1.What is the role of the SEC with regards to IPO's and financial statement filings?
2.What is the role of Groupon's BOD, particularly the BOD Audit Committee? Did the BOD Audit Committee fulfil its role adequately? How could it have improved its performance?
3.What is the role of Groupon's external auditors with a public IPO filing? Did the external auditors fulfill their role adequately? How might the external auditors have improved their performance?
4.What do you think investors were thinking when they invested in the IPO in terms of the organization and conduct of Groupon?
5.Analyze Groupon's business model. Which stakeholder group is at risk? How much are they at risk? Is the risk immediate?
Lesley Simmonds kept seeing Groupon appear in the news with reference to its accounting practices. As a ent, 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 ite states, "Groupon negotiates huge discounts - usually 50-90 per cent off - with popular es. 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." 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. To make a purchase, a customer paid Groupon to use its website or various applications. Only after a pre- nined number of Groupons had bee coupons had been bought did the deal become green-lit 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 finan blic 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 measur AP 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 w 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 Groupon justified the use of ACSOI due to the high cost of acquiring customers, the a customers, the argument being that acquisition costs were far greater than retention costs and as such expenses would substantially decrea 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 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). not alone when it came to becoming creative with non-GAAP financial measures. For a publisher of how-to articles, capitalized the cost of its writers over five years. Themere: yelling Media, a publisher of how-to article such as "adjusted OIBDA " short for "operating income before depreciation and amortization" and used only by less well-known companies such as Demand Media but also by corporations s Time Warner.5 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. 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: 1 Grammarize my excitement with four points . 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." ied 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 t we expect to end when this period of rapid expansion in our subscriber base concludes." 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 hat 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." After an extended period of controversy, Groupon gave up its resistance to abandoning ACSOI. The controversy abo 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 non- GAAP financial measures and its top-line revenue. In this revised filing, instead of using ACSOI, Groupon chose a different measure which they termed Segmented Operating Income (CSOD). The only difference between CSOI and ACSOI was that CSOI did not exclude onl not exclude online marketing expenses. (See Exhibits 4, 5 and 6 regarding the calculation of ACSOI versus CSOL.) 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 Internat 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 woul eparately 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 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 top line 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 der the traditional redemption payment model, Groupon paid the merchant for all Groupons purchased over a period of generally 60 days. Under the redemption payment mod ants were not paid until the customer redeemed the Groupons. A great amount of volatility was luced 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 it's working capital deficit. It is important to note as well that this working capital deficit did not ude 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 ra new Groupon sales that oucompany is growing rapidly, it generates a lot more cash from ons. 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 ov cash to merchants than it had on hand "10 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 cash - and paid out $942 estors and executives (highly unusual for such a young company). If Groupon does get into cash trouble, therefore, it wi be because the company didn't discover an a didn't discover an amazing new business opportunity or raise all the capital it needed. It will be because of, well, greed."li 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 ount for an increase in higher priced offerings, which were more likely to be refunded to customers. The company had started to sell dis 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 Observers questioned the analyst commented that, "This should have been highlighted by the auditors. The business tors, Ernst and Young. One 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 re udit Analytics reported based of 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 is 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. 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
