Leaf Group Ltd.
Q3 2017 Earnings Call Transcript

Published: 8 Nov 2017

[Operator:]

Good afternoon. My name is Emily and I will be your conference operator today. At this time, I would like to welcome everyone to the Leaf Group’s Third Quarter 2017 Earnings Call. [Operator Instructions] 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 Q3 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 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 share our third quarter results and provide an update on our market place and media segments. Additionally, I will share thoughts on 2018 including our current expectation of reaching adjusted EBITDA profitability in Q4, 2018. Jeff will follow with more details on our financials. At Leaf Group we continue to pursue our mission of building creator driven brands for passionate audiences in our design and lifestyle categories. We believe that our Q3 results further validate our strategy with accelerating market places growth, new product offerings and strengthening of our media brands. Q3 was a strong quarter for Leaf Group with revenue growing 19% year-over-year to $33.5 million and organic revenue growth accelerating to 11% year-over-year, driven by improvement at Society6. Importantly, our adjusted EBITDA loss narrowed 12% year-over-year to negative $1.9 million, driven by improving scale in our higher-margin media segment and increasing leverage over corporate expenses. At the same time, we continue to invest for growth, especially in our marketplaces segment. Beginning with our marketplaces segment, we had a very strong quarter with accelerating revenue growth, and significant sequential improvement in segment operating contribution. Marketplaces segment revenue increased 35% year-over-year in Q3 to $22.5 million, driven by improving growth at Society6 and solid contribution from the Deny Designs. Adjusting for the Q2 acquisition of the Deny Designs, marketplaces segment revenue increased 20% year-over-year in Q3, along with stronger top line performance marketplaces segment operating contribution improved by $1.3 million quarter-over-quarter to negative 0.4 million. Driven by a solid back-to-school season, revenue growth in our largest marketplaces business Society6 accelerated to 20% in Q3. Our key back-to-school products including art prints, laptop sleeves and carryall pouches, all grew sales by over 50% year-over-year. Traffic for Society6 showed solid growth up 14% year-over-year, driven by our SEO efforts which resulted in a 27% increase in organic search traffic. Additionally, our lifecycle and retention marketing efforts continue to improve as we drove 34% year-over-year growth and repeat customers during the quarter. The Society16 [ph] was successful in driving a 3% year-over-year, and 7% quarter over quarter improvement in average order value through pricing and promotion optimization. Alongside improving revenue growth our optimization efforts drove gross margin higher quarter-over-quarter to 30% in Q3. We continue to expand product selection adding backpacks, duffel bags and a refresh of iPhone cases bringing the total number of products currently available on Society6 to 43. Additionally, recently acquired Deny Designs had a solid Q3 driven by strength in its wholesale distribution channel, which included the addition of several new retail e-commerce partners. Saatchi Art continue to gain share in the highly fragment Art market, including the launch of exclusive limited edition prints. Q3 revenue for Saatchi Art grew 23% year-over-year, driven by solid growth online, and one Art Fair hosted in the quarter. We recently announced that based on our highly successful U.S. debut, the other Art Fair will return to Brooklyn and host its second U.S. fair this year on November 9 through 12. Already in Q4, we have held fairs in London and Sydney and we expect to further expand their presence with more art fairs in new locations including Los Angeles in March 2018. In mid-September we launched, Limited by Saatchi art, which features a curated selection of exclusive limited edition prints by emerging artists. Our limited edition prints offering further expand Saatchi Arts market opportunity and provides an attractive entry point for consumers. In October, we are pleased to announce the addition of Jeannie Anderson as General Manager of Saatchi Art. Jeannie brings nearly 20 years of e-commerce and product experience, most recently as the Senior Vice President of product marketing and optimization at ZipRecruiter and head of product a Dog Vacay. Based on our expanding product selection at Society6 and Saatchi Art, our engaged customer base and strides in pricing optimization, we believe, we are well prepared for the upcoming holiday season. In our media segment, Q3 revenues were $11 million or 33% of revenue up 1% quarter-over-quarter. The media segment had a solid Q3 as we continue to execute against our strategy of creating premium media brands, which are leaders in their respective categories. Core media revenue, which excludes the contribution from our small international sites and former custom content business, was up 6% year-over-year, driven by continued strength at LIVESTRONG. Media segment operating contribution grew 18% year-over-year to $4.8 million, representing a 44% margin. We continue to see positive momentum at LIVESTRONG with revenue growing 28% year-over-year, driven by 19% traffic growth and improvements in monetization. In Q3, LIVESTRONG partnered with fantastic leaders and pioneers in the Wellness space, including Olympian Shawn Johnson, Huffington Post founder Arianna Huffington reality TV star Lauren Bushnell. LIVESTRONG also partnered with Create &Cultivate at Microsoft’s headquarters in Redmond to meet with over 1000 entrepreneurial millennial women. LIVESTRONG is further expanding its brand and diversifying revenue with stronger, it’s healthy living podcast in the subscription-based, MyPlate Calorie Tracker app. In the early days for the podcast, it has already reached over 100,000 listens. The MYPlate app continues its impressive growth with revenue up 102% year-over-year and was recommended in a recent New York Times wellness article. As I mentioned on recent calls, one of our key initiatives for 2017 was to move all of our media brands onto a new common proprietary technology platform, which we successfully completed in October. This new platform greatly increases the productivity of our product and engineering teams, speeding a feature development, product deployment across our sites. Based on our new technology platform, we are rolling out improved article designs that use dynamic layouts to create more engaging and brand leading storytelling. This design is currently live on Hunker articles and will be rolling out to our other properties in the next few months. Another big milestone in Q3 was a substantial completion of our verticalization initiative by adding five new media brands through our portfolio over the last year. Our new vertical properties continue to expand the audience, with traffic increasing 12% year-over-year. Hunker, our home design site which launched in April, continues to climb and calm scores at supported home category, reaching number six in September. Traffic to Hunker site increased a robust 88% sequentially in Q3, reaching over 25 million visits in the quarter. Together with Cuteness, our number three ranked pet site we are building leaders in these high-value categories. As part of the verticalization strategy, eHow is now highly focused do-it-yourself craft oriented content site with strong long-term prospects yet now represents less than 10% of overall media segment revenue. These leadership positions have enabled our vertical brands to work with great partners this quarter, including Bark & Co, Domino and IKEA. Before turning it over to Jeff for a review of the financials, I wanted to provide a few initial thoughts on 2018. Based on strong consistent growth in our marketplaces segment, and improvements across our core media businesses, we remain confident in our revenue growth plans in 2018. Additionally, with high media segment operating contribution margin and improving volume leverage in our marketplaces segment, we expect leaf group to achieve adjusted EBITDA profitability in Q4, 2018. When I started at Leaf Group three years ago, our team took on a complex and difficult business transformation. Three years in, we have built a great business, with growing marketplace brands that have a community of over 300,000 artists, media brands that are leaders in lifestyle categories with over 50 million monthly unique visitors and a path to profitability in 2018. As we look out to next year, I’ve never been more confident and excited about the quality and potential of our businesses., I will now turn the call over to Jeff for remarks regarding the financials.

[Jeff Misthal:]

Thank you, Sean. I appreciate this opportunity to share our Q3 financial results. Before I begin, let me clarify that all references to revenue in my prepared remarks will be stated on a pro forma basis net of our dispositions of certain other nonstrategic media properties during the course of 2016. Note that in Q3; we have fully anniversaried the sale of Cracked and the difference between our GAAP numbers and pro forma numbers are much smaller. A reconciliation of our pro forma revenue to GAAP revenue for the relevant periods is available in our earnings release. Additional information on our key operating metrics is also included in our earnings release and supplemental financials. On to our Q3 results, first, total revenue in Q3 was $33.5 million up 20% year-over-year on a pro forma basis and up 11% adjusting for the acquisitions of Deny Designs as well as the dispositions of certain other assets. Our marketplaces segment grew 35% year-over-year while our media segment declined 2% year-over-year in a pro forma basis. Second, adjusted EBITDA was negative $1.9 million in Q3, a 12% improvement versus negative $2.2 million in the prior year. Third, free cash flow was negative $1.3 million for the quarter, improving 64% year-over-year Beginning with our marketplaces segment, Q3 revenue was $22.5 million up 35% year-over-year a 300 basis point acceleration from Q2. Q3 revenue growth was driven by a 20% year-over-year increase at Society6, incremental contributions from Deny Designs and 23% growth for Saatchi Art includes some of the Other Art Fair. Marketplaces gross transaction value increased 33% year-over-year to $28.1 million in Q3, while transactions were up 35% year-over-year. Gross profit for the marketplaces segment was $5.7 million on a GAAP basis. On a trailing 12-month basis, gross profit was $19.8 million up 12% year-over-year. Underscoring strong value creation in our market places segment. We continue to make progress in our third key initiative of expanding deeper into the home-to-core market. In Q3, over 80% of our product sold from Society6 were in the home decor category. Gross transaction value for Society6 increased 24% year-over-year driven by a 20% increase in transactions and a 3% increase in average order value. Revenue for Society6 grew 20% year-over-year, 300 basis point acceleration from Q2 growth of 17%. Gross margin for Society6 was 30% in Q3 down 760 basis points year-over-year due to the noisy promotional environment which began in Q4, 2016 and continued into 2017. However, gross margin is up 200 basis point sequentially in Q3, as our promotion and pricing optimization efforts are taking hold. Saatchi Art also had a solid quarter with revenue up 23% year-over-year in Q3 inclusive of revenue from The Other Art Fair. The year-over-year increase in revenue is driven by the commission change we implemented in Q2 and improving traffic in transactions at Saatchi Art. The Other Art Fair hosted one fair in Q3 in Bristol U.K. the same as in the year ago period. Turning out our media segment. Q3 media revenue was $11 million, down 2% on a year-over-year basis, while up 1% quarter-over-quarter, excluding our international sites and the wind down of our custom content business, revenue for core media business was up 6% year-over-year to $10.4 million. Revenue from other media which includes our international sites and the former custom content business was $0.6 million down 59% versus the prior year. Total average monthly visits to our media properties in Q3 were $231 million, up 7% versus the prior year. Approximately 58% of these visits came from mobile. Total video views for all of our media properties were $195 million, up 11% versus the prior year. At the end of Q3, our media properties had over 14 million total social followers across Facebook, Pinterest, Instagram, YouTube and Twitter up 16% year-over-year. Revenue per visit or RPD for our media properties was $15.80 for Q3, down 10% versus the prior year and up 3% from Q2. As Sean discussed, we completed the migration of our content from eHow.com to our category specific vertical properties. In conjunction with these moves, we see an initial dip in traffic and RPV. After rolling out Cuteness as our pets brand in Q2, 2016 revenue on the site has increased over 100% year-over-year in Q3, due to increased engagement and RPV growth of over 50% from branded advertising dollars. Q3 adjusted EBITDA improved 12% year-over-year to negative $1.9 million, driven by revenue growth, expanding media segment operating contribution and cost-saving initiatives offset by headcount additions, higher levels of promotions in our marketplaces segment and marketing investments to expand brand awareness and paid customer acquisition at both Society6 and Saatchi Art. Overall our Q3 non-GAAP operating expenses calculated as GAAP operating expenses plus stock-based compensation, depreciation and amortization and excluding product costs which may vary with revenue were $20.1 million, down $0.4 million from the prior year. In Q3, marketplaces segment operating contribution was negative $0.4 million versus positive $0.8 million a year ago, and up $1.4 million sequentially versus Q2, 17. This reflects our continued increase levels of investment across our marketplace businesses including headcount marketing and promotional activities to drive customer growth and scale. The media segment operating contribution in Q3 was $4.8 million, up 18% year-over-year representing a 44% margin, which was up 800 basis points year-over-year. These improvements were driven by our efforts to further streamline the high-margin business. Lastly, corporate operating expenses decreased by 11% year-over-year to $6.3 million. We continue expect to realize significant leverage in our corporate overhead costs as revenue continues to grow. Our free cash flow was negative $1.3 million in Q3 versus negative$3.6 million in the prior year reflecting our lower EBITDA loss and normal capital expenditures. At the end of the third quarter, we had $33 million of cash available inclusive of $3.9 million received in July from the sale of Cracked that was held in escrow, 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 state NOL carry forwards of approximately $62 million which expire between 2017 and 2036. Finally as Sean mentioned earlier, as we see continued revenue growth and improving operating contribution in our marketplaces segment, continued strong media segment operating contribution margin and improved leverage across corporate expenses, we believe we are well-positioned to be profitable for Q4, 2018 on an adjusted EBITDA basis. That concludes the financial summary, and we will now turn the call back over to the operator to open the lines for questions.

[Operator:]

[Operator Instructions] And your first question comes from the line of Jason Kreyer with Craig-Hallum. Your line is open, please go ahead.

[Jason Kreyer:]

Hey guys, good afternoon and congratulations on the strong results. I just wanted to start with marketplace, so obviously great trends in our repeat orders from Society6 and just wondering if you can dig into that a little bit deeper, talk about if you’re marketing to existing customers are little bit differently that’s driving the increased transaction?

[Sean Moriarty:]

Yeah Jason, this is Sean, thank you. Yes, Ruben Baerga joined us in early May, and his team have done a really really good job operating the business over the past six months, much more sophistication with respect to pricing and promotion, definitely a focus on retention side and getting customers to come back, specialized promotions against higher price point product and then the expansion of product offering has helped a lot too. But overall, just very thoughtful high-quality execution by the team.

[Jason Kreyer:]

And can you talk at all about like the lifetime customer value, maybe specifically on Society6 because it seems like the cost to acquire a customer is going down and if you’re growing repeat orders that would increase the lifetime value, so I mean it seems like you seem pretty considerable expansion there over the past several quarters.

[Sean Moriarty:]

Yeah you know lifetime value is a moving target. We are I would say more conservative than expensive you know in this quarter in particular. We focused more on repeat particularly than new, particularly as we were exerting more promotional discipline than we had in prior orders. There is ample room to grow the new customer base, what we did in it, as you know over the course of the past year, just broadly speaking the overall market has been heavily promotional, but it seems to have stabilized somewhat, you know we made very specific choice to really focus on the repeat business and to inject some discipline into the pricing and promotion games we have.

[Jason Kreyer:]

Talking about promotion going into Q4, I think that’s when we saw the promotional activity really increase last year. Do you have a sense on how that environment looks right now, or do you think you can offset a lot of the promotional activity with some of the pricing changes that you’ve put in place?

[Sean Moriarty:]

Yes, it's interesting, Q4, even though we're already into it, you really don't know what the season is going to bring to you for another few weeks, but I what we can comment on is over the course of the year that really heavy broad promotional environment we saw in retail has seemed to stabilize a bit. And I said earlier, I think I said that we didn’t expect it was going to be long term sustainable for every retailer to be discounting you know through the floor and everything and that we felt that if we were disciplined, we have to play a little bit to make sure we are capturing the intention of consumers, but we certainly weren’t going to chase anything to the bottom. You know since we’ve said that, we’ve seen stabilization more broadly which really speaks well to the -- to the increased discipline and focus that we have and so far, so good but we’ll see.

[Jason Kreyer:]

On the Deny acquisition, that’s been a couple of quarters now, have you seen any -- I know when you made acquisition we talked about potential cost synergies, because they had some manufacturing capabilities or perhaps some revenue synergies just taking advantage of some cross promotion between mid perhaps a 6 and Deny Design, you know -- has that, has any of that occurred in the quarter or has your outlook changed in terms of those opportunities at all?

[Sean Moriarty:]

Outlook hasn’t changed at all about the strategic logic of that acquisition. The first thing you want to make sure you do in any M&A scenario when you buy something is that you don’t screw it up, and we’ve spent you know the first six months really getting to know the team, integrating the team into Leaf Group and spending more time with the Society6 team and I think we are really well positioned heading into 2018 to start to execute some of the strategic opportunities we saw. And whether that’s broadening the wholesale offering where they’ve already done a great job building our business with really high quality retail partners, extending the product assortment on both Deny Designs and Society6 where there is probably 15 to 20 products that Deny offers today, they are fantastic products that we did not offer on Society6 or cross marketing and cross promotion. Also just given the platform that we’re building here from a market place perspective, you know we offered Deny scale without having the incremental cost of having to really build out the platform of their own beyond what they already have. All of the core back-office technology that makes scale in the Marketplace work is resident inside the Leaf Group. So as they grow, they get to grow on top of that. I think 2018 is where we start to see the real fruit of that acquisition as we integrate more deeply and well certainly we feel confident that we’ll have a lot of good things to share with you in the coming quarters.

[Jason Kreyer:]

Switching over to the media segment, the RPV reversal in Q3 was certainly encouraging, is there any way to break that down in terms of where you’re seeing the improvement because it seems like it’s been driven by LIVESTRONG over the last several quarters, and now it appears as though you’re starting to get better RPV trends of from the eHow properties well we can’t really see that in the numbers.

[Jeff Misthal:]

So I think you are exactly right, Jason. I think you know LIVESTRONG is still driving a good deal of the RPV improvement. On the top line the eHow and vertical is also starting on certain healthy verticals. We are also starting to see that we called out the script that the Cuteness RPV and revenue have pretty successful year-over-year use since the launch of that site. So pretty excited about that rolling up to similar playbook to the rest of the verticals, but we haven’t gone into more detail on those vertical sides.

[Sean Moriarty:]

One of the things that’s a little tricky is you are trying to project timing in a world where that’s very difficult to do, but we do have the history, right. We do know that call it four to six quarters after LIVESTRONG really returned to help both from an audience growth perspective and a content quality perspective, we started to see the improved monetization. If you look at Cuteness by way of example, that site launched about five quarters ago and as Jeff just pointed out last quarter there was significant year-over-year growth from a revenue perspective, so somewhere in that ballpark of four to six months of growth in – four to six quarters excuse me, of both real audience growth and sustained quality of engagement is where that significant revenue improvement seems to come, but it is has been variable by property for us which is why we try not to gaze too closely into the crystal ball individual property level, but what I can tell you is the quality of these sites Hunker for example was launched in early Q2 of last year, so we are not even a year out with that property. It’s doing very very nicely so we do expect absent specific understanding on month or quarter timing. I mean, all things are set you know for revenue to improve at some point out in the future these sites continue to say strong and grow, and we absolutely believe they will.

[Jason Kreyer:]

All right, one more and I’ll see the floor. Just Jeff, wondering if you can give any more detail on the long term profit opportunity you established the 4Q 2018 goal of EBITDA breakeven, maybe you can run through the components of that and I think obviously a lot of that is operating leverage but are there additional cost improvements that you can make to get to that target?

[Jeff Misthal:]

Yes, I mean, so I'll answer the easy question first, which is the last part. There's always cost improvements that we had. We are just trying to make sure we are making them at the right time, in the right places, as to not stunt the growth of the business. I think from a topline perspective, the media type, very high margin business, the flow through those dollars to the bottom line is extremely important to hitting that. That total profitability goal for Q4 on a EBITDA basis. So focusing on growing the media business also focusing on the marketplace aside, continuing to grow the top line and also managing the gross margin as well as the investments that we are making, whether it’s as we’ve done in the past on headcount or among the marketing side of the business, so making sure those are all being weighed against the top line growth and protecting that margin, but putting that all together, I think getting to that point in Q4 of next year is absolutely something that we will do provided the market and the world around us cooperate and....

[Jason Kreyer:]

Great. Thanks for the...

[Sean Moriarty:]

This is Sean. We are now three years into this and this is the strongest team of leaders that we’ve had – we’ve been at this for a while and understand the business is better and this is also the first time where we’ve had stability across the portfolio. And so, that’s what gives us the confidence that continued high quality execution is going to continue to put us in the right direction. We are very focussed if you look back over the course of three years, we’ve been very disciplined with respect to cost, the quarter-over-quarter operated more efficient company and even when things were very challenging on the media side, we’ve always been growth oriented. We believe that you create valuable sustainable businesses by investing in quality and building brands that matter, and even through the toughest of times we found a way to do that. So we are super excited to have on a much more stable foundation and strong growing brands, the opportunity to take this business not only back to profitability but we view that as really starting to generate the fuel that’s going to allow us to actually grow faster and build even better businesses.

[Jason Kreyer:]

Sounds, great. Alright, appreciate the color. Thanks guys.

[Operator:]

And that concludes the Q3, 2017 Leaf Group earnings call. Thank you for joining.