Leaf Group Ltd.
Q2 2018 Earnings Call Transcript

Published: 3 Aug 2018

[Operator:]

Good afternoon. My name is Jodi and I will be your conference operator today. At this time, I would like to welcome everyone to Leaf Group's Second 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, Sean. And thank you, everyone, for joining us this afternoon. We appreciate the opportunity to share our second quarter results. Our CFO, Jantoon Reigersman, will follow with more details on our financials. In Q2, Leaf Group delivered solid 20% top line growth, with revenue of $34.3 million, driven by 35% growth in Media and 11% growth in Marketplaces. We also delivered significant margin improvement, with EBITDA of negative $0.6 million, an 84% improvement year-over-year. With the acquisition of Well+ Good in early June and in keeping with our strategy, we substantially solidified our leadership position and expanded our reach in the critical and growing fitness and wellness category. We are excited to have the talented team of Well+ Good join Leaf Group, with Alexia Brue taking charge of our overall fitness and wellness vertical, which also includes Livestrong. Our back office integration of Well+Good is mostly complete, and we look to integrate our sales and product efforts in second half of 2018, positioning the group well for a seasonally strong Q1 in 2019. Overall, we had strong Media and improved monetization in Q2. Excluding the acquisition of Well+ Good, our Media revenue increased 25% year-over-year, a strong pick up from 12% in Q1. I want to call your attention to Hunker, which just celebrated its 1-year anniversary in Q2. Hunker is quickly becoming a leading digital brand in the home space as evidenced by its $8.8 million unique monthly visits in June 2018, making it the sixth-largest digital home brand as measured by comScore. Hunker hosted 2 different panels at Dwell on Design and the LA Design Festival featuring prominent homes design experts. Hunker also expanded its partnerships in Q2, including co-branded product initiatives for the Apartment Therapy, a content collaboration with Queer Eye's Bobby Berk and guest interviews on KCRWs, highly acclaimed design and architecture radio program. Hunker's success clearly demonstrates our ability to build new brands to monetize well against our target audiences. Video continues to be a bright spot for our media businesses from a monetization and products' perspective. With our strong existing advertiser base in premium original video content, we've been able to grow significantly in both video ad revenue and programmatic revenue. On the Marketplaces front, our efforts to focus on disciplined promotions at Society6 continue to fuel significant gross margin improvements, with overall Marketplaces gross profit up 22% year-over-year in Q2. Alongside margin improvement, Society6 continues to expand its product line with the introduction of 8 new products during Q2. Ahead of the key holiday season and under the leadership of Andrea Stanford, the team is working on improving artist tools and services and completing the integration of Deny Design products with the Society6 platform. Our market differentiation and positioning for Society6 is as follows

[Jantoon Reigersman:]

Thank you, Sean. I appreciate this opportunity to share our second quarter financial results. At a high level, total revenue for the quarter was $34.3 million, up 20% year-over-year, driven by 35% year-over-year growth in our Media segment and 11% year-over-year growth in our Marketplaces segment. Adjusted EBITDA was negative $0.6 million in Q2, an 84% or $3.3 million improvement versus the prior year period. Free cash flow was negative $2.9 million, an improvement of 4% to 2% year-over-year, ending the quarter with a cash balance of $32 million, reflecting the $10 million upfront cash payment for Well+Good and the $2.3 million net working capital adjustment. Q2 Media revenue was $14.7 million, up 35% year-over-year from $10.9 million previously. Excluding the acquisition of Well+ Good on June 5, our Media business grew a robust 25% year-over-year, a strong acceleration from 12% in Q1. Q2 growth was driven by 16% year-over-year growth of Livestrong, an improved monetization in video, programmatic and direct. As we continue to integrate the sales and product efforts of Livestrong and Well+Good into a single fitness and wellness category, we will not break out Well+Good on a separate basis going forward. As you will notice in the earnings release, this quarter, we've added Google Analytics visitor numbers to our overall operating metrics table. We have moved from internally derived figures to Google Analytics overall. To make the transition transparent, we will report both the internal figures as well as the GA data for 2018, but we intend to exclusively report visits data from GA beginning in 2019. Both figures have different methodologies, and therefore, the figures will not be perfectly correlated. In order to establish a better industry standard in comparison, GA was chosen as the main source going forward. For a GA data, total visits to our Media properties in Q2 were 770 million, up 7% versus prior year. Revenue per visit or RPV for our Media properties was $19.04 for Q2, up $3.99 or 26% versus the prior year. RPV without Well+ Good was $17.81, up $2.74 or 18% versus prior year, reflecting the strength in video and programmatic as well as improving monetization across our Media assets. Q2 Marketplaces segment revenue was $19.7 million, up 11% year-over-year. This growth was driven by 11% year-over-year increase at Society6 group, consisting of Society6 and Deny Designs, and 12% growth for the Saatchi Art Group. Marketplaces' growth transaction value increased 9% year-over-year to $24.5 million. Transactions were down 8% year-over-year, largely due to prioritizing sales on the Society6 platform directly rather than third-party Marketplaces, yielding lower transaction volume but increasing AOV in overall margins. Society6 group had a solid quarter as we continue to focus on lifting AOV year-over-year through continued promotional discipline. In Q2, AOV for Society6 group increased 19% year-over-year, helping drive 24% year-over-year growth in gross profit. We will continue our focus on promotional discipline and gross profit growth in the second half of 2018. Saatchi Art Group also had a good quarter, with revenue up 12% year-over-year in Q2. The year-over-year increase in revenue was driven by 40% revenue growth at Saatchi Art as a result of increased transactions and higher average order values, offset by lower revenue from The Other Art Fair due to a change in the fair schedule, as Sean mentioned earlier. Our quarterly adjusted EBITDA loss improved 84% year-over-year to negative $0.6 million, driven by strong growth in Media segment contribution margin and improved leverage in Marketplaces. Q2 Media segment contribution margin increased 41% year-over-year to $6.2 million, driven by high incremental flow-through. On the Marketplaces side, segment contribution margin improved by roughly $1.2 million to a negative $0.5 million. Corporate expenses of $6.8 million represented 20% of revenue, down from 23% a year ago. Q2 free cash flow was negative $2.9 million, up 42% compared to a negative $5.1 million in the second quarter of 2017. Our balance sheet remains debt-free. Now to an important administrative note. At the time of the company's rebranding to Leaf Group, the ticker symbol LEAF was not available. So we opted instead for the current LFGR. LEAF has now become available and as such we will seek to make this transition effective on Monday, August 13. Note though that some third-party market data providers might lack in adopting this change. 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 the line of Jason Kreyer of Craig-Hallum.

[Jason Kreyer:]

First I wanted to start it on the Media segment. Obviously, you saw great growth there, particularly on the monetization side. Can you give just a sense of the mix of different monetization message? So I know some of the ads are monetized via AdSense, programmatic, branded content. So can you break that down? And how things have been monetized in the past? And then how you expect that to shift going forward?

[Jantoon Reigersman:]

Sure, Jason. This is Jantoon. Thanks for your question. So I think the short version is, historically, on average, we've been roughly monetizing in the Media side around 40% on the AdSense level. And then there's a breakout between programmatic and direct. As you know, we've only hired our internal sales person, Jay Ku, last year in May. So he's been building up a team to really focus more on the programmatic and the direct side of things. So you will see a shift happening over time, where we will slowly but surely move the remainder of that 60% higher up the (inaudible) to more towards direct. And so historically, we've probably been around 10% on direct level, and I think you can expect that to increase overtime. So it's probably the rough indications that I can give you.

[Jason Kreyer:]

So help me understand how that changes - my understanding is that the acquisition of Well+ Good really supplement the direct capability. So does that change those efforts? Does that accelerate those efforts?

[Jantoon Reigersman:]

Yes, absolutely. So I think Well+ Good is a phenomenal team that is really best-in-class in direct, right? So besides the fact that it's a great brand, fits well with our customer demographic, it's also an absolutely very talented team that has proven to be very, very effective on direct in general. And in order to build a really strong direct desk, that takes time. And so for us the opportunity to get Well+ Good in is obviously very attractive stand-alone, but it also allows us to then use that best-in-class practice and start pushing, for example, a greater effort on direct on Hunker, as an example. But remember, direct always has a lag, right? So that's something that takes time and that's something that you build over many, many years. Well+ Good has been doing this for many, many years already, right? And so it takes time for us to do that. But the long story short, as we definitely have a focus on direct and we'll have a greater emphasis on direct over the next couple of years. Now we're talking about direct, and I also want to highlight the strength of our programmatic desks. So we are absolutely exceptional in programmatic. I think the team has done really well there and continues to do really well there. We have seen very healthy growth in that area. And so really the move of the [indiscernible] in general is something that we're very focused on.

[Jason Kreyer:]

All right. Well, send my congrats to Jake because he has done a great job there. Sticking with Media. We've seen more cross promotion of marketplace products across your Media sites, and I know you've introduced this curated offering. So just wondering if you have any insight into how that's been received? And then if you can give any thoughts on how that changes going forward?

[Sean Moriarty:]

Jason, this is Sean. And we've talked about this on calls in the past. One of the great opportunity for Leaf Group is, given the fact that there's meaningful overlap of the customers that we serve by age, by gender, by education level, by passion and the fact that we're in these categories of fitness and wellness and art and design principally, we've been conducting experiments and tests over the course of the past year, plus on how we can introduce brands to customers even when they may be visiting another property. And if we can do that well, and I expect we will unlock that over the course of the next couple of years, that cross-promotional opportunity is going to drive massive differentiation for Leaf Group as a business, and all of our brands will be beneficiaries. The key to it, though, Jason, is to do it very, very intelligently, meaning we want to make sure if we are speaking to a customer on Hunker about decorating their home, we introduce them to Society6 or Saatchi Art, if it's appropriate based on our knowledge of them, who they are and what they care about. The context that they came to Hunker and then if we can land them under appropriate place on Society6 or Saatchi Art or another one of our properties, so that they truly feel like that was a value-add recommendation on our part. And so while it's early, we're very consistently doing integration to having curators from Saatchi Art or Society6 guest appear on Hunker. And we'll give you more color on that as we go. It's early days, but we're certainly hardened by the progress that we're making.

[Jason Kreyer:]

Thanks for the color, Sean. On Marketplaces, so just trying to get a sense, can you break down at all the results that you saw between Society6 and Deny Designs? I'm trying to understand the transaction volume was a little bit slower this quarter, down year-over-year. So just trying to figure out what the drivers of that would be?

[Sean Moriarty:]

Jason, it's Sean again. So a couple of things. So Q2 is a seasonally softer quarter for these businesses, and we're always focused on maximizing the opportunity, both for the long term, but also recognizing what a particular quarter gives us. And so we really focused on a few key things in Q2, and we got very good results from it. One, we launched 8 new products in the quarter that takes a lot of time and effort to get right, and it takes some time for those products to burn in. Two, as you pointed out, we spent an awful lot of time over the course of the past year integrating Deny Designs and have made great headway. Also, in the quarter, where demand has been softer just seasonally, we focused an awful lot and we've done this in the past on promotional discipline and margin improvement, and that's pretty evident in the results that we delivered. The other thing I should say, we continue to refocus Society6 much deeper in the home decor category, and that's evidenced in the higher AOVs. So the near-term effect of that, it's lesser on the transaction side but higher on the AOV, is delivered. We'll always take more growth, don't get me wrong, but there's no question that we're developing a very focused brand strategy for Society6 and augmenting that with the integration of Deny Designs. So where the quarter came in, it was really consistent to the very specific decisions we made.

[Jantoon Reigersman:]

And the only thing I want to add, and especially as it relates to the transaction levels really focused - the increased focused on what we do direct to consumer. And somewhat it will pull back from, like, third-party marketplace. And so that's really - therefore, you see a translated and really a focus on the gross profit element, right? So remember, I think, overall, we've always been focusing on the Q4 adjusted EBITDA profitability mark. We feel that hitting our profitability mark is really truly important. We also feel that proving a sustainable profitable business across the board is a really important metric towards the streak. And so for us to focus on that is important, and that's an immediate priority. We would also argue that as soon as we hit the profitability mark, I think there's a lot of room to further invest in these young and upcoming brand. And as Sean mentioned earlier in the preamble as well is really that we feel that there's a lot of room for expansion of these brands over the next couple of years in terms of their general awareness. And so a reinvestment further on that level will be important for us. But I think profitability is an important buy-in, as we appeal to a wider investor base illustrate in general.

[Jason Kreyer:]

Thanks. That's a great segue to my last question. Just great cost discipline this quarter. So if you can give any insights into how we should think about operating costs as we go forward from Q2 levels?

[Jantoon Reigersman:]

Sure. So as I mentioned - so I think our real focus is obviously we reiterate our Q4 adjusted EBITDA profitability. And then, obviously, if you look at the historical trend lines, you can imagine that. Then you can think about full year profitabilities into '19. And so as a result, we're really thinking through, a, having a fairly healthy base in terms of our cost as a company. So remember, we are continuously focusing on decreasing our corporate overhead charge as a percentage of revenue, which, again, we've done really healthy this quarter and will continue to do going forward as well as within the respective brand. So long story short, we'll always be very disciplined in terms of our cost. We'll always be very disciplined in terms of our yields across the board, whether that's our investments, whether it's our acquisitions or whether it's our general capital allocation. So I think - does that answer your question?

[Jason Kreyer:]

Yes, that does. That's helpful.

[Operator:]

Your next question comes from the line of Maria Ripps of Canaccord.

[Maria Ripps:]

You had a lot of success with MyPlate app. Could you talk a little bit about what kind of growth in there now? And how significant that is for the overall segment growth?

[Jantoon Reigersman:]

Sure. So thanks for the question, Maria. So I think the app - the MyPlate app, I think what we've said in the past is that it was a significant grower, obviously, that continues to be a really, really healthy grower for us. Remember, though, that I think it's more of an examples to diversification of the revenue, as it is really a driver of the absolute financials for us. It's roughly 1/5 of the revenue for Livestrong. So it's still relatively small. Not enough to break it out, but it's really a healthy grower and it continues to be healthy grower, and it's something that we focus on as a diversification strategy in general. And remember, one of the things we're very focused on in general is really being a leader within our different categories. And then think about monetization second. So we're going to continuously diversify our ways of monetization. The MyPlate app is a good example of that, but it's not necessarily the greatest economic driver. So it's not that the MyPlate app is the main driver for the overall Media growth, if that's what you're focusing on.

[Maria Ripps:]

Great. And any color roughly on what portion of 10-million plus cumulative downloads are currently active users?

[Jantoon Reigersman:]

So I would say probably like 7 million or 8 million out of that. Sorry, so 7% or 8% - so sorry, let me say that again. 7% or 8% of the sort of full downloads. And we have the current downloads that we mentioned were around 11 million or so. So 7% or 8% are daily active users effectively.

[Maria Ripps:]

Great, thank you. And Jantoon, you mentioned that video ads was an area of strength for you this quarter. What is it as a percent of overall inventory? And what kind of CPM premium do you see on those units?

[Jantoon Reigersman:]

So we don't disclose the details around our video because that's - as you can imagine, a lot of competitive intel. But I think that those are very healthy for us, very healthy return metrics, number one. Number two, I think also because we have this very intense-driven audience, our completion rates of video are very attractive. And we're working on progressive ways of actually making sure that video is nicely embedded also in a variety of mobile experience. And so I think we're just very, very much leading in the effort of thinking through how video could be monetized and how video could be really helpful to our advertising partners.

[Sean Moriarty:]

It's certainly very attractive, it's growing nicely for us, and we think there's abundant opportunity, Maria.

[Maria Ripps:]

Great. And last one for me. Any color you could share with us on a relative margin profile for Well+ Good?

[Jantoon Reigersman:]

Yes. So I think overall - so I think - well, let me say this way, I think Well+ Good, what we said in the past is obviously that it's a fast-growing company and it's been profitable since its inception. I think it is direct. And remember that direct runs higher RPVs, but probably slightly lower average margin profile that we have currently. And so over time, you can imagine that what we've always been guiding towards is like a healthy margin for a media business is in the high 30s. And currently, we're running in the low 40s. So over time, you're probably in the high 30s mark long term.

[Operator:]

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

[Jason Helfstein:]

Three, hopefully, quick ones. Were Deny Designs or The Other Art Fair material to the year-over-year changing revenue, number one? Number two, if you took out Art Fair business, in general, how were the KPIs have looked? Obviously, because that's creating the noise in there for the Marketplaces division. And then just lastly, some general comments about your acquisition pipeline for the rest of this year and next year.

[Jantoon Reigersman:]

Sorry, Jason, can you repeat the last question?

[Jason Helfstein:]

Yes, sure. Some general comments about your acquisition pipeline this year and next year.

[Jantoon Reigersman:]

Sure. So let me start with the noise of The Other Art Fair, and as we elaborated a little bit on that earlier. So last year's quarter, we ran 3 fairs, this year quarter, we only ran 1. And in some - in Q1, if you look at the numbers of Q1, it was the reverse. And so in some ways, you should actually look at it, maybe spread it over 6 months and that's probably more like for like. We run - like, on average, if you think about the full year 2017, we ran 7 fairs. In 2018, we'll run 10. And so - that you can also look at up on The Other Art Fair's website. So overall, Saatchi Art without The Other Art Fair grew 40% year-over-year. And so the fact it's only 12% is because it's just the noise of The Other Art Fair. So Saatchi Art was a very healthy grower. So I think that's probably the best way to think about it. The other reason on the Deny Designs piece, Deny really has no noise anymore. So Deny is pretty much fully integrated in S6. So we run the Deny brand for our business-to-business business, and we basically have Deny products on S6 that we sell - as S6 products. So it's fully integrated, and it's really impossible to separate those 2. And so that's also why we've stopped separating those sometime ago. So overall, 40% versus 12% on the Saatchi Group, with Saatchi alone is probably the best way to think about it. To answer your question on the acquisition pipeline, look, I think we have a healthy actionable pipeline. We have that always. We are always seeking good acquisitions. It's hard to find businesses that we really like and fit within our portfolio because we're looking for bootstrapped, founder-led businesses where we really like the teams, and Well+ Good is a great example. Deny Designs was a great example. The Other Art Fair was a great example. So we do feel that we've always an actionable pipeline. The problem is we are very picky buyers, and we feel that we really are very focused on the value creation we can generate, that's number one. Number two is, I also think that we are well set up as a business. So we are really platform at the end of the day. Remember, every time we had a brand, our corporate expense should not need to increase in any shape or form. So on a relative basis, we have a really good opportunity to fully integrate. I think one of the things that is also important, and I think Sean mentioned it also on the preamble, is that Well+ Good is a good example, but back office of Well+ Good is already fully integrated in the business. And it just shows you our ability to acquire and integrate. I think it has evolved very much over the years, and I think we're a very good acquirer. Now having settled that, I also want to be really articulate and say, hey, we're - we are always looking at attractive M&A opportunities, but let's also have a look at Hunker as a good example. It's a homegrown organic platform and brand that we're continuously to build out. So our ability to do both organic growth and accelerate organic growth and be able to do good accretive M&A, our ability to do both is very unique, and we'll continue to pursue both over the next many years.

[Sean Moriarty:]

And Jantoon, one point - one more point on that for Jason. For sure, we're very, very disciplined. And there's a finite number of opportunities for us in any given time. But as we are stronger and better company by the week, by the month, by the quarter, by the year, we are more attractive to the type of companies that we like than we were before, and we're much better equipped to take action and deliver value on the other side. So where we're always going to be very quicky - excuse me, very picky. We're going to be much better positioned from an M&A perspective than we've ever been before. And so I certainly like where we're headed, and it's obviously going to be a very important weapon in our arsenal.

[Operator:]

And that completes the time we have for our question-and-answer session. This concludes today's conference call. Thank you for joining. You may now disconnect.