Groupon Inc (GRPN) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to Groupon's second-quarter 2014 financial results conference call.

(Operator Instructions)

Today's conference call is being recorded.

For opening remarks, I would like to turn the call over to the VP of FP&A and Investor Relations, Genny Konz. Please go ahead.

Hello, and welcome to our second-quarter 2014 financial results conference call.

On the call today are Eric Lefkofsky, CEO, and Jason Child, CFO. Kal Raman will be available for questions during the Q&A portion of the call.

The following discussion and responses to your questions reflect management's views as of today, August 5, 2014, 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-Q.

Groupon encourages investors to use this investor relations website as a way to easily finding information about the Company. Groupon promptly makes available on this website free of charge the reports that the Company files or furnishes with the SEC, corporate governance information, and select press releases and social media postings.

Our results for the second quarter reflect the acquisitions of TMON and ideeli since their respective dates of close in January. We will at times discuss performance, including and excluding the impact of these acquisitions, for comparison purposes. Additional detail regarding the contribution of each to the quarter will be included in our 10-Q.

On the call today, we will also discuss the following non-GAAP financial measures: adjusted EBITDA, non-GAAP earnings per share, and free cash flow, as well as FX neutral results. In our press release and our filings with the SEC, each of which is posted on our investor relations website, you'll find additional disclosures regarding non-GAAP measures, including reconciliations of these measures with US GAAP.

Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2013.

Now I will turn the call over to Eric.

Thanks, Genny.

We made good progress in the second quarter. Our local marketplace of over 240,000 deals continue to gain broader awareness. We reached another all-time high in mobile transactions, as nearly 92 million people have now downloaded our app. And our international business continued to stabilize and is now contributing nicely to our bottom-line.

Q2 was another record quarter for Groupon. Gross billings increased 29% to $1.82 billion, and revenue increased 23% to $752 million. Adjusted EBITDA came in toward the high-end of our range at $59 million, up from $40 million last quarter. And non-GAAP EPS was in line with our expectations at $0.01.

The demand remains healthy in North America. Billings grew 12% to $799 million, led by a 26% year-over-year growth in our goods business and 44% growth in travel. North American revenues also increased 12% to $424 million. Gross profit was about flat sequentially at $108 million, and segment operating income was $15 million, up from $11 million in Q1.

EMEA billings were about flat with the prior year at $483 million, also reflecting strength in goods, which grew 14% year over year. Revenue growth was 42%, as the mix of direct revenue was higher in the quarter. In addition, we generated $28 million in segment operating income, up from $19 million in Q1, as a result of marketing reductions. After much work, EMEA has now seen two quarters in a row of year-over-year customer growth after a few quarters of decline, and remains profitable and on stable footing.

Rest of World grew 145% in billings, largely driven by the acquisition of TMON. Excluding our Korean business, Rest of World grew 17% on an FX-neutral basis. Revenues grew 40%. The large difference between billings growth and revenue is related to TMON's deal margins, which have historically been in the low-teens, as are typical for large Korean e-commerce companies.

The Rest of the World segment operating loss was $18 million for the quarter, reflecting continued investments, largely in TMON. While these investments are larger than we originally anticipated, they have driven significant growth that has and continues to exceed our expectations. Excluding TMON, our losses improved by about $5 million year over year, which is on track with our plan to generate positive segment operating income by Q4.

In light of the good progress we've made in Rest of World, Kal Raman is transitioning from COO to CEO of APAC so that he can focus all of his energy on continuing to unlock value in our high-growth Asian markets. I want to thank Kal for all the great work he has done building our infrastructure as COO. He has built a strong team that positions us for success going forward. Kal will continue to report to me in his new role.

Recall that for 2014, we have three primary objectives. First is to re-accelerate our local growth in North America and abroad. Second is to improve the gross margins and operating efficiency of our goods business. And third is to continue to achieve stability in our international operations and reduce our losses in Rest of World so that every region in which we operate is generating positive segment operating income by year end, excluding any impact from acquisitions. We continue to believe we're on course to achieve all three objectives by the end of 2014.

Let me start with the first. Our North American local billings growth re-accelerated in Q2, albeit only slightly, after two quarters in a row of deceleration, from an increase of 1.4% last quarter to 1.8% this quarter. We believe one of the main drivers of this is that redemptions have appeared to stabilize. The average number of unused Groupons per customer, which is a good indicator of people's willingness to buy more, has declined by more than 25% in the past year. That number has now been stable for the majority of 2014, which leads us to believe that we have seen the bottom.

We intentionally drive people to redeem more of their Groupons because we believe it leads to greater customer satisfaction and higher lifetime value. Recall that we began to see headwinds in our local business toward the end of Q3 of last year, due in part to a shift in consumer behavior related to our marketplace. Whereby more people were waiting to buy our deals closer to the time they intended to actually use them.

As redemptions stabilize and other improvements we've put in place take hold, we expect local growth to continue to accelerate. The acceleration of our local business continued robustly in July, which we believe is another sign that we're on track to deliver double-digit year-over-year billings growth in North America local by year end.

That said, our take rates in North America local decreased by roughly 300 basis points compared to last quarter, predominantly driven by an increased proportion of sales for high-quality lower take rate merchants in the quarter. In addition, we've increased site-wide sales and order discounts over the past few quarters in an effort to drive adoption of our marketplace.

Until now, we've absorbed the impact of these discounts ourselves. Going forward, we intend to pass on a portion of these promotional discounts to our merchants. As these efforts unfold, we believe that take rates in local improve and remain within the range we've seen over the last couple of years going forward.

Our second priority is to improve our goods margins, particularly in North America. Our costs have historically been almost 2X that of other comparable e-commerce companies. To address this, we've made some significant changes, including shifting more of our business to drop ship, moving more fulfillment to our own distribution center in Kentucky and increasing units per order.

We're pleased with the progress we've made to date, with gross margins in North America increasing over 400 basis points quarter over quarter, from 5% in Q1 to 9% in Q2. And we believe we're well on track to achieve our goal of double-digit gross margins in North America by year end.

Our third priority is to continue to improve our international operations and reduce our losses in Rest of World. We made significant progress in the quarter, reducing our total segment operating loss from $25 million in Q1 to $18 million this quarter. As we continue our regionalization efforts, and as APAC growth gains momentum, we expect continued improvement in Q3. Given our progress to date, we expect to generate positive segment operating income by Q4, excluding TMON.

As we shared last quarter, we define long-term success as both gross billings and gross profit growing at least 20% annually over the next five years. We're focused on the operating objectives I've highlighted because we believe they are the purest drivers of gross profit dollar growth over the long term.

We also advanced our strategic objectives in the quarter. First, mobile. Mobile remains over half our business worldwide. Mobile mix as measured by transactions continued to increase in Q2, reaching yet another all-time high. As we said last quarter, we are no longer becoming a predominantly mobile business, we now are a predominantly mobile business. Nearly 92 million people have now downloaded our app, and by most reports, we are now the most mobile large-scale e-commerce Company in the world.

Yet activations remain behind web. So while people are engaging with Groupon through their mobile devices, we have yet to optimize the customer experience. Each quarter we make progress, and we're inching our way closer to parity over time.

Second, local. Local and mobile are converging. Local is all about geography, and mobile is all about proximity. Both are intertwined, which is why our mobile business has grown so fast. That said, we have yet to truly deliver on the vision of Groupon, the vision of a world where all merchants and consumers are connected in real time through a network that allows every merchant to attract the very best customers, and allows every customer to find the very best deals.

What we've learned over the past year is that in order to win, we need Groupon to become an integral part of our customers' lives, a daily habit. To achieve that, we need to make the experience of buying and redeeming at Groupon as easy as pulling out your credit card or buying an app on your phone. When people use their Groupons, they buy more. When they don't, they buy less.

To close the loop and get more people using their Groupons, we need to connect merchants to our customers in real time, making the Groupon experience seamless, frictionless and fun. After years of work and significant investment, the tools we've built to close this loop are starting to hit the market with the rollout of our local commerce platform, which I'll discuss in a minute.

Third, marketplace. When we began, our reps only had one product to sell -- a daily deal email featuring one business at a time in a given city. When we built the first version of our marketplace, we needed a new product that would allow merchants to be on Groupon more regularly. So we created an inventory system, allowing merchants to reduce the number of units sold on the first day and instead sell a designated number of units every month. Today over 75% of our North American merchants opt to be in our marketplace on an ongoing basis.

Recently, we enhanced our product, allowing merchants the ability to offer deals that vary, based on both time of day and day of week. Which allows us to attract a whole new range of merchants that historically couldn't work with Groupon because they have times when they're just too busy to take on more customers. They can now block those times off or reduce the discount rate to more tightly control the flow of customers that Groupon delivers.

But even with these enhancements, we still only offer a little over 105,000 deals in North America, out of a pool of nearly 7 million targeted merchants. Even with all of our effort, our marketplace is still only covering a small slice of the market.

But what if virtually every local business had a presence on Groupon? What if this was a customizable, and more importantly, transactable space where merchants could not only put up deals on our site, but also post their specials directly to our customers? And what if customers could search these sites and find a wealth of other relevant information, including tips and reviews, in addition to amazing deals, offers and specials?

As our marketplace has evolved, we've come to realize that despite the gains we've made and continue to make in expanding our supply, having less than 5% of the available merchants on our platform isn't sufficient. We need a solution for the other 95% of merchants that don't work with us today. To address this, we're launching two new products, [Pages] and Gnome, that together enhance our local offering and allow us to connect the last mile of local commerce.

Pages create a web and mobile presence for every local merchant, filled with useful information for our users, including contact information, maps, time of service, recommendations, tips, and most importantly, a wider variety of discounts. We've already built pages for millions of merchants in North America, and expect to begin rolling them out in the coming quarters.

Gnome is our new operating system for merchants. Whether they're running a deal or just looking to claim their merchant page, we believe Gnome bridges a critical gap for us, putting us right inside our merchants. Wrapped inside an iPad mini with a credit card swiper, Gnome offers merchants seamless redemption, enabling customers to redeem at their Groupons without ever taking their phone out of their pocket. It also offers a digital cash register that vastly improves workflows, a lightweight and elegant point-of-sale system that captures item-level detail, and full payment processing at some of the best rates in the market.

In addition, customers can leave tips and reviews right on Gnome. We've now deployed Gnome in over 75 cities in North America, and expect to continue the rollout throughout the rest of this year.

When you combine Gnome with the nearly 92 million people that have downloaded our apps, you can begin to see the foundation of a true local commerce network unfold, a network where users and merchants are continuously connected, allowing consumers to explore the world around them and save money while they're at it. And allowing merchants to offer real-time discounts and incentives to get the right customers coming in their doors at the right times.

While these new products are ramping up, we'll continue to build additional supply and demand to accelerate adoption of our marketplace. Searchers accounted for 10% of our overall traffic in North America in June, with customers who searched continuing to spend materially more than those that did not. Our marketplace is doing well. But with Pages and Gnome, we believe we can take it to an entirely new level.

Overall, we are pleased with the progress we've made across all of our initiatives this quarter. We remain focused on execution, both in North America and in our international markets, via our One Playbook initiative that is entering our most exciting stage through the final unification of our American and European technology staff.

With that, I'll now the call over to Jason to discuss our financial progress in the quarter.

Thinks, Eric.

With the details available in this afternoon's press release, I'm going to run through the highlights of our performance and then provide our outlook. Note that all comparisons, unless otherwise stated, refer to year-over-year growth. Let me run you through the numbers.

Gross billings increased 29% to $1.82 billion. North America grew 12%, EMEA was about flat, and Rest of World increased to 145%. As Eric mentioned, TMON has and continues to run well-ahead of the expectations we had at the time of the acquisition, contributing $317 million to billings in the quarter. Excluding TMON and FX, and further taking the exit of Groupon's legacy Korea business into consideration, we were pleased to see Rest of World growth for the second quarter in a row increasing 17%.

Revenue increased 23% to $752 million. North America grew 12%, EMEA grew 42%, and Rest of World grew 40%, lower than 145% billings growth as a result of the substantial addition of lower margin TMON billings to the mix. Gross profit was $390 million in the quarter, compared to $385 million last year. Gross profit growth lagged billings growth, due to a greater mix in direct revenues.

North America, in particular, was also impacted by continued investments in quality, as well as order discounts, to drive awareness of our poll marketplace. Given our focus on growing gross profit dollars, we were pleased to see the slight increase quarter over quarter, even in light of these investments.

Adjusted EBITDA was $59 million in the quarter, down $21 million compared to last year, primarily due to in approximately $30 million increase in SG&A related to TMON and ideeli. Note that we also had a $26 million increase in marketing and order discounts to drive awareness for pull.

As you think about the relative profitability of our segments, it's important to keep in mind that the North America segment reflects almost all of our technology costs. So as we've invested heavily in global product and technology over the past year, it has had a short-term impact on North America's profitability.

GAAP loss per share was $0.03. Excluding stock compensation, amortization of acquired intangible assets and acquisition-related costs, all net of tax, non-GAAP earnings per share was $0.01. Free cash flow was a negative $54 million for the quarter, resulting in a trailing 12-month free cash flow of $41 million. Free cash flow in the quarter was impacted by payments timing, as well as a few key strategic investments, including the shutdown of Groupon Korea. We expect free cash flow to pick up materially in the back half of the year, as it did in 2013.

As of June 30, we had $868 million in cash and cash equivalents, after spending $106 million in connection with our share repurchase program. Including the 17.2 million shares repurchased in the quarter, we've repurchased a total of 24.7 million Class A common shares under our existing authorization, for an aggregate purchase price of $182 million. Approximately $118 million remains available under our existing repurchase authorization, which will expire in August 2015. The timing and amount of any repurchases will continue to be determined based on market conditions, share price and other factors.

Turning to a couple notable highlights of our non-financial metrics, active customers reached 53.2 million worldwide for the quarter. Customer growth accelerated for the second quarter in a row, and excluding acquisitions, was the strongest growth we've seen in a year. Notably, EMEA customers increased year over year for the second sequential quarter. Customer spend, as measured by trailing 12 month's billings per average active customer, was $137 compared to $132 last quarter, driven by the addition of TMON.

Moving on to our categories. Local gross billings increased 6% to $859 million, with continued growth in customers, units and active deals. EMEA declined 6%, and North America increased 1.8%, a slight increase over Q1. Rest of World grew 48%, driven by TMON.

Local gross profit decreased 8% to $269 million, with billings growth and lower cost of revenue more than offset by take rate declines. The reduced take rates reflect an increased proportion of sales for high-quality merchants and the impact of order discounts as we focus on marketplace adoption in North America, as well as the increased mix of lower margin TMON revenues.

Before I move away from local, I want to touch on EMEA, where local billings declined 6%. While in North America, the overall profitability of local is higher than that of goods, the economic health of these businesses in EMEA is more similar, given that our goods gross margin in EMEA is roughly double North America's. As a result, we are more agnostic on category mix in EMEA, but we do expect local billings to return to stronger growth by year end.

Goods gross billings increased 65% to $720 million, with all segments contributing to the growth, even after excluding the impact of acquisitions. Goods gross margins were 11.5% globally, reflecting a greater mix of direct and lower margin TMON revenues, most of which are recognized on a third-party or net basis.

Direct margins increased 100 basis points year over year to 12.2%. With nearly half of our goods billings now direct, the dollars in aggregate continue to move in the right direction. And as Eric mentioned, with continued focus on the reduction of shipping and fulfillment costs, we expect to see continued improvement in gross margins this year. Finally, travel gross billings increased 44% to $240 million, with North America growth accelerating to 44% in the quarter.

Before I close, let me provide some additional color on a few specific items. Marketing expense was $64 million in the quarter. In addition, we invested over $24 million in order discounts, taking our net investment up to $88 million, a $26 million increase compared to a year ago.

We invest marketing dollars in a variety of ways. We spend money to acquire subscribers and app downloads, which tend to have longer-term payback horizons. We invest money in order discounts, which drive billings growth and awareness, but obviously come at the expense of margins. And we invest money in transactional advertising, such as search and display, which has a shorter-term payback than acquiring a subscriber, but still can extend out several quarters.

It's in this last category that we're just beginning to make real progress and see some improvements in our line. As our efficiency of spend continues to rise, we are likely to continue to invest heavily in this area throughout the balance of the year. Together, we believe these investments will produce long-term benefits.

Secondly, we've entered into a three-year $250 million revolving credit facility. While we have no immediate plans to draw on the line, we believe this will provide us with additional balance sheet flexibility going forward.

Finally, turning to our outlook. For the third quarter of 2014, we expect revenue between $720 million and $770 million, adjusted EBITDA between $50 million and $70 million. And non-GAAP EPS excluding stock compensation, amortization of acquired intangibles and acquisition-related costs net of tax between zero and $0.02.

As it relates to the full year, we are revising our outlook and now expect adjusted EBITDA to exceeded $270 million, as opposed to $300 million. Although we continue to have the opportunity to reduce our market and investments, including in TMON, over the remainder of the year, to achieve a target in the $300 million range, we don't believe that this reduction makes sense based on the ROI of our recent investments and their potential impact on 2015.

As always, our results are inherently unpredictable and may be materially affected by many factors, including the high level of uncertainties surrounding the global economy and consumer spending, as well as exchange rate fluctuation.

With that, I'll turn the call back to Eric.

Thanks, Jason.

We believe Groupon has an opportunity to become the starting point for local commerce. We've now built the foundation for Groupon to become a true platform. As we approach our 6th birthday in November, we believe we have an opportunity to connect the last mile of local commerce in ways that were never before imaginable.

With the deployment of Gnome, we intend to provide our merchants with a suite of tools that connect them to our community of over 200 million subscribers, nearly 92 million app downloads and over 53 million active customers. Merchants will finally have technology that allows them to manage the inflow of customers, and customers will finally be able to explore the world around them and save money while they're at it. And we believe this all will happen seamlessly, anytime, anywhere, through the phones in their pockets and the tablets on their counters.

Our local mobile and marketplace investments, together with Gnome, represent the culmination of years of hard work and a significant investment, which we believe firmly positions us to realize our vision of connecting local commerce.

With that, let's take some questions.

(Operator Instructions)

Heath Terry, Goldman Sachs.

Great, thanks. Just one question to start with, on Gnome. Do you have a sense of -- [pretty] surely among the early adopters for Gnome -- whether it's being used to replace existing payment systems completely, or is it at least just being used primarily as a system for redeeming Groupons?

And then secondly, how do you think of the strategy for re-accelerating North American growth? Do you believe that the improving economy is leading to a less promotional local e-commerce environment that's limiting the number or type of merchants that are willing to use Groupon? Or is this something that can be fixed through the strategy that you're putting in place?

Yes, so let me start with the Gnome. First and foremost, Gnome is our operating system for local merchants. And it certainly serves as a redemption device. It's actually a beautiful redemption device. Customers can walk in and basically redeem their Groupons seamlessly, frictionlessly, without even pulling their phone out of their pocket.

And it's also being used by a meaningful percentage of our merchants as a payment device, because we offer some of the best payment rates in the market. We don't quote what percent that is, but it is certainly a significant percentage of people who are trying us for payments, and we're excited about that.

It's also being used by many people as a point-of-sale device, because roughly 60% of our merchants don't have a point-of-sale device. And they're longing for this kind of item-level detail so they can figure out how to attract more customers and how to maximize the yield.

So Gnome is rolling out. It's in about 75 markets today. And our long-term goal is to get every merchant that we work with and certainly every merchant that we contact to take a Gnome device. So I would say we're excited about the payment prospects, but it's still early days to quote exact statistics.

As it relates to local growth, we are very focused on executing both parts of our local growth strategy in North America. One is obviously getting our pull business right, and the other is getting our push business right. Our push business, which is all about sending better emails and attracting higher-quality merchants -- we've made some great strides.

And in our pull business, which is our marketplace, we continue to see that business move up and to the right. It was about 8% of transactions a few quarters ago, and then 9%, and now 10%. The adoption hasn't been as strong as we would like, but it is making great progress.

And we're excited that after two quarters in the role of our local business decelerating, this quarter we actually saw that trend reverse. And the local business began to grow again in North America, albeit slightly, from about 1.4% growth to 1.8% -- a big part of that being the fact that unused Groupons and redemptions have now started to stabilize.

And most exciting, I think, for us is, we've seen some real acceleration in our local business in North America in the later part of Q2 and then rolling into July. We've seen robust growth. So we feel like we're very much on track in getting that business back on track and hitting the goal that we had stated, which is double-digit growth by year-end.

Great. Thanks, Eric.

Thank you.

Mark Mahaney, RBC Capital Markets.

Thank you. Two questions, please. Eric, you talked about making improvements to the mobile product. Could you draw those out a little bit? And user interface improvements, marketing improvements -- what do you think you need to do to improve the mobile offering?

And then, could you just clarify a little bit more of these recent returns on marketing investments -- and I think you mean that the returns have been improving. But could you draw that out? Why have the returns on the marketing investments been improving? Is it better use of channels, less competitive pricing environment? If I interpreted that right, could you just draw that out a little bit? Thank you.

Yes. So let me first provide a little context before I get into the mobile piece. Groupon is very much a business in transformation. Over the last year, we've invested a tremendous amount of time and energy into expanding just beyond a daily deal email business. We've been investing in building this mobile marketplace that people come to and search for deals.

And we've made some really amazing progress -- over the past year now, over 50% of our business is mobile worldwide. We're again at an all-time high; 92 million people have downloaded our app, another all-time high.

And yet we have yet to really fundamentally shift consumer behavior. And I think a big part of that -- there's two parts of it. One is the actual inventory that's in our marketplace. We still -- despite the fact that we have 105,000 merchants offering deals in North America, we still are servicing less than 5% of our target market. And we need to service the other 95%. If you went to search for something and only found an acceptable result 5% of the time, you would stop searching.

The second part is the user experience. It still is -- it's not beautiful and elegant yet to really search among our deals and explore your local market. And in part, it's because all this is relatively new. We've only been in the marketplace business for the last year or two. So we're still trying to find a way to figure out that most optimal user experience.

Ideally, you want that nearby tab on the mobile to be intuitive. You want it to know what's around you, and almost be like 3D glasses that show you all the merchants that are nearby you and who's willing to offer a special or a deal to get you to come in.

And if you look at the strategy we put in place by creating merchant pages, it's all about getting that additional inventory onto the platform. It's about finding a way to service not just 5% of the market, but 95%, so that our customers get used to checking Groupon first, opening up the app all day long. And that's how you really create this local commerce platform and this local commerce network. So that's the mobile piece.

In terms of marketing ROI -- look, when you spend money on marketing, you're principally trying to drive billings growth. And we just had two quarters in a row of record billings growth. A little over $1.8 billion last quarter, $1.820 this quarter. And if you look at it on a year-over-year basis, including acquisitions, our additional marketing spend in marketing and order discounts was maybe $26 million. It lifted our billings by well over $140 million. So our spend is certainly delivering some of the results that we want.

But as always, when we spend money on marketing, even though the returns are exciting and are getting better all the time, it is in the short-term dilutive to earnings, and over the long-term, it's obviously accretive. Because like most companies like us, our marketing can tend to have a payback of three quarters or four quarters. It's not all paying back intra-quarter.

And so we feel like we're in a good place in that we can double down on some of these marketing investments in light of the return we're seeing. And not just focus on reducing marketing by $20 million or $30 million to hit one quarter, but really focused on how do we create that double-digit long-term growth, both in billings and gross profit, not just at the end of the year this year, but really rolling into 2015.

Mark, just to add a quick clarification, the marketing-plus-order discounts was up $26 million year on year, which -- and that's for all --both Groupon and our recently acquired companies. And the billings increase was about $4 million, and then the revenue increase was about $140 million.

That's why I'm not the CFO.

Thanks, Eric. Thanks, Jason.

Paul [Beaver], Bank of America Merrill Lynch.

Hi, guys. Thanks for taking my questions. First off, can you provide some color on the adoption rate of the coupon business that you launched?

And then secondly, last 4Q you were pretty promotional in the goods segment. What should we expect in terms of the goods gross margins as we head into the holiday season? (technical difficulty)that you said double-digits. But should we expect the same level of promotional activity as last year?

I'll take the coupon piece and Jason can take the goods -- the margin piece. We launched the coupon business, for those who don't know, called Freebies. And we launched it because we had this very large community, over 200 million subscribers, over 53 million customers, over 92 million people have downloaded our app. And they're constantly coming to our site looking for amazing things to do and things to discover.

And we've always had a very good relationship with large national retailers, going back even five years ago, when we ran the Gap or Nordstrom or some of these early deals that we ran. Our customers find it exciting not just to buy -- to them, that national retailer-- it's a national chain, but it's in their local community, right? It's a block down the street, or whatever it is. We've always offered deals for those folks.

We are pleased that our Freebies business has really come out of the gate and is thriving. We have over 30,000 coupons on the site today, from over 6,500 stores, over 200 leading brands. So we really have jumped into that market in a big way. And we're thrilled with how it's growing. That being said, we have yet to provide details beyond that, other than to say it's doing super and we're thrilled at how that product has been adopted by our consumers.

And related to goods margins, if you go back to Q4, while we were somewhat promotional in terms of, I think, the total landed cost, in terms of free shipping, et cetera, we do expect to do that again. But the pure product margin was actually very solid. So the pure product margin, which is basically just the cost of the products or what we sell it for less cost of the product, excluding any other cost. That's been in the 30%-ish range, and it's been stable actually going all the way back to middle of last year.

So the issue that we saw in Q4 had much more to do with a much more intense peak demand than we had expected, which caused much higher shipping costs, and even some refund costs when we hit our capacity much earlier in the holiday period than we wanted. So what we're doing this year to account for that is just have a much more robust logistics and warehousing plan that will enable us to handle that peak.

And as a result, you saw a bunch of -- you saw significant increase, a 400-basis point increase in margins from Q1 to Q2. You should expect to see continued improvement and should expect to still see us hit the double-digit gross margin in direct goods in North America by Q4.

Thank you.

Douglas Anmuth, JPMorgan.

Great. Thanks for taking the question. This is Kaizad on the line for Doug. Eric, I was wondering if you could elaborate on merchant pages a little bit. How much of the content will be consumer-generated? How will they be marketed to users? How will they be monetized? And maybe you can talk a little bit about the volume of reviews you're collecting today. Thanks.

So just to provide a little color on Pages. So Pages are essentially -- for those that haven't seen them, Pages are mini-sites that live on Groupon on the web. If you want to see one, you could type in, for example, I think, Flying Fish. You go to Google and type in Flying Fish Groupon or Flying Fish Seattle -- it's a restaurant in Seattle. You could go to Groupon and type it in our search box, and you'd see a merchant page.

These pages essentially allow merchants to access our large community of people looking to buy. And they really have two primary purposes. One is, merchants can put up the kind of information that consumers want to see. We have maps and content and terms of service and contact information. We also allow our customers to leave tips. They can say, hey, this is the best burger in Seattle. Or when you go to the restaurant, you ought to try this.

We have a very large community and so we've been accumulating a significant number of reviews. And these pages have been highly interacted with by our consumers, and we expect that to only grow over time as we roll them out. We launched them in a few cities; we expect to launch them throughout the rest of the country over the next several quarters.

But the second -- the bigger opportunity, besides the content, which I think is going to be amazing in light of how big our community -- and how active our community is, is that these are places to transact. So merchants can put up the kind of specials they put up on their chalkboard. They can put them up on their merchant page, and all of a sudden, there's this huge community of people that can be enticed to come in because their merchant is offering some kind of unique deal, even if the deal is not as large as one of our normal deals that we email or push out to people.

So it's a huge opportunity. Just in the time we've launched these pages, we've had tens of thousands of people that click at the request-the-deal button, or an enormous number of people have left tips, and the like. And so we think these are going to really add to our marketplace and help round it out.

Thank you.

Ross Sandler, Deutsche Bank.

Hi, thank you. This is actually Kevin LaBuz on behalf of Ross. I have one for Eric and one for Jason. Eric, we've recently seen OpenTable, La Furshet, [Marco's] and a number of other players in the local enabler space be acquired. Just wondering if the market doesn't appreciate the potential at Groupon, would you consider alternatives?

And for Jason, your guidance assumes around $115 million of EBITDA in 4Q, which is double the 3Q level. So what's giving you the confidence in that EBITDA guide?

So let me start with the first, and then maybe Jason and I can both the jump on to the second. So the first is, look, our heads are down. We're focused on Groupon. We have an enormous amount of work yet to do here. That being said, if you guys were offering to buy the Company, we're happy to entertain anything. We don't think about that kind of stuff. We think heads down, run the business well, and we don't tend to spend a lot of time speculating about people that might knock on our door.

In terms of guidance, look, we feel confident. I'll let Jason weigh in, in a second. But we obviously feel confident. We started out -- maybe I'll speak to some of the macro drivers, and then he can speak to the specifics.

We started last quarter -- we laid out three operating objectives. We laid out -- the first is, we wanted to have our Rest of World losses go down. We wanted to have our goods margins go up. We wanted our local business to re-accelerate. And we made great progress on two of those. Obviously our Rest of World losses improved dramatically in Q2. Our goods margins are up 400 basis points. And our local business, which had decelerated from two quarters in a row, has kind of turned the corner and we've seen really strong growth over the last few months, especially into July.

We feel like we're executing as well as we can in light of the fact that we've got a business in transformation. But all the leading indicators we see lead us to believe that we're doing the right things by continuing to make these investments and it's going to pay the dividends we want. Active customer growth, spend per customer units, traffic, all that stuff moving in the right direction.

So in terms of the -- how the numbers work, that's why we gave the forward views on some of the key financial drivers of the business for Q4. And that is, if you model local growing at double-digit rates in North America by Q4 and at the current take rate range, which, over the last three quarters has been somewhere between 35% to 38%, in that range with that growth, you are going to see pretty significant flow-through on local.

Goods, if you continue to see the seasonal strength that you'll see in all categories, but especially in goods. And you actually apply a double-digit margin to that, unlike the 7% or so that we saw in direct in Q4 last year. And you take the improvements that you're seeing in EMEA as well, where they actually hit nearly 20% double-digit in the most recent quarter, you will also see pretty significant flow-through there.

And then lastly, when you take the Rest of World business that lost $24 million or so back in Q1, and then now is reduced to about $18 million, and then flow that now down to breakeven, actually by year-end, that's also a pretty significant contributor as well. So the three of those combined are the things that give us confidence that the guidance range we have is reasonable.

All right. Thanks a lot.

Brian Fitzgerald, Jefferies.

Hi, this is Tom [Veleco] for Brian. Thanks for taking my question. You just reported a very nice gross margin improvement for goods. And my question is, do you think you already have the [fulfillment] infrastructure for services business efficiently, or is there need for more investment?

I'll say a word and then I'll have Kal say a word as well, because obviously he's been knee-deep in that for the past several years. But we made significant investment. We recently opened up our own distribution center, I think in Q4 of last year. And the team has made a significant number of investments that give us confidence that we have the kind of capacity we need going into the holiday season, along with a network of 3PLs we have in place to be able to handle the volume.

This has been a maturing process for us. I'll thank Kal for doing an amazing job, and the team that we built underneath Kal that can carry on that work going forward; they've really done an amazing job. If you look at 400 basis points of improvement just in the last quarter, you can start to get some idea of us really getting our hands around this business and making sure that we are doing the basic blocking and tackling well.

Yes, thanks, Eric. Like Jason said, if your product margins have been pretty stable, and the oscillation or the vacillation we had in gross margins, driven by [rad housing] and [settlement] costs which exceeded -- which was twice what normally covers [payer spend]. And we have been diligently working on fixing our rad housing and settlement cost by putting them through our [central B], where we have got [renewals] cost of operation, and we are also shifting in a very sensible way a bunch of our inventory to drop shippers.

And we are doing all that without hurting our customer experience. It's about doing those things diligently and [a lot of them you] do again and again. As we've already seen 9%, we feel very confident that we'll get double-digits by focusing on the basics, one [time faction], one [arter] at a time, in the way we have done so far.

Okay, great. Thanks for the color.

Arvind Bhatia, Sterne, Agee.

Thanks for taking my question. Eric, you talked about the three key goals again for the fourth quarter. And then I also heard you talk about 2015 in general as a growth year. But can you talk to the next year and relative to these three goals, do we see a continuation of these trends? Or do we see a seasonality that -- how should we think about the overall goal for 2015?

And then perhaps longer-term, how you are viewing your long-term margin goals, long-term billing targets, say, over the next two to three years?

And then last question is on competition, maybe if you can address what you might be seeing in the marketplace today. Thank you.

Let me start with the three goals. If you look at these, these are very big goals that we put in place a quarter ago. And looking at the numbers a quarter ago, I think a great many people thought we would have a very hard time achieving them by year-end. Reducing our losses in Rest of World to basically zero, getting our goods margin which had been hovering around 5% to double digits. And most importantly, improving our local growth, which had been hovering around 1%, 2% to double-digit growth by year-end in billings was, I think, lofty.

We felt confident that we had been doing a bunch of work behind the scenes that had not really translated into the external results you see, and that we could achieve all three of those. We've made some significant progress on two of the three, and we expect that by next quarter we make even more progress. At the end of the day, we feel very good.

And once these things are in place, once you have appropriate goods margins, once you have every region which we operate making money. Once you have a local business that's growing at healthy rates again -- and we'd like to see that low double-digit work its way to 20%-plus over time. And so once those things are happening, the business will generate some great leverage, we believe.

So that's what we're focused on. We're not here to provide 2015 guidance at this time. We're only here to say that these fundamental -- these ABCs are in place. And we're making good progress, and if we achieve the goals we set out, we'll set ourselves up for even greater growth in 2015.

In terms of competition -- then I'll let Jason handle the margin question -- we are a business in transformation. This is a market in transformation. The daily deal email business exploded five years ago. It was cloned by almost every major technology company in the world. And we have fared well against that group over the last several years as we've been gaining market share and other people have been exiting the business, or have not had those same gains.

In large part, it's because we got very focused on mobile, we got very focused on building a marketplace, we got very focused on creating a solution that would appeal to people that are basically consuming on the Internet in a different way. And our main focus today is to go even beyond that.

We've made huge strides in mobile and huge strides in building a marketplace, and now we're trying to go one step further and actually connect and build a platform. And really get, not just 100,000 merchants, but hopefully one day, 1 million merchants or 2 million merchants -- or more, that are connected to Groupon all the time. And so in that journey, we're a pioneer. We don't really have a direct competitor. And so we don't spend a lot of time thinking about the competitive landscape.

Yes, and in terms of the long-term targets, we have not changed our long-term targets. And that is on a billings basis. Because of the competition directed at third-party, I think it's best to look at it on a billings basis. We think the long-term margin targets -- CSOI margin targets -- are actually about to -- roughly about 8% to 12% for the local business, and high-single-digits for the goods business. If you want to convert that to an EBITDA basis, you would just add about 200 basis points to that number, if you exclude D&A as well.

In terms of time bounding, we haven't said when we think we'll hit those long-term targets. It's somewhere probably beyond next year though.

Can you speak to just top-line level that you would need to achieve to get those kinds of margin levels?

No. The problem is, is like you see with other e-commerce companies, it depends on what your confluence of investments versus mature business is. And so, it's very hard to do.

What I will say is that, look, we are very focused on growing billings, and we are very focused on growing gross profit dollars. These are the things that we are very focused on, and we have said we want both of those growing at 20%-plus. And we're going to work tirelessly until we get there.

We invested -- if you look at Q2, we invested in margins, we invested in basically getting quality merchants on the platform and putting up some site-wide sales to drive awareness to our pull marketplace. So we make investments from time to time. And as Jason mentioned, we're going to continue to do that. But we are very focused on getting billings to where we want to get it to. And having the gross profit dollars that flow from that business going up into the right, and up into the right materially, on a quarter-over-quarter basis.

It's a huge category, right? We're in a $1 trillion worldwide market -- multi-trillon dollar worldwide market, and we are focused on getting it right.

Thank you.

Ken Sena, Evercore.

On the Gnome and Pages, you have some major competitors there, and I know that many of them are offering PLS and in-fill listing on local businesses, and even deals. Could maybe you speak to your differentiation there? And is it purely through deals -- and you mentioned reviews and tips. But how confident are you that reviews on a deals site won't end up being problematic? Thank you.

The first thing I'd say is, look, if you think about Groupon's core competitive advantage, it's the sheer volume of transactions occurring on our platform. We just did $1.8 billion last quarter. We probably sent 50 million-plus people into local merchants to actually buy stuff. We are, for many merchants, their largest source of new-customer acquisition, by miles. That's the market in which we play. It's a transactional -- it's a local transactional market. It's local commerce.

And in that, we don't -- yes, there are people who offer PLS systems and there are people who have review sites. But that's not our primary competitive landscape. Our competitive landscape is basically driving commerce inside those local merchants. And obviously in that, we are by far the leader.

And then I think it's going to be our sustainable advantage, which is also why we don't think about Pages as a review site. We think about it -- the informational aspects of the page are simply there to make our users have a better experience. It's there to leave tips and other comments that our users can find helpful as they're looking to make a purchase.

That's basically what we want to drive. We want merchants using our platform to optimize yield. We want them using our platform to get the right customers coming in their door at the right times. Again, in that space, we just don't have competitors of our size and scope today.

Thank you. And just on the reviews?

On the reviews again, the way we think about it, we think more about consumers leaving tips than we do think about building a review product to compete with other review products in the marketplace. We're not here to create a giant review site; that's not our primary purpose. Our primary purpose is to create transactional pages where consumers can find amazing deals and decide where to go, plan their day, make last-minute decisions based upon which merchants can entice them to come in.

Because obviously the additional cost for a merchant that's empty that hour or has people sitting around or has food that they're not going to cook, is very low. And so getting yield right in local commerce is a big deal. That's what these pages are focused on.

So the fact that we have -- are collecting a significant amount of reviews and tips on these pages is something we'll manage carefully, because that's not our focus. Our focus is not to create this open platform where people are leaving negative reviews that's somehow causing us any harm. Our purpose in life is to create a transactional space where consumers can find amazing things to buy and discover around them, and access our merchant community that way.

Got it. Thank you.

Thank you. Ladies and gentlemen, that does conclude our program for today. Thank you for your participation, and have a wonderful day. You may disconnect your line at this time.