Groupon, Inc. (GRPN) Q1 2012 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Groupon First Quarter 2012 Financial Results Conference Call. [Operator Instructions] Today's conference call is being recorded. For opening remarks, I'd like to turn the call over to the Vice President of Investor Relations and Corporate Development and 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'll 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 expanded 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 a 75% year-over-year revenue growth and 33% quarter-over-quarter revenue growth. That's the strongest quarterly revenue growth that we've seen in a year. 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. SmartDeals, 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 SmartDeals 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 opportunity 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 SmartDeals internationally. The same is true with the marketing technologies that have helped us increase our subscriber activation rate and even the -- many of the operational tools that we provide to our salespeople that 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 growth 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 served more than 100,000 unique merchants in a quarter and ended 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 U.S. in March was 83 on a leading market research firm called ForeSee's 100-point scale. That's within approximately 2 points of ForeSee's 5-year average #1 satisfaction score for online retailers. Our U.S. 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 rollout of enhanced merchant support products and services that are part of the Groupon operating system initiative. During the past 2 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 their other customers. To highlight another example, Groupon Scheduler has also seen early success with more than 2,500 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 4 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 with launching Groupon daily deals. Granted, our brand has grown significantly in the past 3 years, helping pave the way for Now!'s growth within its footprint. However, this milestone is significant for a service of its type and the 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 2 exceptional board members to see us through the next stage of our growth. First, Dan Henry has spent more than 20 years in American Express, where he has been CFO since October of 2007. Prior to joining American Express, he was a partner with Ernst & 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 a stockholder vote 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 2 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 with T-Mobile, McKinsey & Company and Procter and 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 Wal-Mart. Kal brings expertise in both technology and operations and has already proven to be a strong addition to our team. Both Veit and Kal will play central roles in our continued growth and our evolution as a public company. Before I turn it over to Jason, I'd like to encourage you all to read my recently published better 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 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 technologies, 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 have 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 reconciliations 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 a year-over-year basis. Gross billings, or the total amount spent by customers on Groupons, were $1.35 billion, up 103%, or 108% excluding changes in foreign exchange or FX. Revenues 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 noncash stock-based compensation. Excluding these noncash 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 continued to make progress towards our long-term target of 25% to 30%. International segment operating income margin became positive at 8.5%. International operating margin continued to lag North America's due to our continued aggressive investment in early-stage markets. Non-GAAP EPS for the quarter was $0.02 compared with a loss of $0.41 in the first quarter of 2011. GAAP EPS was negative $0.02 compared with a 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 composition shortly. Consistent with last quarter, we are profitable in many countries and subject to tax. For the time being, we remain unable to offset tax charges from profitable countries with NOL from unprofitable countries. Primarily as a result of these tax charges in 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 includes a reduction of approximately $0.01 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 revision 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 it 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 in our finance department. We are also in the process of implementing the controls necessary to ensure that our internal controls over financial reporting are effective. As required by SOX, we will evaluate and report on the effectiveness of our internal controls at year end, and our evaluation will be reviewed by auditors as part of the 2012 year-end audit. Now I'll move on to a review of some of the key operating fundamentals from the quarter. I'll frame my review of the financial fundamentals from Q1 in these 3 sections: First, revenue leverage, where the interplay between customer growth and revenue per customer expansion are 2 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 efficiencies. And third, strong free cash flow 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 what's continued to drive healthy cash flow dynamics that further strengthen our balance sheet. Let's start with revenue leverage. Our growth is primarily driven by 2 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 of 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 revenue growth we recorded in Q1. While Groupons per customer and price per Groupon both declined marginally in our International segment during Q1, this is in line with the opportunity Andrew highlighted earlier for us to evolve our technology platform and deploy improved personalization overseas. We also benefited from improvements in our deals inventory and quality. Deal selection continued to expand as we secured more and more merchant partners located with closer proximity and in more dense 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 sales support organization of over 5,000 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 progress. In our local deals business, proximity is the #1 driver of purchase behavior. Our data suggests that deals that are within 5 miles of the user have more than a 5x conversion rate compared to deals that are more than 20 miles away. As Andrew mentioned, we've begun to roll out features like SmartDeals 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 some emails. SmartDeals 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 continue to grow, but we're also happy with the progress of our new channels. Our results within our Getaways business in Q1 is a great example. Getaways continued to grow last quarter with a 45% sequential increase in the number of deals offered in the 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 midterm. 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 32% 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 purchasers also grew more than 50% faster than first-time purchasers. These improvements came while lapping the highest trade and marketing spend in the company's history, which included large onetime deal promotions and broad-based 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 '11. At the same time, we added approximately the same number of new 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 customer 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 cash flow 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 fluctuation. 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 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 as 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 moats 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 questioner in queue is Ralph Schackart with William Blair.

I was wondering if you can provide some 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 and the Street had modeled with a 25% decrease in the spend. Was it primarily a shift from customer marketing away from subscriber acquisitions? Just hoping for some more color on that.

Thanks for the question. So we've continued 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.

Great. One more, Andrew, if I could. What was driving the strong revenue acceleration in North America in the quarter? It was up, I think, 33% sequentially. I think you talked about the tech innovation such as personalization. Was that the sole factor? Maybe if you could give a little more color on that as well.

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 #1 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 some results from personalization in the quarters to come globally.

Next questioner in queue is Ross Sandler with RBC Capital Markets.

Guys, I just got 2 questions. Andrew, first, you're experimenting with a 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 Groupons 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 controls today? Can you tell what's going on in the business in real time? And what else needs to happen from here to remove that material weakness clause in the 10-K by year end?

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 it's 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 customer -- 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.

So Ross, so on the question of controls, I guess the material weakness, to kind of go back to the -- what we disclosed on March 30, so the material weakness was in particular related to the financial statement close process. So there are some kind of very specific tasks that we've implemented and some that we're still going to implement. So in particular, as you mentioned, there was a number of people. We certainly -- 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. At the most, kind of specific would be on refunds. I mean last quarter, we did change our refund methodology to get much more granular into using actually a statistical model that is actually now mapping on really a weekly basis to check what's 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, closed process. So the answer would be I would say in terms of when we'll be remediated, we took a -- we've made a lot of progress this quarter. We'll probably make a lot of progress next quarter. And hopefully, within the next quarter or 2, we will have done all the steps necessary. However, as you stated, this is a material weakness. It's something that is not reviewed by the auditors until year end. And so the actual removal of the -- of that label, the 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.

Next questioner in queue is Jason Maynard with Wells Fargo.

I have 2 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. 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 then the second point would be on the personalization front, it was interesting in your shareholder letter you cited the improving purchase success in the Chicago market because of SmartDeals. 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?

Thanks for the question. 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 an -- 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. And 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 and services, then 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 the -- to a mobile device where you have less screen real estate, where it's 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 -- on mobile devices, which merchants can use to ease the process of redemption, turn Groupon Now! deals now on and off and a number of other factors to manage their Groupon campaigns.

And then on the personalization side?

So on the personalization side, we -- we've seen some great results, and we still think that it's the early earnings. And 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 the personalization will drive engagement and allow us to maintain the type of cohort behavior we've seen from our customers in the past.

Next questioner in queue is Heath Terry with Goldman Sachs.

Andrew, on the technology work that you've been doing, what kind of penetration does SmartDeals have in the U.S. so far? And is that different by website, email and 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, Heath. So on personalization, we have gender and location information on over 80% of our active subscribers, which allows us to provide targeting and enable SmartDeals. Results vary from market to market on the effectiveness of SmartDeals. So markets where we have more deals running per day tend to do better in markets where we have more deal proximity available to users. So for example our market like Chicago, where we're running well over one dozen deals -- new deals per day, we see north of 50% conversion rate improvement for SmartDeals. 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 up-sell merchants into our other marketing solutions such as Groupon Now! and Groupon Rewards. If you're interested, I'd encourage you to check out the demo of the Merchant Center application that we have available at merchants.groupon.com/demo. It's a pretty fantastic experience that merchants get.

Great. And with this -- 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?

Heath, this is Jason. In terms of take rate, I think it's a little early to kind of look at the total mix impact of these new categories. While 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 is 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%. And so if you kind of adjust for that kind of one-time step up in the refund, we're looking at 40.6% versus 41.3% this quarter. So a relatively small difference.

Next questioner in queue is Mark May with Barclays.

One second. Sorry, first one has some 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, things like payment days, deal discounts, redemption terms, those sorts of things. If you'll give us a sense of how, if at all, some of the major deals facets are 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?

So terms of our relationships with merchants have been involving, if you look at 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 predictive refund rates of merchants. In certain cases, we will invoke a hold back from the merchant's final payment that is meant to cover predictive refund rates. Or in some high-price-point 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 reengage with our customers as well as just generally run their business. So as we've introduced tools like Groupon Now!, which is about yield management for businesses in addition to seeing customer acquisition benefits of the core daily deals channel; or as we've introduced Groupon Rewards, which is a powerful retention and reengagement tool that we offer for merchants, and our early results are showing that Groupon Rewards 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 businesses, which is quite powerful and exciting to both customers and partners.

And...

Great.

And regarding the -- sorry, 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 of quarters now, continued -- and I think that's kind of -- we think that's the best example of kind of how to think about our model. So to kind of 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 billion. 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, their expense in the contribution profit would be about $55 million. So 305%.

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 -- 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.

Since International represented about 57% of revenue in the quarter, I had a couple of questions there. To begin with, could you update us on your efforts in China? And 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 2 to 3 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 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 lower take rates than we see in other countries around the world. So -- but we're very happy with our partnership, and we plan to continue to invest and have a lot of confidence in the 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's at 14.3%, and that's marketing as a percentage of revenue, and International is at about 25.5%. So what that basically means is if we spend 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 or actually slightly higher than International. So the reason they're not the same is because we have a much larger amount of traffic. I mean, Andrew said earlier we have significant organic customer growth in North America because of our brand reach, and we're able to kind of 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 will 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 2. At this point, I'm just not ready to say.

Our next questioner in queue is Lloyd Walmsley with Deutsche Bank.

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 SmartDeals 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. But I mentioned earlier, we have a 79 merchant satisfaction score from ForeSee, which is remarkably high compared with others in the B2B sector. Whether or not these things will affect refund rates here, 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.

Do you think they could get better as SmartDeals proliferate and you're getting better per 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 the -- 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 effectively it'll impact refund rates.

Our next questioner in queue is Ken Sena with Evercore Partners.

So on Groupon Now!, you mentioned the 1.5 million Groupons sold. Can you say how those -- 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 2 less comparable?

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 where everything is growing according to expectations. But again, it's still quite small. Nothing significant about the deal structure that leads to a 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 with a -- at a 50%-plus discount that makes them say, "Why not?" As for Groupon Now!, it's more about "I'm -- 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 launch that concept into the minds of our customers in a sticky way. And it's also gated, to some degree, on mobile penetration. But again, long term, we think it's a big part of where Groupon is going.

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 -- how Groupon is shaping up.

Our next questioner in queue is Daniel Ernst with Hudson Square.

I have 2 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 this great merchant dashboard I'm looking at here on the demo. And 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 that what I would call R&D spending that's embedded in there. Can you talk about where that's going as a percentage of revenue and maybe talk about breaking out the R&D portion of that as expensed or as 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 servicing 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 -- maybe a lot more deals that are within 5 miles?

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, okay? So think of the R&D expense as mostly in 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 kind of 10% to 15% of revenue over time.

So, this is Andrew, on our ability to continue to increase deals, that's the -- just to give you an idea of where it stands right now, in a market like Chicago, I think roughly 20% to 25% of our subscribers are seeing their featured deal within 5 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 front-line sales force. We think that will start to come into play in -- probably not in Q2, but beyond as we get these salespeople 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.

Andrew, I think you talked earlier about how Getaways is adding some new customers here. Can you talk about how you've seen 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 investments that might be required for the International platform and then the time frame over which you'll get on par with North America?

Sure. Thanks for the questions. In general, we've seen that this -- the new channels that we've been experimenting in, whether it's Groupon Getaways or Groupon Goods, attract 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 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.

Just help me understand the investment that's required to bring the International platform to rebuild there, and over what time frame it will 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 on -- in the Q3 time frame as we start to roll out SmartDeals internationally.

And at this time, ladies and gentlemen, we have time for one final questioner. Our final question comes from Clay Moran with Benchmark Company.

Just it seems to me like you must be gaining significant market share. So I was wondering if you could comment on where you're strongest in regards to market share. And do you think you're gaining, as part of those gains accelerating in any sense as to particular strength geographically?

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.

We do have one time for additional questioner, Mark Mahaney with Citigroup.

I'll be real brief. 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, Mark. The number I was speaking of is the gross number of new customer adds. What we saw -- the number you're referring to includes attrited customers over last year. Remember, we define active customers as customers who purchased in the last year. The reason we've seen some of those customers attrite 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.

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.