest of world increased 145%. As Eric mentioned, TMON has and continues to run well ahead of the expectations we had at the time of the acquisition, contributing $317 million to billings in the quarter.

Excluding TMON and FX, and further taking the exit of Groupon’s legacy Korea business into consideration, we were pleased to see rest of world growth for the second quarter in a row increasing 17%.

Revenue increased 23% to $752 million. North America grew 12%, EMEA grew 42%, and rest of world grew 40%, lower than the 145% billings growth as a result of the substantial addition of lower margin TMON billings to the mix.

Gross profit was $390 million in the quarter, compared to $385 million last year. Gross profit growth lagged billings growth due to a greater mix of direct revenues. North America in particular was also impacted by continued investments in quality as well as order discounts to drive awareness of our pull marketplace. Given our focus on growing gross profit dollars, we were pleased to see the slight increase quarter over quarter, even in light of these investments.

Adjusted EBITDA was $59 million in the quarter, down $21 million compared to last year, primarily due to an approximately $30 million increase in SG&A related to TMON and Ideeli. Note that we also had a $26 million increase in marketing and order discounts to drive awareness for pull.

As you think about the relative profitability of our segments, it’s important to keep in mind that the North America segment reflects almost all of our technology costs, so as we’ve invested heavily in global product and technology over the past year, it has had a short term impact on North America’s profitability.

GAAP loss per share was $0.03. Excluding stock compensation, amortization of acquired intangible assets and acquisition-related costs, all net of tax, non-GAAP earnings per share was $0.01.

Free cash flow was negative $54 million for the quarter, resulting in a trailing 12 month free cash flow of $41 million. Free cash flow in the quarter was impacted by payment timing as well as a few key strategic investments including the shutdown of Groupon Korea. We expect free cash flow to pick up materially in the back half of the year as it did in 2013.

As of June 30, we had $868 million in cash and cash equivalents after spending $106 million in connection with our share repurchase program. Including the 17.2 million shares repurchased in the quarter, we repurchased a total of 24.7 million class A common shares under our existing authorization for an aggregate purchase price of $182 million.

Approximately $118 million remains available under our existing repurchase authorization, which will expire in August 2015. The timing and amount of any repurchases will continue to be determined based on market conditions share price, and other factors.

Trying to a couple of notable highlights of our nonfinancial metrics, active customers reached 53.2 million worldwide for the quarter. Customer growth accelerated for the second quarter in a row, and excluding acquisitions, was the strongest growth we’ve seen in the year. Notably, EMEA customers increased year over year for the second sequential quarter.

Customer spend, as measured by trailing 12-month billings per average active customer, was $137 compared to $132 last quarter, driven by the addition of TMON.

Moving on to our categories, local gross billings increased 6% to $859 million , with continued growth in customers, units, and active deals. EMEA declined 6%, and North America increased 1.8%, a slight increase over Q1.

Rest of world grew 48%, driven by TMON. Local gross profit decreased 8% to $169 million, with billings growth and lower cost of revenue more than offset by take rate declines. The reduced take rates reflect an increased proportion of sales for high-quality merchants and the impact of order discounts as we focus on marketplace adoption in North America, as well as the increased mix of lower margin TMON revenues.

Before I move away from local, I want to touch on EMEA, where local billings declined 6%. While in North America, the overall profitability of local is higher than that of goods, the economic health of these businesses in EMEA is more similar, given that our goods gross margin in EMEA is roughly double North America’s. As a result, we’re more agnostic on category mix in EMEA, but we do expect local billings to return to stronger growth by year-end.

Goods gross billings increased 65% to $720 million, with all segments contributing to the growth, even after excluding the impact of acquisitions. Goods gross margins were 11.5% globally, reflecting a greater mix of direct and lower margin TMON revenues, most of which are recognized on a third-party or net basis.

Direct margins increased 100 basis points year over year to 12.2%. With nearly half of our goods billings now direct, the dollars in aggregate continued to move in the right direction, and as Eric mentioned, with continued focus on the reduction of shipping and fulfilment costs, we expect to see continued improvement in gross margins this year.

Finally, travel gross billings increased 44% to $240 million, with North America growth accelerating to 44% in the quarter.

Before I close, let me provide some additional color on a few specific items. Marketing expense was $64 million in the quarter. In addition, we invested over $24 million in order discounts, taking our net investment up to $88 million, a $26 million increase compared to a year ago.

We invest marketing dollars in a variety of ways. We spend money to acquire subscribers and app downloads, which tend to have longer term payback horizons. We invest money in order discounts, which drive billings growth and awareness, but obviously come at the expense of margins. And we invest money in transactional advertising, such as search and display, which has a shorter-term payback than acquiring a subscriber, but still can extend out several quarters.

It’s in this last category that we’re just beginning to make real progress and see some improvements in ROI. As our efficiency of spend continues to rise, we are likely to continue to invest heavily in this area throughout the balance of the year. Together, we believe these investments will produce long term benefits.

Secondly, we’ve entered into a three-year, $250 million revolving credit facility. While we have no immediate plans to draw on the line, we believe this will provide us with additional balance sheet flexibility going forward.

Finally, turning to our outlook, for the third quarter of 2014, we expect revenue of between $720 million and $770 million; adjusted EBITDA between $50 million and $70 million; and non-GAAP EPS, excluding stock compensation, amortization of acquired intangibles, and acquisition-related costs, net of tax, of between $0.00 and $0.02.

As it relates to the full year, we are revising our outlook and now expect adjusted EBITDA to exceed $270 million, as opposed to $300 million. Although we continue to have the opportunity to reduce our marketing investments, including in TMON, over the remainder of the year to achieve a target in the $300 million range, we don’t believe that this reduction makes sense based on the ROI of our recent investments and their potential impact on 2015.

As always, our results are inherently unpredictable and may be materially affected by many factors, including the high level of uncertainty surrounding the global economy and consumer spending, as well as exchange rate fluctuation.

With that, I’ll turn the call back to Eric.

Eric Lefkofsky – Chief Executive Officer and Director

Thanks, Jason. We believe Groupon has an opportunity to become the starting point for local commerce. We’ve now built the foundation for Groupon to become a true platform. As we approach our sixth birthday in November, we believe we have an opportunity to connect the last mile of local commerce in ways that were never before imagined.

With the deployment of Genome, we intend to provide our merchants with a suite of tools that connect them to our community of over 200 million subscribers, nearly 92 million app downloads, and over 53 million active customers. Merchants will finally have technology that allows them to manage the inflow of customers, and customers will finally be able to explore the world around them and save money while they’re at it. And we believe this all will happen seamlessly, anytime, anywhere, with the phones in their pockets and the tablets on their counters.

Our local mobile and marketplace investments together with Genome represent the culmination of years of hard work and significant investment, which we believe firmly positions us to realize our vision of connecting local commerce.

With that, let’s take some questions.

Question-and-Answer Session

Read the Full Transcript here

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