Leaf Group Ltd.
Q1 2018 Earnings Call Transcript

Published: 8 May 2018

[Operator:]

Good afternoon. My name is Chantelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Leaf Group's First Quarter 2018 Earnings Call. On the call with me today is Sean Moriarty, CEO; Jantoon Reigersman, CFO; 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 conference call. I'm pleased to have Sean Moriarty, our Chief Executive Officer, and Jantoon Reigersman, our Chief Financial Officer on the call with me today. Following the Safe Harbor statement that I will make, Sean will update you on our business, and then Jantoon 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 a 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, everyone for joining us this afternoon. We appreciate the opportunity to share our first quarter results with you. After my remarks, Jantoon will provide details on our financials. The first quarter marked a great start to 2018. Team delivered strong 24% year-over-year topline growth with revenue of $33.7 million driven by 32% growth in marketplaces and 12% growth in media. In addition, we delivered significant margin improvement with adjusted EBITDA of negative $1.2 million a 72% improvement year-over-year. Strategically, we continue to focus on our key categories of fitness and wellness and art and design. Continued progress within these categories enables us to reach a large intent driven and highly engaged audience which reached an average of 54 million visitors a month per comScore in the quarter. In January Livestrong had its highest audience on record with over 32 million unique monthly users as reported by comScore. While Livestrong is primarily ad supported its subscription revenue from our fitness app MyPlate is becoming meaningful. MyPlate was recently recognized by the industry as a 2018 Webby award winner for best visual design. For the overall media segment, we are excited with the performance of the quarter growing revenue 12% year-over-year. This growth is the result of our focus on high-quality content, our continuous improvements in user experience, and ad stack monetization. We have significant room to further optimize the ad stack and drive a higher percentage of ad fill up to stack. New programmatic clients in the first quarter included Home Depot, Fitbit, Planet Fitness, Nissan and AT&T. We also continue to build our pipeline of brand direct deals. Our programmatic strength coupled with progress on direct brand sales will enable us to increase revenue per visit over time. In the quarter we launched new direct brand partners, including Athleta, Wonderful Pistachios, Clorox, and Go RVing. All of these brands are buying with us for the first time as we demonstrate, one that our sites are premium environments providing brand safety for the advertiser; two, that we have highly engaged intent driven audiences; and three, that we have advanced targeting capabilities. As our brands grow in prominence we increasingly see new opportunities. For example, Society6 won a very competitive direct branding campaign with National Geographic. While Society6 is primarily marketplace site, its audience and community of creators are passionate about art, creativity, empowerment, and storytelling. In short, the very audience that would be interested in Genius Picasso, the second season of the Emmy nominated series on National Geographic. The collaboration contains three short films featuring female Society6 artists who created original works of art inspired by three of Picasso's Muses. NatGeo will promote the films on their channels reaching over 45 million Facebook followers and 87 million Instagram followers, providing great exposure for Society6. For our marketplace brands we are focused on increasing brand awareness and driving audience growth as we scale the business in 2018. We are well-positioned to do so having established strong gross margins and solid unit economics. Additionally, we will finalize the integration of products from Deny Designs onto the Society6 platform and further build out Deny's growing wholesale channel. Alongside our brand and customer efforts, we will continue to expand our product selection and strengthen our tools for our artist's community. Our Saatchi Art Group continues to lead in the rapidly growing online art market for emerging artists. In Q1 Saatchi Art Group delivered 103% revenue growth year-over-year driven by expanding the number of events with the Other Art Fair in improving conversion at Saatchi Art. The Other Art Fair business is not only growing rapidly, it also provides a strong customer acquisition channel for Saatchi Art and deepens our relationship with key emerging artists in markets across the globe. Saatchi Art recently launched a new version of its iOS app which includes rich augmented reality features enabling customers to see what art will actually look like on their own walls. Customers can also take photos of the art as placed in their space, a feature of keen interest to interior designers. Overall, we continue to pursue our mission of building digital first brands for passionate audiences. Our quarterly results validate our strategy. I will now turn the call over to Jantoon for remarks regarding the financials.

[Jantoon Reigersman:]

Thank you, Sean. I appreciate this opportunity to share our first quarter financial results for 2018. At a high level total revenue for the quarter was $33.7 million up 24% year-over-year driven by 32% year-over-year growth in our marketplaces segment and 12% year-over-year growth in our media segment. Adjusted EBITDA was negative $1.2 million in Q1 a 72% or $3.2 million improvement versus the prior year period. Free cash flow was negative $7 million an improvement of 20% year-over-year ending the quarter with a cash balance of $46.5 million. Q1 media revenue was $12.8 million up 12% year-over-year from $11.4 million. This was driven by a healthy 17% growth in our core media properties including a 25% year-over-year growth at Livestrong. As a reminder our core media business excludes our international and the wind down of our custom content business. Total visits to our media properties in Q1 were 772 million up 11% versus prior year. Revenue per visit or RPV for our media properties was $16.56 for Q1 up 1% versus the prior year. Q1 marketplaces segment revenue was $21 million up 32% year-over-year. This growth was driven by a 25% year-over-year increase at Society6 Group inclusive of Deny Designs and a strong 103% growth for Saatchi Art inclusive of the Other Art Fair. Marketplaces' gross transaction value increased 35% year-over-year to $26.6 million while transactions were up 15% year-over-year. Society6 Group had a solid quarter as we continued to focus on lifting AOV year-over-year through price increases and reducing promotional discounts. Note, that as we further integrate Deny Designs product onto the Society6 sites, we no longer reporting Deny and Society6 financials separately. Saatchi Art Group had a strong quarter with revenue up 103% year-over-year in Q1 inclusive of revenue from the Other Art Fair. The year-over-year increase in revenue was driven by successfully expanding the number of fairs hosted by the Other Art Fair, improving conversion at Saatchi Art, and the commission change we implemented in Q2 2017. Our quarterly adjusted EBITDA loss improved 72% year-over-year to negative $1.2 million driven by a strong growth in media segment contribution margin and positive contribution margin in marketplaces. Q1 media segment contribution margin increased 51% year-over-year to $5.5 million driven by a high incremental flow through. On the marketplaces side segment contribution margin improved by roughly $1.5 million to $0.1 million driven by higher year-over-year transaction volume and our focus on improving gross margin through disciplined merchandising, partly offset by continued investment in these young and growing platforms. Corporate expense of $6.8 million represented 20% of revenue down 5.4% from 25.4% a year ago. Q1 free cash flow was negative $7 million up 20% compared to negative $8.7 million in the first quarter of 2017. The improvement in free cash flow was mostly driven by strong adjusted EBITDA growth of 72% year-over-year. The Q1 ending cash balance of $46.5 million reflects the $23.4 million in net proceeds generated from our February 12, 2018 follow-on offering. Our balance sheet remains debt-free. We had federal net operating loss carry-forwards of approximately $190 million which expire between 2021 and 2037 and state NOL carry-forwards of approximately $65 million which expire between 2019 and 2037. As a reminder, the gross balance of these NOLs was not impacted by the recently passed new federal tax legislation. 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] Your first question comes from Jason Kreyer with Craig-Hallum. Your line is open.

[Jason Kreyer:]

Hey gentlemen, good afternoon and congrats on the good start to the year.

[Sean Moriarty:]

Thanks Jason.

[Jason Kreyer:]

So the new branded advertisers that you've brought on in the quarter, it sounds like a pretty impressive roster, just wondering if you can may be walk through your thoughts across each of the different web properties and kind of what you're seeing for, is this primarily related to Livestrong are you starting to see a little bit more success across the vertical sites as well? And then kind of a followup question to that would be, you had the acceleration in visits, but the RPV was up like 1% year-over-year, so if there's any updated thoughts on the outlook for RPV?

[Sean Moriarty:]

Jason, this is Sean. So, you know, as the sites continue to improve in quality and as audience grows and engagement strengthens and also gross social channels what we see is more advertiser interest. Also keep in mind our branded sales details then our market for bid over a year and as these are getting stronger, so too our relationships to that branded sales team has with advertisers and agencies. No question Livestrong being our biggest property is a source of that strength, but also a great say by Hunker which really didn’t even exist a year ago and you know I think in March of this past year it is over 6 million units in the home design category with heavy inspirational bent really started to captivate advertisers. So I would say Livestrong is leading the way, but the other sites absolutely are highly dealing. These are intent driven audiences were in great categories and the quality is consistently improving.

[Jantoon Reigersman:]

And I'll now add, regarding the RPV side Jason, so the RPVs have truly stabilized and expect them to continue to be stable going forward and as we add these quarterly programs to our site going forward over time we'll be seeing and you can expect those to go on and that's something we're working towards. Remember though that obviously RPV is just like the rest of our sites, has seasonality in them, so you have like, you go slightly lower in Q2 and you are just back upwards in Q3 and Q4 as within the other parts of the business.

[Jason Kreyer:]

Got it, thanks. Switching over the marketplace business, so obviously pretty solid results both in the S6 and Deny Design as well as Saatchi. On the S6 and Deny side can you give us a little sense on if there are certain categories in a Home Décor or apparel something like that, where you're seeing the acceleration and where the GTV to like 35% in the quarter?

[Jantoon Reigersman:]

Yes so we continued to be very strong Jason in wall art, you know, not just obviously the originals business with Saatchi Art on their print editions on Site6 has been really solid performance for us, but we've continued to expand those wall art offerings where the established these a couple of years ago which continued so very strongly recently March products like wallpaper and so we've captivated an audience with this design rich wall art where our selection is really, really strong. As we've also pointed out we're pushing deeper into the home décor category primarily with accent products and that's also where you can see that positive impact on AOV as we become a more established home décor brand.

[Sean Moriarty:]

This goes in line also with the migration that we continue to do between Deny and S6 right? So Deny's products are now every day we put more Deny's products on to the S6 platform and so as a result by default you will see a blended rate of AOV go upwards and so our rate has increased already year-over-year and you can expect it to further increase and then at some point stabilize. And then the other piece is as you start focusing on different type of product mix the AOV could obviously change in light of that as well. So it's never a preset target in any shape or form, it's a natural result of the product mixes that we focus on, but overall, you can expect it to go up on S6 given that the nice products are slightly higher priced than they would be level.

[Jason Kreyer:]

Jantoon, just on that last point, so you're working to move the Deny products over to S6, does that go both ways, are you moving more of the content that's on Society6 on to Deny over the course of the year?

[Jantoon Reigersman:]

Yes, so I think that the overall focus is really to have S6 as a platform for direct-to-consumers and obviously Deny is the real focus on B2B in the retail side of things. And so, and the products of Deny that will land on S6 are also just branded S6 for that matter and so it's just a different product category and so that's really the idea, is just to have Deny brand that focuses on B2B, but you have an S6 product category that will further expand it and further expand it in the home category as Sean just mentioned.

[Sean Moriarty:]

Yes and Jason one thing I'll call out, the products that are on Society6 is certainly the artists and designs are on Society6 that may be highly appealing to our trade B2B partners are certainly – will certainly make those available as well. So it will flow both directions, yes.

[Jason Kreyer:]

Okay, now that's great. Then Jantoon, just on the operating leverage going forward, good progress in Q1 here. I don't know how or maybe you want to address this, but can you give a sense of what the long-term margin opportunity is on each operating segment or kind of the incremental margins you know maybe how much OpEx would you need to spend for the next $20 million of revenue or something like that?

[Jantoon Reigersman:]

Yes, I mean, look I think you, one way to think about it is more higher level flow through rates, right? So well, basically on the media side that's more of a mature business in some ways and your flow through rates are pretty clear around, between a 35%, 40% mark. You have an overhead, also the corporate element that you see it decreasing on a percentage of revenue basis year-over-year and we continue to obviously monitor greatly both, I think in the past we also indicated that you can expect that to be like a gross like $6.8 million or so before going forward give or take going slightly up or down some of the editions as we think. And on the marketplaces side, these are obviously young growing businesses, but over time there is a longer term target I think you could focus on the flow through rate of 20% to 25%. And so, but obviously on the marketplaces side there is really a balance between and its always a continuous balance between investing for further growth as well as focusing on the margin element and making sure that customers will only focus on discounting. So there is always a balance and the trade will be continued to make and so I think at a higher level 400% flow through rate on the media side 20% to 25% on the long term, on the marketplaces side a healthy good flow through rates to consider. Does that answer your question?

[Jason Kreyer:]

It does and then just to kind of go back to what you've said in the past and you are still focusing on EBITDA profitability as we exit the year?

[Sean Moriarty:]

Absolutely, yes it's a big focus for us and we continue to really make sure that the businesses are aligned to hit those targets, so absolutely.

[Jason Kreyer:]

Okay maybe last one and I'll hand it over, so the acceleration that you saw across the media properties you know with the visits that were up in Q1, any way to kind of break out where those came from, is it primarily organic visits, are you pursuing new paid or unpaid channels, any additional color driving that would be great?

[Sean Moriarty:]

One of the things we're really happy with Jason is, as the quality of the products improve, the quality of the content, the quality of the contributors we see sustained growth across all channels, so it's very evenly distributed. It correlates very highly to quality. So if you think about the channels of Search and Social and email and direct, they all have good healthy trends behind them and we expect those trends to continue as we maintain that focus on quality.

[Jason Kreyer:]

Okay, perfect. Thanks a lot guys.

[Sean Moriarty:]

Thank you.

[Operator:]

[Operator Instructions] Your next question comes from Michael Graham with Canaccord. Your line is open.

[Michael Graham:]

Thank you. Hey guys, congrats on the number. I just wanted to ask one first on the media segment as well. I'm just wondering if you look at the growth in Livestrong it sort of double the growth of the media segment and what's the best framework for thinking about kind of those two growth rates converge over time, does the whole media segment work its way closer to the Livestrong growth area or just how should we think about that?

[Sean Moriarty:]

Yes, I think Michael for context one thing to look at, Livestrong has been a healthy business over the course of the past couple of years and we've continued to maintain its strength. Keep in mind a year ago we really looked at launching new focused verticals. So a site like Hunker which really didn’t even register from an audience perspective last March was over 6 million units this March and, so you really have a look at those verticals we've launched over the course of the past 12 to 18 months and as they get larger and as these brands become fuller you will start to see that in form overall media growth.

[Jantoon Reigersman:]

One way and I - one way to probably think about this Michael is that, I think last quarter or maybe the last couple of quarters we’ve given the organic growth rate does which includes Livestrong, totaled this past quarter was 70% organic growth rate. You can expect that as we effectively flushed out the International and the wind down of custom content businesses we lapsed that year-over-year and Livestrong growth rates will converge closer to the, a bit to the organic volume. So closer, slowly but surely will come closer together. Does that make sense?

[Michael Graham:]

Okay, it does yes, so settling out the overall growth rate in media is more like the Livestrong growth rate moderates a bit more than the other way around, so I've got that, so it makes sense. Okay, sounds good and then okay, and then the other one I just wanted to get your thoughts on, I know you've got this, nice focus on like this passion areas of Art home goods and fitness and I guess strategically should we anticipate that it's more likely that you build up under these areas or are you also thinking of adding new areas and if so, sort of what's the process for kind of figuring that out?

[Sean Moriarty:]

Sure, I think the notion of mediated passionate customers where they care most and in our case did so wellness and our designer our categories are focus makes an awful lot of sense for us, particularly in the age of dominant distributors. We still believe in the power of brands. We believe we're in the right categories to serve the most passionate customers within those categories and I would say it's more likely than not as we expand, we'll expand where we're already strong because category leadership means an awful lot to us. That said, if we find that there is a category that we're not yet in for whatever reason, we believe that we can be very successful, vis-à-vis any other opportunity in the portfolio that we certainly would not turn our nose about it, but I think generally speaking you can expect to see us go from strength to strength in categories that we already know well and we already have real operating leverage in.

[Michael Graham:]

Okay, that makes sense. I really appreciate it and congrats again.

[Sean Moriarty:]

Thank you.

[Operator:]

Your next question comes from the line of Jason Helfstein with Oppenheimer. Your line is open.

[Jason Helfstein:]

Thanks. Let me, I’ll do another follow on M&A question and then a few others. So on timing of M&A should investors expect transaction to happen in this year, what's holding you back and kind of without telling us what you're looking at specifically, how would you describe, how robust the M&A pipeline and is far as identifying targets? That's question number one. Those are two and then I’ll ask the other two.

[Sean Moriarty:]

I’ll take it is a question for me and I guess back to the beginning. We're pretty active out there looking at businesses all the time. And I would say from that perspective our pipeline is always pretty darn good one. Really the question around what makes the most sense for us is a confluence of factors which is where are we in our core business. We always want to make sure that any M&A is done from a position of relative strengths, B we're very disciplined with respect to price, and C we truly believe at a given point in time any M&A we do is going to truly be a strategic accelerant to our business and that's probably even more art than it is science although there's a lot of rigor in it. And to your first part of your question actually, we're certainly well we're very active in looking at strategic opportunities to expand the business. We don’t work against specific timelines nor would we speak publicly as to where we are because the M&A game itself is one that's highly unpredictable. And I think the most important thing is to be disciplined and patient and move when the time is exactly right. So any public speculation and timing I don't think serves any of our constitutions particularly well nor does it serve us well.

[Jason Helfstein:]

Okay and then just on the art marketplace business, how should we think about the conversion rate? Is there a way to think about AOV relative to transactions, how that trended versus the year ago? I mean it is not a specific number can you qualitatively think about talk about how that's trending, how you're thinking of it, how you’re managing it?

[Sean Moriarty:]

When you're talking about regional art given the fact that it’s low frequency and it’s high price points, you want to look at your conversion rate on a relative basis against channels and against price points and against nature and types of works and see if you're making relative improvements as you go, particularly when you're pioneering a category. And particularly, in the original art category where we offer for example on Society6 is really visually rich. So we don't, you wouldn't try to comp in original art business with an AOV of $1000 to an e-commerce business at $50 AOV particularly when just the characteristics of the buyer in the buying state are different. But we're constantly making relative comparisons to see are we improving the experience and making it easier for consumers to get to a buying setting as we go.

[Jason Helfstein:]

And then just one last one, and Jan can you share what was the year-over-year growth in marketing expenses for media for marketplace and for media separately, so not, just the percent change not the dollars if you don't mind sharing that?

[Jantoon Reigersman:]

Let me – so we don't split amounts right normally, so if you think overall we've decreased it by 4% as the novels do the marketing we don't split out between the two and the reason why we don't do that is because we feel it’s really comparative right? But I think if you think about it at a different level, so if you think about Society6 as an example what the average here will be 60 bucks right, and gross margin levels are around 28% in Q4, 2017 that we disclosed at the time. Then you can see it in our marketing spend for the marketplaces business is very efficient. And so, but it’s certainly something I wouldn’t even argued that in some ways it's event too efficient and we would definitely look into maybe potentially even investing in it more over time. And so at the right time, we're probably going to disclose it in some further detail but at this time we're not really ready to do so.

[Jason Helfstein:]

Okay, thank you.

[Operator:]

That concludes the Q1, 2018 Leaf Group Earnings Call. Thank you for joining.