Leaf Group Ltd.
Q2 2017 Earnings Call Transcript

Published: 4 Aug 2017

[Operator:]

Good afternoon. My name is Cheryl and I will be your conference operator today. At this time, I’d like to welcome everyone to the Group, Leaf Group’s Second Quarter 2017 Earnings Call. On the call with me today is Sean Moriarty, CEO; Jeff Misthal, SVP of Finance; and Shawn Milne, Investor Relations. Shawn Milne, you may begin your conference.

[Shawn Milne:]

Good afternoon, everyone. On behalf of Leaf Group, welcome to our Q2 2017 conference call. I'm pleased to have Sean Moriarty, our Chief Executive Officer; and Jeff Misthal, our SVP of Finance, on the call with me today. Following the Safe Harbor statement that I will make, Sean will update you on our business, and then Jeff will provide more details on our quarterly financial performance and key operating metrics. Any metrics discussed on the call without a 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. We will also state certain financial results on a pro forma basis, eliminating the impact of dispositions of our Cracked business and certain other non-strategic online properties. Reconciliations of these non-GAAP and pro forma 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, and thank you everyone for joining us this afternoon. We appreciate the opportunity to update you on our second quarter results and what is planned for the remainder of 2017. Q2 marks our fourth consecutive quarter of revenue growth up 19% year-over-year on a pro forma basis to $28.6 million and up solid 10% excluding the acquisitions of The Other Art Fair and Deny Designs. Our EBITDA loss narrowed by 24% year-over-year to negative $3.9 million. Today, I will provide an update on our news segment contribution disclosure our key 2017 initiatives and provide a more detailed review of our marketplace and Media businesses. Jeff will follow with more details on our financials. First, we are now providing segment operating contribution, giving investors a more detailed look at profitability within each of our two business segments. There are marketplace segment, we continue to invest in our emerging businesses including improving our management talent and debt, expanding product selection, acquiring high value customers at an accelerating pace and building brand awareness, setting the stage for sustainable revenue growth in the large and fragmented $27 billion online home goods market. Our Q2 marketplace is operating segment contribution, was negative $1.7 million versus negative $0.2 million a year ago, reflecting our stepped up level of investment which began in the second half of 2016, and higher level of promotional activity in the seasonally slower quarter. Given the massive disruption at retail and faster ramp of online penetration in our key markets, we remain confident these investments better position our brands to drive customer growth and drive operating scale in the future. In our Media segment, we are especially pleased to report strong and accelerating momentum in our core Media business which grew revenue 13% year-over-year in Q2, a full 600 basis point improvement over Q1. Core media was driven by strong 50% growth for LIVESTRONG and continued progress in our verticalization efforts. Our strategy to build the great products with high quality content in key lifestyle categories is driving solid audience growth, paving the way for further improvements in monetization and sustainable long-term revenue growth. The combination of solid core media revenue growth, streamlined operations and high incremental margin, drove media segment operating contribution from $0.7 million a year ago to $4.4 million in Q2 2017, representing a 40% operating margin which we believe demonstrates the hard work and execution of our teams over the past couple of years. Second, turning to our key initiatives, we made significant progress in Q2 rolling out a common technology platform for our media businesses with five properties live by the end of the quarter. In Q2, our common platform enabled us to roll out a number of features across several of our properties including infinite scroll, which resulted in a page view per visit lift to 15%. The new platform has enabled the rapid deployment of new product features across our brands, helped us to operate our properties more efficiently and drove cost leverage. We continue to expect the platform implementation will be completed before the end of the year. Our second initiatives are media verticalization strategy. In Q2, we launched our fifth and largest vertical Hunker in the home category. We're pleased with the initial results and growing audience in Hunker, reaching over 13 million visits in June, which represents a key opportunity in the significant home category. Our verticalization strategy is now paying off with audience growth as Q2 visits were vertical sites improved 15% year-over-year and 6% quarter-over-quarter marking the first year-over-year growth since 2013. Our third initiative is focused on expanding further into the home décor category and our market place segment. In Q2, we expanded our product assortment on Society6 with a recent introduction of window, curtains and pillow shams. And as we prepared for the back-to-school season, we added to our existing product lines with Twin Xl comforters and duvets covers. In addition, Deny Designs which we recently acquired expanded its product selection with four new products for the home including benches, counter stools, bar stools and round side tables. Turning to our review of our market place segment, Q2 revenue grew 32% year-over-year to 17.7 million representing 62% of our total revenue. On an organic basis, adjusting for the acquisitions of The Other Art Fair in Q3 2016 and Deny Designs in Q2 2017 market place grow for 17%. Let me dive deeper into the two primary end market places that we operate. Society6 delivered 20% year-over-year growth in gross transaction value and 17% year-over-year growth in revenue in Q2 as our refers to improve our onsite search experience towards 24% year-on-year improvement and conversion rate. Additionally, our introduction of new products in Q2 and recent pricing optimization helped offset and continued heighted promotional environment. In Q2, we continue to acquire high quality new customers while improving the efficiency of our paid marketing spent. Society6 grew new customers 26% year-over-year, a meaningful improvement over Q2 2016 when new customers grew 16% year-over-year. Our focus of quality and service continues to generate high customer satisfaction rates as well as drive repeat customer growth, which was up 37% year-over-year. In Q2, Saatchi Art inclusive of The Other Art Fair increased revenue 63% year-over-year while new customers grew 62% and repeat customers grew 27% year-over-year. Saatchi Art made great strides integrating The Other Art Fair, driving significant attending growth for fairs through e-mail marketing and launching a new art fair in Melbourne and our first U.S. based fair in Brookline in June. Additionally, Saatchi Art's product development team launched a new mobile app on iOS and Android for The Other Art Fair, providing fair information, artist profiles and portfolios and the ability to buy tickets for the fairs. Post event, the Saatchi Art team drives retargeting efforts through e-mail marketing to fair attendees to recap the fair and drive follow on sales of those artists work online at Saatchi Art. Lastly, turning media segment revenue was 10.9 million, representing 38% of our total revenue for Q2. Medium revenue was up 2% year-over-year on a pro forma basis, driven by 10% growth in visits year-over-year. Excluding the contribution from a small international sites and former custom content business, our core media business revenue grew 13% year-over-year underscoring our confidence in a long-term sustainable growth of our brands. LIVESTRONG continues to show strong momentum, growing audience with the six straight quarter with visits up 17% year-over-year and revenue increased for the fourth straight quarter up 15% year-over-year. We continue to build relationships for the top names in wellness and fitness including new interviews with Julianne Hough, Ana Ivanovic and Shaun T with a combined social following of over 15 million people LIVESTRONG also launched its new stronger healthy living podcast with interviews with Bulletproof's Founder and CEO, Dave Asprey; and leading Instagram influencers, Anna Victoria. LIVESTRONG’s MyPlate App had 100% growth year-over-year in downloads and nearly 0.5 million monthly active users, up 46% year-over-year. In Q2, we continue to be focused on producing original content for our vertical properties. The new brands are seeing significant improvement in traffic and exceeding our initial expectations. With Sapling becoming the number two ranked personal finance site and Cuteness ranking third in the high value pet's category, each on an ad supported basis according to comScore. As we continue to scale our media audience across each of our brands, we are seeing increased opportunities for co-marketing and partnerships. eHow began working on a co-marketing partnership with Pinterest, resulting in a list of video views. Hunker continues to be embraced by credible brands in the home space as evidenced by the launch of our co-branded store with Domino featuring products created by Hunker. Overall, we are pleased to share our strong Q2 results and remained confident in our strategy. We look forward to updating you on our initiatives and the progress in our businesses in our third quarter call. I will now turn the call over to Jeff for remarks regarding the financials.

[Jeff Misthal:]

Thank you, Sean. I am pleased to take you through our second quarter results. Before I begin with the headline financials, let me clarify that all references to total revenue in may prepared remarks will be stated on a pro forma basis and net of our dispositions of Cracked and certain other non-strategic properties during the course of 2016. A reconciliation of our pro forma revenue to GAAP revenue for the relevant period is available on our earnings release. Additional information on our key operating metrics is included in our earnings release. Please note, we are now reporting segment operating contribution from marketplaces and media to provide investors greater clarity into the operating performance of our businesses. Now on to Q2 results. First, total revenue in Q2 was $28.6 million up 19% year-over-year on a pro forma basis and up a solid 10% year-over-year adjusting for the acquisitions of Deny Designs and The Other Art Fair as well as the dispositions of Cracked in certain other assets. Our market price segment grew 32% year-over-year while our Media segment grew 2% year-over-year on pro forma basis. Second, adjusted EBITDA was negative $3.9 million in Q2 a 24% improvement versus negative $5.1 million in the prior year period. Third, free cash flow was negative $5.1 million for the quarter. Starting with our marketplace segment, revenue was $17.7 million in Q2 up 32% year-over-year. This revenue growth was driven by 17% year-over-year growth in Society6, incremental contributions from Deny Designs and 63% growth for Saatch Art including the other out there. In Q2, Socieity6 added window, curtains and pillow shams and ended the quarter with 41 products approximately 250,000 artist and 4.1 million designs available on the site with home décor products representing over 70% of total sales. For Q2, the total number of transactions for Society6 grew 27% year-over-year while average order value was down 5% year-over-year, but up 1% quarter-over-quarter, reflecting both our promotional pricing efforts and introduction of new products in Q2 with higher price points. Gross margin for Society6 was 28% in Q2, down 500 basis points year-over-year or up 200 basis points from Q4. We continue to focus on our promotion and pricing strategy as we move into the key back-to-school season. Saatchi Art also had a solid quarter with revenue up 63% year-over-year in Q2 inclusive of the revenue from The Other Art Fair. We continue to expand The Other Art Fair's calendar of events, improve conversion rates and drive growth in our art advisory business. And with the commission change we implemented in Q2, we saw the year-over-year increases in revenue. Turning now to media business, revenue was $10.9 million up 2% year-over-year on a pro forma basis and down 4% sequentially. Excluding our international sites and wound down of the custom content business, revenue for the core business was up 13% year-over-year compare to 7% in Q1. LIVESTRONG had a particularly strong quarter with year-over-year revenue growth for its fourth straight quarter. LIVESTRONG grew revenue 50% year-over-year and was up 8% versus Q1, a seasonally strong quarter, and a testament to the team's focused effects in building a strong brand with engaging content in growing audiences. Revenue from our international medial sites in the former studioD custom content business make up the balance of our other media revenue of $0.3 million down 77% versus prior year and down 53% quarter over quarter. Average monthly visits to our media properties as a whole in Q2 were $236 million, up 10% versus prior year and up 2% versus prior quarter. Approximately 58% of these visits came from mobile with significant reach in engagement also occurring off our own properties. In Q3 2016, we introduced video views and social followers as two key operating metrics to evaluate audience and engagement. In Q2, total video views for all of our media properties were over $200 million, up 21% versus the prior year. At the end of Q2, our media properties had over 14 million total followers across Facebook, Pinterest, Instagram, YouTube and Twitter. Revenue per visit for our media properties was $15.37 for Q2, down 10% versus the prior year and down 6% from Q1. In Q2, we continued migrating content from ehow.com to our new vertical properties and we see an initial dip in traffic and RPV with each of these content moves. We expect RPV for the new vertical sites to increase in future quarters as we optimize the yields on those pages. And as the size of the audience on the vertical properties becomes increasingly attractive ad by for direct brand advertisers. We continue to focus on building our branded sales pipeline with large Fortune 500 brands and our media agencies. Onto adjusted EBITDA, Q2 improved 24% year-on-year driven by revenue growth and cost saving initiatives offset by headcount additions, higher levels of promotions in our marketplace segment and marketing investment to expand brand awareness and paid customer acquisition at both Society6 and Saatchi Art. Overall, our Q2 non-GAAP operating expenses calculated as GAAP operating expenses, less stock-based compensation, depreciation and amortization and excluding product costs which may vary with revenue were $21 million down $1.4 million from the prior year. Our free cash flow was negative $5.1 million in Q2 versus negative $4.0 million in the prior year. Free cash flow for Q2 2017, reflects our EBITDA loss as well as capital expenditures. At the end of the second quarter, we had $30.5 million of cash available after accounting for the $6.7 million cash payment for the Deny Designs acquisition while maintaining a zero debt balance. As of December 31, 2016, we had federal net operating loss carry forwards of approximately $155 million which expire between 2021 and 2036 and stay NOL carry forwards of approximately $62 million which expire between 2017 and 2036. Additionally, in July, we received $3.9 million in cash that had been held in escrow related to the sale of Cracked. Also note that as part of the consideration for the Deny Designs acquisition, we have continued consideration for up to $3.6 million payable in three equal annual installments on the first through third anniversary of the closing. Turning to our new segment reporting, we are now providing a breakout of segment operating contribution disclosure in our earnings release in 10-Q. In Q2, we previously mentioned market price segment revenue increased 32% year-over-year to $17.7 million. Market price segment operating contribution was negative 1.7 million versus a loss of $0.2 million a year ago, which reflects continued investment in our emerging marketplace assets including increasing headcount, marketing and promotional activities to drive long-term sustainable growth and scale. Media segment operating contribution increased nearly $3.7 million year-over-year to $4.4 million, driven by revenue growth, our efforts to streamline the business and higher incremental margins. Lastly, corporate operating expenses decreased by 3% year-over-year to $6.6 million. As we have previously mentioned, we expect significant leverage in our corporate overhead costs as revenue continues to grow. Before I conclude, let me add a few remarks as we think about our second half financials. With continued growth in our marketplace segment, further integration of Deny Designs, the ongoing strength of LIVESTRONG business and positive trajectory in our core media properties, we are confident in revenue growth for the balance of 2017. Looking at operating expenses, we will maintain our investment in marketing for our marketplace segment to continue to acquire and engage new and repeat customers and build brand awareness. We expect to continue to optimize infrastructure and corporate overhead expenses and as a result those should decrease as a percentage of revenue over the longer term helping to narrow our EBITDA losses year-over-year on an annual basis. As a reminder, we expect the acquisition of Deny Designs to be roughly breakeven on an EBITDA basis in 2017 excluding one-time transaction costs. Also note that acquisition of Deny Designs added $4.9 million of intangible assets, which will be expensed on a GAAP basis over the next several years. With sustain strong marketplace growth, LIVESTRONG's outstanding performance and the return to health and profitability of our core media business, we are excited by our progress and confident in our future success. That concludes our financial summary and we will now turn the call back over to the operator to open the lines for your questions.

[Operator:]

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

[Jason Kreyer:]

Sean, it's pretty clear that there is -- you're showing a lot of evidence of the turnaround in this business. And I am wondering if you can kind of comment, is there any reason we shouldn’t see these trends continue going forward? And kind of as you think about that as you can just give just a little bit of thought on, how we should think about this new segment reporting which we appreciate the additional detail by the way? But how we should think about this segment reporting over the long-term? Where do you think those operating contributions can go in the next several years? Thanks.

[Sean Moriarty:]

Thanks Jason. I think for us to continue to drive progress it's contingent both on high quality execution from team and the nature of markets we operate in. And as we look forward, the market continues to behave on both the media and marketplace aside consistent roughly with what we have seen over the course of the past year so and we continue to execute well, we should continue to make great progress. We should call out obviously the media landscape has been a volatile one not just for us, but for many others. But as the quality of our products and service improve on the media side of the business, that volatility seems to have diminished not just from the sector perspective but I think the quality of our business actually insulates us from some of the inherent volatility. On market place side, these are young businesses. We continue to acquire very high quality customers. We see no reason why we can’t continue to do that. And at the same time we also acknowledge that for retail and general and e-commerce specifically, we've been pretty active promotional environment. And if you want to get the customers intention and drive them to purchase, we expect that we’ve reached a new normal from a standpoint of promotional activity. All of that being said, we certainly like our chances, we've got a very good team, we’ve proven we can execute as on a go forward basis, I see no reason why we should be able to continue to. When it comes to giving investors more clarity, certainly moving to segment reported, it's something that we feel as an important step for us. We want it to be easier for you all to understand, how to evaluate our business. And we felt that we’ve certainly achieved the level of internal clarity that allowed us to do that in a way that would actually be helpful to you. In a first couple of years of turnaround, here is day-by-day taking stock of what you and it's hard to see the best way articulate and express that to investors, but certainly with this move we think certainly we're better equipped to manage our business day-to-day and you'll are better equipped to see what we're doing. So, we're very happy with it.

[Jason Kreyer:]

Switching to market place I guess. Just give me a little bit your thoughts on how to think about the promotional activity and I know you mentioned that you started implying some change -- integrating some changes on pricing. It also a new -- new level of promotional activity, so I'm wondering how we should think about those margins given the volatility we've seen over the last two to three quarters? Should we use these margins going forward? Or is there going to be a little bit more seasonality on the margin given we're kind of entering high promotional period with back-to-school and then it probably tappers off after that?

[Sean Moriarty:]

It's great question. I think what we seeing starting probably late Q3 early Q4 last year is really as I think said, we're getting a new normal from a standpoint of promotional activity. And so, I would say the future is more likely to resemble the most recent past rather than 12 to 18 months ago from a standpoint of promotions in way today impacts margin. But we're really focused substantially on the, Jason, and how you work through this is by building a brand in the business that truly matters the people which is why we spend so much time, internally executing against the coir high quality customers and then engaging them turning them into repeat customers and then making sure of their experience is what the matters and we measure that internally and through that promote scores and other means. If we do that, we know that overtime as we put more products into the pipeline, as we reap some of the benefits of scale, as we get better just being mergence overall with respect to pricing and merchandizing that we're going to a very, very quality business. But I think from a practical standpoint as you're thinking about the business, purely from a promotional expectation, I would say where we're today reflects the level of the activity is probably impact on the business that they could recently seen in terms of gross margin, but there is a number of things we can do to address that and grow beyond going forward.

[Jason Kreyer:]

Okay understood. On LIVESTRONG, there was a pretty impressive growth quarter for you, 50% revenue growth and 17% visitor growth implies. You are doing a lot on the kind of yield optimization for your visitors. And can you contrast what you are doing at LIVSTRONG with what the potential opportunity is with these specialty verticals sites that you have rolled out under the eHow umbrella?

[Sean Moriarty:]

I think the success we are seeing in LIVSTRONG is on the basis of consistent execution now over the course of the past two years, and I think the thing to point out is that LIVSTRONG really started to recover probably 18 months earlier that what was once eHow. It is now spread across several new brands that we have recently launched, so I think certainly if you think about the categories that we are in high passion, high quality large categories, home and pets and DIY, there should be real opportunity for us on a go forward basis to start driving substantial improvements and monetization. But I think the key thing is to recognize than we have been at this with positive momentum with LIVESTRONG for year two and year and half longer. Hunker for example just launched in bigger really in April and now just getting up curve as a full fledge branded site. The second thing that I should point out as you should probably know, the branded sale is something we believe is the substantial opportunity, we have never been better equipped from a standpoint of the health of our properties or the size and vibrancy of our audience, and also from a standpoint of the capability of our people in selling. So, over the course of the next few quarters, we expect to see those investments paying off for us from a premium branded perspective.

[Jason Kreyer:]

Last one for me just thinking about opportunities to cross promote between the media and marketplace kind of now that you have Deny Designs integrated. And Hunker seems to after a pretty good start. Are there opportunities to reduce certain things kind of the Hunker side that would give you opportunities to grow both Society6 and Deny?

[Sean Moriarty:]

Yes, we think there is tremendous opportunity, as Hunker comes into its own as a large destination home site, you think about that the passionate audience Saatchi Art, Socity6, Deny Designs, all fit very well highly relevant brands with absolutely matter to that supper base. And over the course of next couple of quarters, we will share more on the work that we are doing here. It's a bit early right now, but we see a tremendous amount of potential.

[Operator:]

Your next question comes from the line of Lee Krowl of B. Riley & Company. Your line is open.

[Lee Krowl:]

The first quarter I had just kind of curious on marketplaces. Now you guys are breaking up by segment, I guess just to confirm that you guys are investing in that business and how do you not and made the discretionary investments in the quarter. Would that business have been positive on an operating basis?

[Unidentified Company Representative:]

I think it’s little hard to say because you’re trying to imagine what your performance would have been -- how do you invest in and lessen your business. But I think the prior performance of the business, if you go back for example, it’s a Q2 last year based on the break out. You see baseline profitability in the business and unit economic should only improve with scale. These are young businesses as we said, we’re not only doing the work of integrating Saatchi Art and The Other Art Fair, but we've got the acquisition of Deny Designs, and Society6 is still substantially in growth mode. And so, we are more than happy to make that upfront investment because we know it’s going to pay real dividends in the future.

[Lee Krowl:]

Got it. And then, I know you guys kind of talk about growth the rest of the year, but how do we think about the market place in terms of seasonality in the second half? Is there kind of an acceleration sequentially as you hit the holiday period? Or maybe just kind of on qualitative basis obviously how that we should think about that?

[Sean Moriarty:]

I think if you look at, prior performance should be pretty good guide of our seasonality trends. I don't have anything to underline seasonality of the business, hasn't -- there is nothing changed in the market to change that. I would say we are doing a better job of driving growth contrary to seasonal trends. We've certainly shown that with LIVESTRONG, which is where we’re been to drive quarterly growth even in those quarters which tend to soften, So I think as we get better as a team, we are able to drive growth even in quarters that are seasonally softer than others. But I wouldn’t expect major change to those trends as we go forward. History should be your guide.

[Lee Krowl:]

Okay. And then switching over to media, obviously great results in LIVESTRONG, and we can kind of use it as guide post at least for the verticalization on certain assets. But in terms of monetization it kind of timing basis, where do you think you are in terms of one to four whatever quarter before you can kind of really start to see that monetization engine of those new business kind of track towards LIVESTRONG kind of economics?

[Sean Moriarty:]

I think we should see evidence into next two to three quarters, right. So, which I’d say, look at Q1 and Q2 of next year certainly and we should have some good signs by Q4 of the success we are having. Pipeline does take while to build and getting new branded advertisers which is going to drive the most leverage. On-boarding them for the first time, it is harder in keeping them if you high quality audiences like we do. But I would say certainly over the next few quarters, we should be able to share with you some signs of success and progress we're making.

[Lee Krowl:]

Okay. And then I guess just kind of one last question with that in mind. Any updated thoughts on kind of line of sight towards profitability? I know it's -- there is a lot of opportunities specially with the moment you have now, but always kind of curious what you're thinking around profitability is may be in 2018?

[Sean Moriarty:]

Yes, I think sustainable profitability matters and off a lot of to us. We will --- I think probably the best way to think about that, that approach vector is to look at the operating leverage we are getting quarter over quarter, look at the top line growth and look at how much takes to the bottom line. And I would say recognize though if we see we see opportunities for meaningful investment that we know pay substantial future dividends, we are going to make that. But I would say the path that we are on and the operating leverage we are showing quarter-over-quarter and year-over-year, help us see out in the future when that’s most likely to be. And if we can get there quicker, sustainably, we'll most certainly well.

[Operator:]

That concludes the Q2 2017 Leaf Group earnings call. Thank you for joining.