Non-GAAP metric and Internal Control Weakness
Basic information about the company:General instructions:To answer the questions, you need to search relevant information from the internet (hint: the most important source of information is SEC filings). Other useful websites include Yahoo! Finance, Google Finance, Capital IQ etc.Non-GAAP metricNon-GAAP performance metrics are commonly used by public companies nowadays, in conjunction with GAAP metrics. In its initial S-1, Groupon used two non-GAAP measures, free cash flows and Adjusted Consolidated Segment Operating Income (Adjusted CSOI). SEC commented “We note your use of the non-GAAP measure Adjusted Consolidated Segment Operating Income, which excludes, among other items, online marketing expense. It appears that online marketing expense is a normal, recurring operating cash expenditure of the company. Your removal of this item from your results of operations creates a non-GAAP measure that is potentially misleading to readers. Please revise your non-GAAP measure accordingly. Refer to Rule 100(b) of Regulation G.”Groupon responded, “The Company respectfully submits that its presentation of Adjusted CSOI, and in particular the exclusion of online marketing expense from such calculation, is consistent with Regulation G. The Company defines online marketing expense as those marketing expenses relating primarily to the acquisition of new subscribers. It does not include expenses relating to any marketing or sales initiatives targeted to existing subscribers or customers. Traditional marketing expenses and offline marketing expenses, which primarily are designed to promote brand awareness and the sale of Groupons generally, are not excluded from Adjusted CSOI. Regulation G prohibits a registrant from, among other things, adjusting a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual if such items occurred in the past two years or are likely to occur in the ensuing two years. See Item 10 of Regulation S-K under the Securities Act of 1933, as amended (the “Securities Act”). The Company does not exclude online marketing expense on the basis that it is (nor does it identify such expense as) “non-recurring, infrequent or unusual.” To the contrary, it states consistently in the prospectus that such expenses are likely to be incurred in the future. See pages 2, 32, 47, 56, 75 and 76 of the prospectus.The Company’s management utilizes Adjusted CSOI internally as a measure to assess the performance of the business and has revised the prospectus on pages 9, 43, 44 and 47 to advise investors that Adjusted CSOI is an internal performance measure and should not be relied upon as a valuation metric. In utilizing Adjusted CSOI as a performance measure, management does not rely on the non-recurring, infrequent or unusual nature of online marketing expense. It focuses instead on the fact that such expenses are almost entirely discretionary and incurred primarily to acquire new subscribers. In view of the Staff’s comment and in order to clarify the rationale for excluding online marketing expense from Adjusted CSOI, the Company has enhanced the relevant disclosures on pages 9, 43 and 47.”Questions:1. What is Adjusted CSOI? What adjustments are made in computing Adjusted CSOI from net income?2. In your opinion, why does Groupon want to use Adjusted CSOI? Support your conclusion with numbers.3. Why did the SEC question the usage of Adjusted CSOI but not free cash flow? What is SEC’s specific concern with Adjust CSOI?4. Do you agree with Groupon’s argument that online marketing expenses are “almost entirely discretionary”?Internal control weaknessSection 404 of the Sarbanes-Oxley Act (SOX) of 2002 requires public firms’ managers to assess the effectiveness of the firm’s internal controls over financial reporting and their auditors to attest to it. When preparing for its initial Section 404 audit after going public, Groupon and its auditors reported this material weakness related to “deficiencies in the financial statement close process” on March 30, 2012. This weakness is believed to have caused material errors in its 2011 10-K filing. According to Groupon’s press release issued on March 30, 2012, the revision of the errors “resulted in a reduction to fourth quarter 2011 revenue of $14.3 million. The revisions also resulted in an increase to fourth quarter operating expenses that reduced operating income by $30.0 million, net income by $22.6 million, and earnings per share by $0.04.”Questions:1. Examine the market reaction towards the announcement of internal control weakness.2. SOX only applies to companies that are public already but not those in the process of going public. How does the internal control weakness affect your assessment of the creditability of Groupon’s financial results reported in its prospectus?
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