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I want someone to write 2 page write-up (single spaced) summary for the case attached, and it should be from your point of view.Also I want you to add a point to support your writing that is in regard to the case. For example, if there are things that affected the company now regarding the issue in the case, please bring that up.focus more on numbers.Don’t forget to footnote and site the information from other sources.
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W12666
GROUPON AND THE SEC1
Vaughan Radcliffe, Mitch Stein and Alexis Gottschalk wrote this case solely to provide material for class discussion. The authors do
not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain
names and other identifying information to protect confidentiality.
This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the
permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights
organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western
University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com.
Copyright © 2012, Richard Ivey School of Business Foundation
Version: 2013-09-24
Lesley Simmonds kept seeing Groupon appear in the news with reference to its accounting practices. As a
prospective MBA student, she wondered what all of the fuss was about and why these numbers were
under such scrutiny. Working as an operations consultant, she understood that financial numbers were
very important to understanding business operations, but she was also aware that there were well -defined
practices for financial reporting. Considering the regulatory agencies and governing bodies that oversee
the accounting profession globally, she wondered if this was all simply a case of media hype.
During a break at work, Lesley perused the Groupon website for its daily deals. Keen to learn more about
the business and to stay current for potential interviews for MBA programs, she decided to do some
research into Groupon’s operations and the current news surrounding its financial statements. If the
accounting issue at hand was no more than just hyperbole, then why was there still so much press on
Groupon’s financials?
ABOUT GROUPON
Groupon was launched privately in 2008 and began by providing daily offers from retailers to local
customers to allow them access to the power of group buying (i.e., discounts). As the corporation’s
website states, “Groupon negotiates huge discounts — usually 50–90 per cent off — with popular
businesses. We send the deals to thousands of subscribers in our free daily email, and we send the
businesses a ton of new customers. That’s the Groupon magic.”2
Currently operating in 43 countries and in numerous cities, Groupon had recently expanded its offerings
from daily deals to include Groupon Now!, Groupon Getaway and Groupon Product. Groupon Now!
showcased local deals only available for a few hours; Groupon Getaway deals were for travel and were
offered in partnership with Expedia; Groupon Goods provided discounts on products.
1
This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives
presented in this case are not necessarily those of Groupon or any of its employees.
2
Groupon website, http://www.groupon.com/learn, accessed October 8, 2011.
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9B12B002
To make a purchase, a customer paid Groupon to use its website or various applications. Only after a predetermined number of Groupons had been bought did the deal become green-lit and Groupons were
issued. At a later time, Groupon remitted payment to the retailer after retaining a commission fee.
THE SPOTLIGHT ON GROUPON’S FINANCIALS: THE IPO FILING
Groupon released its first public set of financial statements as part of an SEC filing (S-1) required prior to
an IPO (see Exhibit 1) . As part of the filing, non-GAAP financial measures were shown and included
cash flow and Adjusted Consolidated Segmented Operating Income (ACSOI).
A non-GAAP financial measure is a numerical measure of a company’s historical or future financial
performance, financial position or cash flows that:
excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are
included in the most directly comparable measure calculated and presented in accordance with GAAP
in the statement of income, balance sheet or statement of cash flows (or equivalent statements) of the
issuer; or
includes amounts, or is subject to adjustments that have the effect of including amounts, that are
excluded from the most directly comparable measure so calculated and presented.3
Groupon justified the use of ACSOI due to the high cost of acquiring customers, the argument being that
acquisition costs were far greater than retention costs and as such expenses would substantially decrease
in coming years. ACSOI was calculated by taking the income (or loss) from operations and adding back
online marketing expenses, stock based compensation and acquisition related expenses. In other words,
ACSOI was said to show Groupon’s business in a steady state of operations versus its current growth
state.
GAAP VERSUS ACSOI
Standard setters have contemplated whether non-GAAP financial measures actually have confused or
enlightened investors since the beginning of the Internet era of the 1990s when the focus on earnings, a
key performance indicator, was replaced by a focus on top-line growth.4 Groupon’s accounting practices
were a cautionary reminder of the dot-com days, when aggressive accounting practices ensued; while
there were some e-commerce successes at that time, such as Amazon and eBay, many more companies
failed (most notably, Webvan, Pets.com, and eToys.com).
Groupon was not alone when it came to becoming creative with non-GAAP financial measures. For
example, Demand Media, a publisher of how-to articles, capitalized the cost of its writers over five years.
It came to light that certain metrics had become more common for companies within specific industries,
such as “adjusted OIBDA,” short for “operating income before depreciation and amortization” and used
not only by less well-known companies such as Demand Media but also by corporations such as CBS and
Time Warner.5
3
Definition taken from “Final Rule: Conditions for Use of Non-GAAP Financial Measures,” http://www.sec.gov/rules/final/338176.htm, accessed November 20, 2011.
4
M. Lewis “Pro Forma Lingo,” CA Magazine 135, 2, August 2002, p. 16.
5
M. De La Merced, “Abracadabra! Magic Trumps Math at Web Start-Ups,” June 17, 2011,
http://dealbook.nytimes.com/2011/06/17/abracadabra-for-internet-start-ups-magic-trumps-math/, accessed September 3,
2011.
Page 3
9B12B002
Lynn Turner, Chief Accountant of the SEC, spoke about how these metrics have been misleading and can
portray an inaccurate picture to investors; he used the term “EBBS — Earnings Before Bad Stuff” for
earnings measures that excluded marketing costs and losses from new product lines or adjusted for
amortization of selected costs.6
Exhibit 4 illustrates how the use of GAAP versus ACSOI can materially alter financial ratios.
Despite the concerns over ACSOI, Groupon’s CEO Andrew Mason touted the company’s ingenuity:
“I’ll summarize my excitement with four points:
1. Growth in our core business is strong,
2. Our investments in the future — businesses like Getaways & NOW — look great,
3. We are pulling away from competition, and
4. We’ve built a great team that I would pit against anyone.
In other words, all the stuff that one would want to look good? It looks good.”7
Satisfied by Groupon’s unconventional performance metrics, Mason explained, “We exclude those costs
because, unlike our other marketing expenses, they are an up-front investment to acquire new subscribers
that we expect to end when this period of rapid expansion in our subscriber base concludes.”8
THE CONTROVERSY
The market had a strong reaction to the use of the ACSOI metric and to Groupon’s accounting practices
in general. As one commentator observed, “The use of such metrics has come with a meteoric rise in
valuations for companies like Groupon, LinkedIn and Facebook that has invited skepticism from analysts
and people in the industry. They are questioning whether some business models — be they a social
network aimed at professionals or a maker of online farm games — can endure.”9
After an extended period of controversy, Groupon gave up its resistance to abandoning ACSOI. The
controversy about this measure had attracted substantial negative publicity and caused the IPO road show
to be cancelled. Groupon then amended its S-1 filing again and made adjustments, most notably to nonGAAP financial measures and its top-line revenue.
In this revised filing, instead of using ACSOI, Groupon chose a different measure which they termed
Consolidated Segmented Operating Income (CSOI). The only difference between CSOI and ACSOI was
that CSOI did not exclude online marketing expenses. (See Exhibits 4, 5 and 6 regarding the calculation
of ACSOI versus CSOI.)
6
L. Turner, Speech by SEC Staff: Remarks to the 39th Annual Corporate Counsel Institute, October 12, 2000,
http://www.sec.gov/news/speech/spch418.htm, accessed September 3, 2011.
7
K.
Swisher, “Groupon’s
Mason Tells
Troops in
Feisty
Internal Memo: ‘It
Looks
Good,”
August 25,
2011,
http://allthingsd.com/20110825/exclusive-groupons-mason-tells-troops-in-feisty-internal-memo-it-looks-good/,
accessed
September 3, 2011.
8
J.
Pepitone,
“Groupon
Updates
IPO
Filing,
Admits
It’s
Unprofitable,”
August
10,
2011,
http://money.cnn.com/2011/08/10/technology/groupon_accounting/index.htm, accessed on December 30, 2011.
9
De La Merced, “Abracadabra! Magic Trumps Math at Web Start-Ups.”
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REVENUE
Revenue was initially recorded as the gross payments Groupon received from its customers while the cost
of revenue included the money that was paid out to merchants.
Exhibit 8 summarizes the joint proposal of the International Accounting Standards Board (IASB) and
Financial Accounting Standards Board (FASB) on revenue recognition. The SEC identified (see Exhibit
7) that Groupon’s initial revenue recognition practice implied that Groupon itself was contracting to
provide the customer with a good or service. As such, the changes in reporting would include accounting
for goods and services separately as well as changing revenue recognition practices to reflect recognition
only when goods or services have been delivered.
Considering that Groupon was simply acting as an intermediary or broker between customer and
merchant, the top line was adjusted to reflect its business model, and revenue became a measure of gross
billings net of the merchant’s share.
While this change did not affect the net earnings of Groupon, it is important to note the impact that topline adjustments can make in terms of an investment decision. Exhibit 9 illustrates revenue as originally
reported and then revised on a net basis.
CASH AVAILABILITY CONCERNS
With a growing working capital deficit (see Exhibit 1) driven by its cash cycle, there was skepticism
about whether Groupon would be able to fund its growth plans.
There were currently two payment models being used to disburse funds to merchants: traditional and
redemption. Under the traditional redemption payment model, Groupon paid the merchant for all
Groupons purchased over a period of generally 60 days. Under the redemption payment model,
merchants were not paid until the customer redeemed the Groupons. A great amount of volatility was
introduced to the working capital needs and subsequently cash flow depending on the payment terms the
merchant negotiated with Groupon.
Thus far, Groupon relied on an increasing dollar volume of transactions, through growth and acquisitions,
to fund its working capital deficit. It is important to note as well that this working capital deficit did not
include future contractual obligations and commitments. However, it is unclear as to whether Groupon
would be able to fund it in a steady (non-growth) state of operation.
Well-known analyst Henry Blodget remarked that, “Groupon is able to generate cash while losing money
because it collects cash from Groupons the moment it sells them and doesn’t have to pay some of the cash
to merchants until 60 days later. When the company is growing rapidly, it generates a lot more cash from
new Groupon sales than it has to pay out to redeem old Groupons. Right now, Groupon is growing so
quickly that this ‘float’ creates positive cash flow even though the company is losing money. The trouble
is that the cash Groupon generates from the Groupon sales is not all Groupon’s to keep. It owes a big
chunk of that cash to the merchants it sells Groupons for. And at the end of Q2, Groupon owed a lot more
cash to merchants than it had on hand.”10
10
Henry Blodget, “Don’t Mean To Be Alarmist, But Groupon Is Running Low On Cash,” August 17, 2011,
http://www.businessinsider.com/groupon-low-on-cash-2011-8?op=1, accessed October 10, 2011.
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9B12B002
The income statement showed dividend payments to current shareholders; however, the prospectus stated
that Groupon did not intend to continue paying dividends.
Blodget observed, “It is also worth noting that, in the history of the company, Groupon has raised a total
of $1.1 billion of cash — and paid out $942 million of that cash to its early investors and executives
(highly unusual for such a young company). If Groupon does get into cash trouble, therefore, it will not
be because the company didn’t discover an amazing new business opportunity or raise all the capital it
needed. It will be because of, well, greed.”11
REFUND PROVISIONS
On March 30, 2012 Groupon reported a material weakness in its financial controls and said that fourth
quarter sales were lower than had been reported due to higher refunds to merchants. Groupon explained
that it had failed to account for an increase in higher priced offerings, which were more likely to be
refunded to customers. The company had started to sell discounted plane tickets in conjunction with
Expedia and began offering Groupon Reserve, a service for upscale offers such as a five-course meal at a
leading California based restaurant for $99. Groupon described the changes as being, “primarily related to
an increase to the company’s refund reserve accrual.”12
This change reduced revenue for Groupon’s first reporting period as a public company by $14.3 million
to $492.2 million. Observers questioned the work of the corporation’s auditors, Ernst and Young. One
analyst commented that, “This should have been highlighted by the auditors. The business is growing so
fast that it sounds like they don’t have the proper financial controls to deal with the growth.” Groupon
shares fell 17 per cent on the day that this problem was announced, falling to $15.28; the IPO price was
$20. Restatements because of material weaknesses were comparatively rare because the SEC required
detailed checks on financial controls prior to an IPO. Audit Analytics reported based on their studies of
IPOs that only 12 per cent of corporations reported having ineffective financial reporting controls within
their first year of trading.13
COMPETITIVE LANDSCAPE
Michael Yoshikami, head of the money management firm YCMNET Investment Committee, stated,
“…We continue to be concerned about Groupon’s model, especially given the low barrier for entry into
this space. But it’s a familiar name and investors tend to gravitate to familiar names at first.”14
While Groupon had seen the benefit of a first mover advantage, there were numerous websites operating
with a similar model (e.g., Living Social, Yelp, WagJag, etc.). It appeared that the barriers to entry might
not be high.
11
12
Blodget, “Don’t Mean To Be Alarmist…”
Groupon Inc. Press Release “Groupon Announces Revised Fourth Quarter and Full Year 2011 Results, Confirms First
Quarter Guidance” Source: http://files.shareholder.com/downloads/AMDA-E2NTR/1804436739x0x556787/75400af4-70b64d7c-be5b-064139525981/GRPN_News_2012_3_30_General_Releases.pdf, accessed April 18, 2012.
13
Douglas MacMillan Groupon Revisions Highlight New Model’s Risks, Business Week 2 April, 2012.
http://www.businessweek.com/news/2012-04-02/groupon-revisions-highlight-new-model-s-risks, accessed April 18, 2012.
14
C. Baldwin, and A. Blaire, “Groupon Shares Surge, But Concerns Linger,” November 4, 2011,
http://www.reuters.com/article/2011/11/04/us-groupon-finalpricing-idUSTRE7A27TG20111104, accessed November 6,
2011.
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9B12B002
With such an increase in the supply of these sites, there was likely to be downward pressure on Groupon’s
margins from both consumers and merchants.
QUESTIONS
Lesley was amazed at how a small amount of research into financial statements and accounting metrics
could drastically impact her opinion of a company. She wondered about the following:
What sources of information are most useful to an investment decision?
What are the future prospects of this business?
What does Groupon’s accounting tell us about accounting?
What does Groupon’s accounting tell us about Groupon?
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Exhibit 1
FINANCIAL STATEMENTS FROM INITIAL S-1 FILING
CONSOLIDATED BALANCE SHEET DATA (INITIAL S-1 FILING)
AS AT DECEMBER 31
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Exhibit 2
GROUPON’S ORIGINAL S-1 ON NON-GAAP MEASURES
Non-GAAP Financial Measures
We use adjusted consolidated segment operating income, or Adjusted CSOI, and free cash flow as key nonGAAP financial measures. Adjusted CSOI and free cash flow are used in addition to and in conjunction with results
presented in accordance with GAAP and should not be relied upon to the exclusion of GAAP financial measures.
Adjusted CSOI is operating income of our two segments, North America and International, adjusted for online
marketing expense, acquisition-related costs and stock -based compensation expense. Online marketing expense
primarily represents the cost to acquire new subscribers and is determined by the amount of subscriber growth we
wish to pursue. Acquisition-related costs are non-recurring non-cash items related to certain of our acquisitions.
Stock-based compensation expense is a non-cash item. We consider Adjusted CSOI to be an important measure of
the performance of our business as it excludes expenses that are non-cash or otherwise not indicative of future
operating expenses. We believe it is important to view Adjusted CSOI as a complement to our entire consolidated
statements of operations.
Our use of Adjusted CSOI has limitations as an analytical tool, and you should not consider this measure in
isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
Adjusted CSOI does not reflect the significant cash investments that we currently are making to acquire new
subscribers;
Adjusted CSOI does not reflect the potentially dilutive impact of issuing equity-based compensation to our
management team and employees or in connection with acquisitions;
Adjusted CSOI does not reflect any interest expense or the cash requirements necessary to service interest or
principal payments on any indebtedness that we may incur;
Adjusted CSOI does not reflect any tax payments that we might make, which would represent a reduction in
cash available to us;
Adjusted CSOI does not reflect any foreign exchange gains and losses;
Adjusted CSOI does not reflect changes in, or cash requirements for, our working capital needs; and
other companies, including companies in our industry, may calculate Adjusted CSOI differently or may use
other financial measures to evaluate their profitability, which reduces the usefulness of it as a comparative
measure.
Because of these limitations, Adjusted CSOI should not be considered as a measure of discretionary cash
available to us to invest in the growth of our business. When evaluating our performance, you should consider
Adjusted CSOI alongside other financial performance measures, including various cash flow metrics, net loss and
our other G …
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