Should You Be Concerned About Groupon's Accounting?

If you missed the headlines after Groupon's (NAS: GRPN) Aug. 13 earnings call, they looked something like this:

  • "Groupon Slides After Results Disappoint"

  • "Groupon Shares Hit Following Forecast After Hours"

A primary culprit for the dramatic after-hours stock price drop? Concerns about the accounting methods used for Groupon's new retail line of business, Groupon Goods.

A very brief history
Longtime investors remember the impact accounting concerns had on Groupon's stock; you lived it. For Groupon neophytes, back in the day (well, OK, last November), right around the time of Groupon's IPO, there were questions surrounding revenue numbers. The concerns entailed the use of gross fees Groupon was reporting as revenue versus the amount it actually received from merchant customers.

Not too long after the accounting "issues," Groupon made the decision, and a wise one in my opinion, to generate another line of revenues beyond what are now called "third-party sales" -- revenues derived from Groupon's traditional merchant coupon business.

The business line management unveiled was Groupon Goods. According to the Q2 SEC filing, Groupon is "the merchant of record" for direct sales of retail goods to customers. Seems straightforward enough, right? The questions from analysts and investors arose after Groupon management disclosed how those direct revenues are accounted for.

Back to today
As per Groupon, Q2 was the first quarter in which "direct revenue, or the amount earned from the sale of products for which the Company is the merchant of record, was material to Groupon's overall performance." The bad news is (apparently) analysts and investors are still stinging from Groupon's earlier accounting woes. The decision to report direct revenue on a gross versus net basis is stirring up some bad memories.

But that's how retail companies report sales. Does Macy's or Target record revenues on a net basis? Of course not, which leads me to believe the concern over having Groupon do the same thing is less about retail sales and more about history.

The reality of Q2
The 45% year-over-year increase in revenue to $568 million in Q2 is cause for celebration. Beyond the obvious growth in total sales, the disparity between North American and International revenues tightened up a bit. The 65.5% jump in North American revenues (international revenues grew 31%) closed the gap between the two regions, which was nice to see.

North America now accounts for 46% of Groupon's total revenues, compared with 40% at this time last year. And with the global economic climate being what it is, the improved revenue balance will help mitigate geographic risk. So what about that disconcerting direct revenue? It more than tripled to $68 million in the second quarter, up from 2011's $19.2 million. In other words, direct revenue accounted for all of 12% of total revenues for the quarter -- 12%. For that, Groupon shareholders get shellacked?

A few more Q2 numbers are worth mentioning -- excluding a couple of one-time items, Groupon earned $0.08 a share, versus the $0.03 analysts had forecasted. Customer acquisition costs improved dramatically, reducing marketing expenses by 58%, and the customer count jumped 68% to a total of 38 million active Groupon users. Twice as many traditional Groupon customers (merchants) are using its support tools, which should continue to solidify customer relationships. Another win was free cash flow, which jumped nearly 50% to more than $96 million.

The real concern
Success breeds competition, and that's what Groupon management and shareholders should focus on. Two of the biggest potential problems for Groupon are already in the market. Google's (NAS: GOOG) Offer product isn't in the same ballpark as Groupon yet, but its decision to go mobile -- with the recently released iPhone app, of all things -- is worth noting. The second biggest player behind Groupon, LivingSocial, has the backing of (NAS: AMZN) , which is why it's in more than 20 countries and growing.

Final thoughts
Getting beaten up for generating an annual run-rate of more than $200 million annually from a new line of business is ... odd, to say the least. One area of Groupon's business model that concerned me was a lack of diversified income streams. The positive results of Groupon Goods in such a short period of time is encouraging, regardless of how it's accounted for.

Whatever your investment style or preference, opportunities like this don't come along every day. If you want stock appreciation, I'd suggest you run, not walk, to your nearest online broker or investment advisor and tell 'em, "Groupon, now!"

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Fool contributor Tim Brugger currently holds no securities positions, including any mentioned in this article. The Motley Fool owns shares of and Google. Motley Fool newsletter services have recommended buying shares of Google and We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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