Leaf Group Ltd.
Q2 2020 Earnings Call Transcript

Published: 2 Aug 2020

[Operator:]

Good afternoon. My name is Mariama, and I will be your conference operator today. At this time, I would like to welcome everyone to Leaf Group's, Second Quarter 2020 Earnings Call. On the call with me today is Sean Moriarty, CEO; Brian Gephart, Interim CFO and Chief Accounting Officer; and Shawn Milne, Investor Relations. Shawn Milne, you may begin the conference.

[Shawn Milne:]

Good afternoon, everyone. On behalf of Leaf Group, welcome to our conference call. I'm pleased to have Sean Moriarty, our Chief Executive Officer; and Brian Gephart, our Chief Accounting Officer and Interim Chief Financial Officer on the call with me today. Following our safe harbor Statement, Sean will update you on our business, and Brian will provide more details on our quarterly financial performance. Any metrics discussed on the call without reference to a specific third-party source are based on our internal data. After the prepared remarks, we will open up the lines for Q&A. You will find our related release along with supplemental materials posted on the Investor Relations section of our corporate website located at ir.leafgroup.com. Before we get started, we need to make the following safe harbor statement. We would like to remind everyone that during today's conference call, Management will make certain forward-looking statements, which are subject to various risks and uncertainties that could cause actual results to differ materially from our current expectations discussed in such forward-looking statements. In particular, comments about our anticipated future revenue, earnings, operating expenses, operating metrics and growth rates as well as statements regarding our business strategy and objectives, plans, intentions, operating outlook, planned investments and the impact of recent acquisitions are considered forward-looking statements. Factors that could cause actual results to differ materially from anticipated results are detailed in our press release furnished to the SEC. I would like to point out that during the call, we will discuss certain non-GAAP financial measures while talking about the company's financial and operating performance, including adjusted EBITDA and free cash flow. Reconciliations of these non-GAAP financial measures to their most directly comparable GAAP measures can be found in the financial tables included at the end of our press release. Lastly, I would like to remind everyone that today's conference call is being recorded and that it is also available via webcast through the Investor Relations section of our corporate website. A replay will also be available on our website. With that, I'll now turn the call over to our CEO Sean Moriarty.

[Sean Moriarty:]

Thank you, Shawn. Good afternoon, and welcome to our Q2 2020 earnings call. Before we jump into the Q2 highlights, I wanted to thank the team at Leaf Group for their resilience, hard work and ability to adapt quickly to the dramatically changed environment during the COVID-19 pandemic. Q2 2020 revenue increased 42% to $51 million, our highest quarterly revenue since 2013, driven by the strongest year-over-year revenue growth rate since the first quarter of 2011. Q2 adjusted EBITDA was $2.1 million, a $4 million improvement year-over-year. Q2 free cash flow was $6.2 million, a $13.8 million improvement year-over-year, driven by significant growth at Society6 and its efficient working capital model. We ended Q2 with $27.9 million in cash. Q2 revenue growth was driven by our Marketplace brand, Society6 and Saatchi Art, which delivered 103% combined growth in GTV and a record number of new customers. Society6 Group delivered 134% growth in GTV, including growth of 172% in U.S. direct-to-consumer GTV and a strong rebound in International GTV, which increased 81% year-over-year. Society6 saw over 175% growth across the home decor category including over 400% in outdoor and lifestyle. Launched at the end of June, facemasks continue to be a top-performing product in July. Saatchi Art online GTV increased 50% year-over-year, which was offset by the cancellation and postponement of The Other Art Fair's live events. We expect that the structural improvements made at Society6 and Saatchi Art will continue to drive strong growth, capitalizing on the upward trend in digital demand, which we believe reflects a fundamental shift in consumer behavior and e-commerce. In our view, these behavioral changes are here to stay. We continue to improve our platforms including mobile capabilities at both brands. Some recent examples are the July releases of new mobile web augmented reality features for Saatchi Art and improved mobile checkout for Society6. Heading into the back half of 2020, we are stepping up investments in customer retention after record-setting new customers for the quarter and are very encouraged by early results at Society6 from new e-mail marketing, paid social and direct mail campaigns. Additionally, Society6 will continue to expand product assortment and introduce new personalization and recommendation functionality ahead of the holiday season. Saatchi Art is increasing focus on digital events given the strong start to The Other Art Fair's online studios, which hit the $1 million GTV milestone in July since launch in early April. We see a significant runway for growth for online studios given enthusiastic artist and consumer response to our early efforts and are planning on further integration between physical fairs and digital events later in the year as conditions permit. Q2 Media revenue decreased 26%, primarily due to the impact of the pandemic on overall industry ad pricing. In response to this industry pullback, our Media sales teams developed its first data-driven report, the Leaf Group COVID-19 study and utilized these findings to provide brands and advertisers with the answers to key questions around new consumer buying habits. This strategy has resulted in more than 50 meetings with key brand marketers and led to a deal with new advertiser, Campbell's brand, V8, for custom campaign across Well+Good and Livestrong. We continue to focus on diversification in our Media revenue through recently launched digital events at Well+Good and expanding our e-commerce efforts at Hunker. Q3 is off to a strong start with Marketplaces' momentum continuing in July, and Media trends are starting to show signs of improvement compared to Q2 on a year-over-year basis. We are seeing early signs of improvement in Q3 for direct Media sales. Our mission remains unchanged as our portfolio of brands is well positioned to provide consumers and artists with products and services in key categories of home, art and design and fitness and wellness. These categories are massive in size, fragmented and are becoming increasingly important in a world where consumers focus on creating beautiful spaces around them in living a healthy lifestyle. We believe that these consumer behavioral shifts are here to stay. And we expect them to drive sustainable growth across our properties going forward. Our portfolio of digital-first brands are in the right categories, to deliver 15% plus annual long-term growth and generate strong free cash flow. Based on our increased confidence and growth outlook, strong incremental margins and largely fixed corporate expenses, we are establishing 2022 targets of more than $250 million in revenue and $20 million in adjusted EBITDA as guidepost for investors to measure our progress over the next several quarters. To that end, we have included our long-term growth strategy and 2022 targets in our investor presentation, which is available on our website. While we continue to run our business in an environment of tremendous uncertainty, we are extremely proud of what our Leaf Group team has delivered over the course of the past quarter. Despite operating in a global pandemic and through a period of extreme volatility, we have worked hard, sacrificed as a team to protect jobs and avoid layoffs and delivered outstanding quarterly results. Our team of people are committed, capable and have proven themselves under the most adverse of circumstances. The strength of our team, quality of our brands and category positioning gives us the utmost confidence that we can continue to deliver strong results and drive shareholder value. I will now turn it over to Brian Gephart to provide a more detailed review of our Q2 financials.

[Brian Gephart:]

Thanks, Sean. Before we take a closer look at Q2 2020 financial results, I wanted to take a minute to describe additional financial information we are providing, starting with Q2 results; First, we are providing revenue by Society6 Group and Saatchi Art Group to give investors incremental revenue detail for our Marketplaces segment. Second, we added an additional financial disclosure for corporate expenses with the breakout of strategic shared services and corporate overhead. Strategic shared services include services, such as business intelligence, financial systems, business development and information systems and provide support across our brands to drive growth as well as a platform to enhance growth through tuck-in acquisitions. Corporate overhead includes services, such as accounting, finance, HR and legal. On to Q2 2020 results, Q2 revenue increased 42% year-over-year from $35.8 million to $51 million, driven by a 101% increase in Marketplaces revenue, partially offset by a 26% decrease in media revenue. Society6 Group revenue increased 128% to $34.7 million. Society6 Group GTV increased 134% year-over-year, driven by 172% growth in U.S. direct-to-consumer and 81% in international. Society6 B2B GTV increased 30% year-over-year. Saatchi Art Group revenue was flat year-over-year at $4 million, as strength in Saatchi Art online was offset by the cancellation or postponement of all The Other Art Fair events for Q2. Saatchi Art online GTV increased 50% year-over-year, driven by an increase in transactions, partially offset by a decrease in average order value. On the segment operating contribution front, Q2 2020 Marketplaces segment operating contribution increased $5.0 million year-over-year to $3.7 million or 9.5% of Marketplaces revenue versus negative $1.3 million in the prior year period, primarily due to strong transaction volume for Society6 Group, partially offset by operating losses for The Other Art Fair due to the cancellation or postponement of all The Other Art Fair events for Q2. In Q2, Media revenue decreased by $4.3 million or 26% to $12.3 million as compared to $16.6 million for the same period in 2019. This decrease was primarily attributable to a decrease in RPV and visits, partially offset by a 37% increase in revenue for OnlyInYourState. The decrease in RPV was primarily attributable to a pullback in ad spending as a result of the pandemic. As of April 25, 2020, we are no longer including visits to the sites migrated or to be migrated to Hearst as part of the Hearst transaction, which was announced on April 28, 2020. In Q2, on a pro forma basis after giving effect to the Hearst transaction, visits decreased by 9% to $539 million from $594 million in the same period in 2019. In Q2, RPV on a pro forma basis decreased by 18% to $22.88 from $27.94 in the same period in 2019. Media segment operating contribution for Q2 2020 decreased 28% year-over-year to $4.8 million or 39% of Media revenue from $6.6 million or 40% a year ago due to lower revenue. Q2 2020 strategic shared services and corporate overhead expenses of $6.3 million represented 12% of revenue, down from $7.2 million, which represented 20% of revenue in Q2 2019. The decrease in Q2 2020 strategic shared services and corporate overhead expenses of $0.9 million year-over-year was primarily due to the impact of salary reductions, which were effective on April 1, 2020, and were since restored as of June 30, 2020. We have added a new slide to our Investor Relations deck, which outlines our expectations around segment operating contribution margin. Media segment operating contribution margin was 38.7% in Q2, and we expect it to remain in the 35% to 40% range going forward. Marketplaces segment operating contribution margin was 9.5% in Q2. And as revenue continues to grow, we expect incremental segment operating contribution margin to be in the 15% to 20% range. We also expect that strategic shared services and corporate overhead will decline as a percentage of revenue. Q2 2020 adjusted EBITDA was $2.1 million, reflecting an improvement of $4 million year-over-year. In Q2 2020, we incurred costs related to the activist and strategic review of $0.5 million including fees of legal, financial and other advisers. Additionally, in Q2 2020, we had $1.5 million in cost savings implemented in April, which included temporary salary cuts of our executive team and salary direct workforce. These cost savings initiatives were restored in late Q2 and early Q3. Q2 2020 cash flows provided by operations was $7.9 million compared to negative $5.9 million in the prior year period. Q2 2020 free cash flow was $6.2 million, a $13.8 million improvement compared to free cash flow of negative $7.6 million in Q2 2019. At the end of Q2 2020, we had $27.9 million in cash with a debt balance of $4 million drawn on our revolving credit facility and $7.1 million related to the Paycheck Protection Program loan. With that summary, we're now ready to take your questions. Operator, please open the line.

[Operator:]

[Operator Instructions] Your first question comes from Jason Kreyer with Craig-Hallum. Your line is open.

[Jason Kreyer:]

Hey guys, thanks for taking questions. And congrats to the whole team over there on a really solid quarter and nice snapback.

[Sean Moriarty:]

Thank you, Jason.

[Jason Kreyer:]

Thanks, Sean. I appreciate the bold longer-term objectives you provided. Just wondering if you can give a little bit more detail there, if you have some segment or vertical targets that are rolling up into those 2022 objectives you provided? Or perhaps you can just kind of parse out some specific components of that that give you confidence that what you're seeing today is going to be relatively sustainable over the next couple of years?

[Brian Gephart:]

Hi, Jason, this is Brian. Thank you for your question. Our mix currently includes Marketplaces segment at 75% of total revenue and growing at a faster pace. So I think that's a fair statement on the mix question. And as we outlined in our opening remarks, you can see the July trends for the Marketplaces segment continuing on from Q2 and things improving on the Media front.

[Jason Kreyer:]

Okay. That's fair. In Society6, the strength that you've seen over the last 90 days or so, can you call out particular categories as the main drivers here? Has it been pretty broad-based in terms of the growth that you're seeing? And then if you can call out anything specifically on what you've seen in masks over the course of the last month?

[Sean Moriarty:]

Sure. So the strength actually of Society6 is pretty broad -- very broad-based actually, Jason. So group GTV up 134%. The U.S. B2C revenues went up 172%, international DTC up 81%. The B2B business, which is primarily drop ship in the quarter because the challenges with physical retailers was still up 30% in the quarter. So really, really strong broad-based improvements in that business. I should point out that the U.S. B2C growth actually started early in Q1. We returned to growth in February, and that growth accelerated in March. And so certainly, there is kind of a tailwind that we're operating in. The work the team has done over the course of the past year has really transformed this business in a significant way. And what we see by way of growth is truly across products category as well. I spoke, I think, last quarter, about the products marketing focus against specific products and categories, as opposed to kind of the flash sale type discounting that had been done previously, and we felt it was going to bear real fruit. And it certainly has. So not only are we broad-based by distribution channel and region, but the strength we've seen in the business is across the product assortment, and that team has done a dynamite job transforming the marketing and merchandising of Society6. Masks launched late. So they had a minimal contribution GTV-wise to Q2, but are a strong selling product for us.

[Jason Kreyer:]

And Sean, you touched on this a little bit, but you've accumulated a much broader customer base, obviously, over the course of the last 90 days, and this is across your Marketplace businesses. And I know we even talked a little bit last quarter about the longer-term opportunity that, that creates. Just wondering if you've begun any specific kind of enhanced targeting measures on that broader customer base or where you see the improved long-term value in going after those and turning those into repeat buyers?

[Sean Moriarty:]

It's a great question, Jason, because that is the flywheel for the business. In Q2, new customer growth was very, very strong. The other thing that I'd point out, and I've talked about this in the past, when new customer growth is coupled with really high customer satisfaction, that really sets into motion that conversion to a repeat customer or a customer for life. And so not only did we have very, very strong new customer acquisition in the quarter, we've had very high customer satisfaction. And keep in mind that's in a pandemic and with really high volumes. So we're set up very, very well to really accelerate the flywheel. The other thing we've done, though, Jason, which is very important is completely redone our life cycle marketing approach. And that is bearing real fruit. So we're very, very confident in our ability to convert these new customers at a level beyond what we've been able to do before. And our customer acquisition strategy has also evolved considerably. And so not only do we expect to get the benefit of really strong retention improvements, but that new customer top of funnel should be -- remain very strong for us as well.

[Jason Kreyer:]

A couple on the Media side here. Just on the direct sales teams. So if you can talk at all about the cadence of Q2 and any feedback you were hearing from direct sales, I'm curious if you had customers kind of at the beginning of the quarter that were asking you to kind of pause relationships and pause a little bit of that execution. And wondering if that stuff has started to come back or any commentary on new customer touch points and if those are starting to evolve after a little bit of a pause in the quarter?

[Sean Moriarty:]

Sure. So as you might imagine with the global pandemic announced mid-March, that really froze a lot of that branded advertising activity. And as you know that there's a sales cycle to that, so a pipeline, which can develop over several months or in some cases, span quarters. When the world hits the pause button, that could be challenging for businesses when that brand advertising pipeline dries up or is at least frozen. Fortunately, for us, roughly 80% of our business is still programmatic, but we have real upside, as you know, in building out the branded opportunity. What we saw over the course of the quarter, I would say, was a thaw. So we remained in constant communication with advertisers and agencies who have a lot of money, we believe, parked on the sidelines, and they're looking for the time -- looking to deploy it. And the progression we saw at least by way of attitude, interest and activity from the beginning of Q2 to the end would suggest that, that's starting to thaw, and we're seeing more early opportunity now than we have in several months. And that's part of the reason why the early signs for Q3 for us are strong is on the basis of, not only the conversations, but the type of opportunities that we're seeing.

[Jason Kreyer:]

So on that thaw in direct, I mean, that's good color. Any color you can give on the programmatic side of the business and how the cadence -- if that cadence was any different?

[Brian Gephart:]

Yes. I think we would answer that question in the same way. The early signs in July for that part of the business are showing signs of improvement.

[Sean Moriarty:]

Yes. And as you know, Jason, in early Q2, those programmatic channels were very, very choppy because many of your large buyers also happen to be in industries, which were really, really hit hard by the pandemic. And programmatic is really that dynamic auction market and if long-established major players have been in it pull out almost completely, it has a real depressive effect on yields. And so over the course of the quarter, that started to show some signs of life as new entrants came into the channel. And again, early in Q3, things seem to be improving.

[Jason Kreyer:]

Okay. Just the last one. Can you give a reminder -- I'd probably get this somewhere in the model? But can you give a reminder of how many payers you had in Q3 and Q4 last year? I just want to make sure we model that out appropriately.

[Brian Gephart:]

Jason, we'll have to get back to you on that. I don't have the exact numbers on hand.

[Sean Moriarty:]

Yes. And so the other thing is that we postponed or canceled the remainder of Q1 and all of Q2 fairs. And so we're actually in rescheduling mode for back half of the year. So for comping perspectives, that's also going to be somewhat ambiguous as we work through the pandemic and its effects on the scheduling for those fairs. Although what I would say is we -- the artists and attendee demand, when we return to a healthy world, should be very strong. And I would -- from a standpoint of the fairs themselves, the team did an amazing job of effectively launching what we believe can be an entirely new franchise with virtual fairs. And we've already eclipsed $1 million in GTV for those virtual fairs, which really allow anybody in the world to experience at least partially the event of a fair that may be happening in Santa Monica or New York or London. And I think with technology and time, that franchise can really be expanded and grown because I think we've all learned that the virtual experience, if done right for stuff that you really care about, could be strong transformative experiences even if they're not in real life.

[Jason Kreyer:]

Got it, alright. Well, thanks a lot guys. Good work, I appreciate all the color.

[Sean Moriarty:]

Thank you, Jason. Appreciated.

[Operator:]

Your next question comes from Maria Ripps with Canaccord. Your line is open.

[Maria Ripps:]

Thanks for taking questions. And congrats on strong results. Just to follow-up on the 2022 targets. To what extent do you see that $250 million in revenue to be driven by M&A versus organic growth? And then sort of related to that, now that you sort of shared with investors your near-term financial goals, what's your philosophy maybe around providing some near-term expectations or guidance?

[Brian Gephart:]

So on the $250 million 2022 revenue target, that is all organic growth.

[Maria Ripps:]

Got it.

[Sean Moriarty:]

As far as quarterly guidance goes, Maria, we don't have any plans at this time to change our approach to guidance, particularly in a pandemic, in a world like this one. We will always consider when it's appropriate to provide incremental information to investors to help them understand where the company is, but no plans at this time to change from our quarterly guidance policy.

[Maria Ripps:]

Got it. And then maybe could you describe sort of a good candidate that would make sense for a strategic acquisition? Would that largely be within your existing verticals? Or would you consider expanding into some adjacent verticals as well?

[Sean Moriarty:]

Yes. No. So it's a great question. I think the best way to answer that is the blueprint of what we've done already with those 4 acquisitions. What we generally look for our founder-led bootstrapped, capital-efficient businesses in categories that we're in that expand our relevance and our strategic positioning. We did that with The Other Art Fair for Saatchi Art, taking Saatchi Art in real life, and that's been a very powerful combination. The marketing heft and platform of Saatchi, coupled with that kind of great in-real-life experience at The Other Art Fair, has made that franchise even stronger. The Deny Designs acquisition really expanded the product assortment we can offer to customers and allowed us really to move Society6 firmly in the home category and also put us in a position to build out a B2B and hospitality franchise where we wouldn't have been able to do that before. And then Well+Good, next to Livestrong, gives us not only real scaled audience but we have the benefit of having a very strong fitness- and nutrition-based information platform in the aspirational wellness brand, Well+Good, which again, really strengthens our position in that category. Now the OnlyInYourState acquisition, which we did 1.5 years ago, was one of those acquisitions, which we'd love to be able to do regularly. There's just not many of them. Really small team, high passion category, unique context, very, very capital-efficient and very well priced. And so generally speaking, we look founder-led, bootstrapped, that -- brands that will extend the strength of our category positioning and really advance our -- and accelerate our strategy. But if we see a great business that we think can be an even stronger business inside of Leaf Group, that happens to be a category adjacency. Jason will take a look at that as well.

[Maria Ripps:]

Got it. Thank you for that. And maybe one more question for me here. So with your Marketplaces businesses delivering this impressive result, which is obviously great to see, how sustainable do you think these trends are sort of over the near term? And Sean, you mentioned that you've seen continued momentum in July. Anything else you could add here on the progression through the last month?

[Sean Moriarty:]

Yes. So I'd say a couple of things, Maria. So I do believe that many of the behavioral changes that we've seen over the course of the pandemic with respect to share shift, off-line to online are going to stay with us. So there will be a benefit to e-commerce brands that deliver for the customer that is going to persist even as the pandemic ends. But when I look at Society6, the single greatest advantage that we have now is on the basis of the work that's been done over the course of the past year by the leadership team, Julie Matrat, Alan Waldman and team, who have done an amazing job getting the business back to growth. The product and platform are stronger than they've ever been, we've just acquired a huge number of new customers, and we now have the marketing shops from both an acquisition and retention perspective and the product experience that really allows us to get that flywheel going. So we feel very, very good about driving growth for Society6 well out into the future on the basis of the flywheel itself that's been created over the course of the past several years, but really scaled up in the past year. And then the last thing I'd say is that Society6 itself with design-first shopping in a world more focused now than ever on home, but also, I would say that focus on the home isn't something that's going to go away in a few months. It's going to elicit all sorts of behaviors and interests, and Society6 is very well suited to deliver high-quality home products at a reasonable price with unparalleled design. And so the category positioning itself, for a business that's healthy and growing right now, just gives us tremendous confidence about what we can do with the business over the course of the next several years. And what I'd add to that is the platform itself, from a product and technology perspective, is getting stronger every day, every week, every month. And so as this business grows, it's going to grow on a platform of increasing strength.

[Operator:]

There are no further questions at this time. This concludes today's conference call. Thank you for participating. You may now disconnect.