Groupon reported earnings last night, and on first glance, a 45% growth in revenues might have been something bulls would have been excited about. This is why it is crucial to look at what is driving revenues, as opposed to the actual number itself.

GRPN’s revenues used to be pretty much straight forward. Here’s last quarter’s 10-Q: (emphases are my own)

Revenue recognition

The Company recognizes revenue from services rendered or product sales when the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred; the selling price is fixed or determinable; and collectability is reasonably assured.

For services rendered, these criteria are met when the number of customers who purchase the daily deal exceeds the predetermined threshold (where applicable), the Groupon has been electronically delivered to the purchaser and a listing of Groupons sold has been made available to the merchant. At that time, the Company’s obligations to the merchant, for which it is serving as an agent, are substantially complete. The Company’s remaining obligations, which are limited to remitting payment to the merchant and continuing to make available on the Company’s website the listing of Groupons sold previously provided to the merchant, are inconsequential or perfunctory. The Company records as revenue the net amount it retains from the sale of Groupons after paying an agreed upon percentage of the purchase price to the featured merchant, excluding any applicable taxes. Revenue is recorded on a net basis because the Company is acting as an agent of the merchant in the transaction.

 The Company evaluates whether it is appropriate to record the gross amount of its goods sales and related costs or the amount earned. For goods revenue transactions where the Company is selling a product, revenue is recorded gross. The Company is the primary obligor in these transactions, is subject to inventory risk and has latitude in establishing prices. Product sales and shipping revenues, are recorded when the products are shipped and title passes to customers. For goods revenue transactions where the Company is performing a service by acting as the agent of the merchant responsible for fulfillment, revenue is recorded on a net basis.

Because of this recognition method, actual reported revenues would have pretty high operating margins (if not for Marketing & SG&A). Cost of the revenue was mostly credit card processing fees, non recoverable refunds, certain technology cost, & editorial costs etc.

But if you look at this Quarter’s 10-Q you’ll find something new. (Again, emphases my own)

Revenue

The Company recognizes revenue when the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred; the selling price is fixed or determinable; and collectability is reasonably assured.

Third party revenue recognition

The Company generates third party revenue, where it acts as the third party agent, by offering goods and services at a discount through its local commerce marketplace that connects merchants to consumers. The Company’s marketplace includes deals offered through a variety of channels including: Featured Daily Deals, National Deals, Groupon Now!, Groupon Goods, Groupon Getaways and GrouponLive. Customers purchase Groupons from the Company and redeem them with the Company’s merchant partners.

The revenue recognition criteria are met when the number of customers who purchase the deal exceeds the predetermined threshold (where applicable), the Groupon has been electronically delivered to the purchaser and a listing of Groupons sold has been made available to the merchant. At that time, the Company’s obligations to the merchant, for which it is serving as an agent, are substantially complete. The Company’s remaining obligations, which are limited to remitting payment to the merchant and continuing to make available on the Company’s website the listing of Groupons sold previously provided to the merchant, are inconsequential or perfunctory. The Company records as revenue the net amount it retains from the sale of Groupons after paying an agreed upon percentage of the purchase price to the featured merchant, excluding any applicable taxes. Revenue is recorded on a net basis because the Company is acting as an agent of the merchant in the transaction.

The Company evaluates whether it is appropriate to record the gross amount of its Groupon Goods sales and related costs by considering a number of factors, including, among other things, whether the Company is the primary obligor under the arrangement, has inventory risk, and has latitude in establishing prices. For Groupon Goods transactions where the Company is performing a service by acting as the agent of the merchant responsible for fulfillment, revenue is recorded on a net basis.

Direct revenue recognition

Direct revenue is derived primarily from selling products through the Company’s Groupon Goods channel where the Company is the merchant of record. The Company is the primary obligor in these transactions, is subject to inventory risk and has latitude in establishing prices. Accordingly, direct revenue is recorded on a gross basis. Direct revenue, including associated shipping revenue, is recorded when the products are shipped and title passes to customers. The Company recognized no direct revenue for the six months ended June 30, 2011.

This new “Groupon Goods” converts a portion of GRPN’s revenues into revenues of a typical e-tailer – with significantly higher “costs of revenue”. Groupon’s new “Goods” business acquires actual items, holds inventories, & they are responsible for shipping etc. This isn’t the same “quality” of revenue as in the past, and cannot be viewed that way.

See this Y/Y comparison of GRPN’s Consolidated Statements of Operations.

As you can clearly see, while overall revenues grew 44.77%, almost 40% of that growth was from this new “Direct revenue” line, which clearly affected their “Cost of Revenue”.

GRPN’s primary (“Third party & other revenue” line) revenues are the ”quality” revenues that you would want. It is a net figure, with very little variable costs. These new “Direct revenues” while helping to grow the top line, will lower margins, and have much less effect on the bottom line.

If not for the $124M in lower marketing, which clearly caused a slowdown (especially Q/Q) in their primary business, there would have been another ($45M) loss for operations.

So while a 45% growth in revenues is not bad on its own, where the revenue growth came from is.

- MicroFundy