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…

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…

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.