Leaf Group Ltd.
Q3 2018 Earnings Call Transcript

Published: 7 Nov 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 Third 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 am 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, Shawn, and thank you, everyone, for joining us this afternoon. We appreciate the opportunity to share our third quarter results. Our CFO, Jantoon Reigersman, will follow with more details on our financials. Q3 marks an important milestone for Leaf Group as we returned to profitability on an adjusted EBITDA basis underscoring our business transformation, setting the stage for driving strong sustainable revenue growth, and significant operating leverage. We see a long runway for revenue growth and diversification as we offer unique high-quality products and services to our overall audience which reaches nearly one-fifth of the U.S. Internet population. In Q3, Leaf Group delivered 24% top-line growth with revenue of $41.5 million driven by 53% growth in Media and 10% growth in marketplaces. We also delivered significant margin improvement with a positive adjusted EBITDA of $0.1 million, a $2 million improvement year-over-year. Our Media segment delivered significant top-line growth and strong operating contribution in Q3. At the same time, we made significant progress integrating Well+Good’s direct sales across Livestrong and other premium sites. This is reflected in our Q3 revenue per visit, which increased 62% year-over-year, primarily driven by our growing direct relationships with advertisers including Starbucks, Reebok and Jade Sapphire. To further leverage our strengthening Media brands, in October we added Michele Calhoun in our Media Group. Michele has deep experience working with top-tier brands and agencies in a multitude of categories including recently serving as Vice President, Head of North American sales at Flipboard. Prior to Flipboard, she held multiple titles at WebMD, as well as roles at IAC and CBS. Over the past few months, with Alexia Brue taking over management of Livestrong in addition to Well+Good, we focused on refining Livestrong’s brand within the growing fitness and wellness category. As a result, we further reduced our library of Livestrong from 80,000 to 55,000 articles, primarily eliminating off-topic content. We will plan for some time, we accelerated this effort in the quarter, because on August 1, Google released a search engine update that negatively impacted the volume of referral traffic to many health-related sites including Livestrong. The update, together with the content removal adversely impacted traffic at Livestrong. Based on our experience, we believe that the types of improvements we are making to Livestrong will fundamentally enhance the audience engagement and brand value and expand the opportunities for monetization. In recent weeks, we are already seeing traffic gains from our actions at Livestrong and continue to see healthy growth at Well+Good. We believe the combination of content quality, audience reach and a best-in-class direct sales organization position our brands well in the rapidly growing fitness and wellness category. Additionally, in our Art and Design category, Hunker continued to gain traction with 9 million unique monthly visits in September 2018 making it the third largest individual digital home site as measured by Comscore. In Q3, Hunker worked with top-tier brands such as Miley and Blue Dart that were attracted to Hunker’s audience and growing reach in our key millennial female demographic. Additionally, Hunker partnered with Urban Outfitters Home developing a co-branded sweepstakes in custom content showcasing Urban Outfitter’s bedding collections, furnishings and accessories. Hunker continues to perform exceptionally well in social media, especially on Instagram with over four times the level of engagement compared to other sites in the category. On the Marketplaces front, our efforts to focus on disciplined promotions at Society continue to fuel significant gross margin improvements, with overall Marketplaces gross profit up 15% year-over-year in Q2. As margin expand, Society6 continues to move further into the rapidly growing online home décor market with the introduction of a new line of furniture in mid-September including coffee tables, side tables, bar stools, and credenzas. Thus far in 2018, we’ve been able to make significant progress in improving margins at Society6 while at the same time driving solid growth in our core U.S. market which grew high-teens in direct-to-consumer sales offset by a year-over-year decline in our international business. At Society6, our focus has been on brand and business building for the U.S. market. Currently, European customers order from our dot com site facing elevated shipping fees, longer delivery times and currency volatility related to the U.S. Despite these limitations, during the quarter, close to 20% of Society6 GTV was from outside the U.S. which speaks to the global residence of the S6 brand and points to a significant opportunity for international revenue growth. With this in mind, in 2019, we will rollout sites with local language, payment support and will provide the level of service that we offer in the U.S. We believe that with increased operational focus and localization of a platform, we will drive revenue growth in international markets. We will share further details regarding our European strategy as we get into fiscal year 2019. Saatchi Art group consisting of Saatchi Art and The Other Art Fair was up 49% in Q3, with three successful fairs hosted by The Other Art Fair, compared to one fair in the same period a year ago. We continue to see significant long-term opportunity as sales of Original Art continues to migrate online. In August, Saatchi Art expanded into the secondary art market with the launch of its retail service. Collectors will now be able to make offers and works that have been previously sold through Saatchi Art. Overall, we are very pleased with the company’s in reaching adjusted EBITDA profitability one quarter ahead of expectations while exceeding our 20% revenue growth target. We are excited for the holiday period and expect strong sustainable growth in full year adjusted EBITDA profitability in 2019. Prior to turning the call over to Jantoon for the financials, I’d like to highlight a tremendous service Vic Parker has provided to the company as a member of our Board of Directors for over a decade. As he steps off the board, we are thankful and proud to acknowledge his time with us. Vic has been a stalwart supporter of the company and valuable advisor and mentor to me personally and we are very grateful for his time and counsel. Jantoon will now provide more details on the company's financial performance.

[Jantoon Reigersman:]

Thank you, Sean. I appreciate this opportunity to share our third quarter financial results. At a high-level, total revenue for the quarter was $41.5 million, up 24% year-over-year, driven by 53% year-over-year growth in our Media segment and 10% year-over-year growth in our Marketplaces segment. Adjusted EBITDA was $0.1 million in Q3, a $2 million improvement versus the prior year period. Free cash flow was $0.9 million, ending the quarter with a cash balance of $32.8 million. Q3 Media revenue was $16.7 million, up 53% year-over-year from $11 million previously. Media revenue growth was driven by the addition of Well+Good, which we acquired on June 5th and further monetization gains across our Media properties. Total visits to our Media properties in Q3 were $665 million, down 6% versus prior year, as growth in premium sites such as Hunker and Well+Good was offset by reductions in Livestrong’s traffic attributable to the August 1, Google Search Engine update and significant reductions in our content library. Revenue per visit or RPV for our Media properties was $25.17 for Q3, up $9.61 or 62% versus the prior year, driven by the addition of a full quarter of Well+Good results and reflecting the strength in video and programmatic, as well as improving monetization across our Media assets. Q3 Marketplace’s segment revenue was $24.7 million, up 10% year-over-year. This growth was driven by a 7% year-over-year increase at Society6 group and 49% growth for the Saatchi Art Group. Marketplace’s gross transaction value increased 8% year-over-year to $30.2 million. Transactions were down 2% 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. By engaging in sales with customers directly, as opposed to through third-party Marketplaces, we established long-term customer relationships. In Q3, Society6 group drove solid growth in the U.S., with direct-to-consumer revenue up in the high-teens, while international revenue declined versus the prior year. In our International markets, healthy growth in Canada and Australia were offset by declines in our European business. As Sean mentioned previously, we have not focused on our international business and we believe that with the right operational support, there is a significant opportunity to improve global sales of Society6 over the next several years. At Society6 Group, we continued to focus on lifting AOV through continued promotional discipline and adding higher price point products. In Q3, AOV for Society6 Group increased 8% year-over-year helping drive 12% year-over-year growth in gross profit. We will continue to focus on promotional discipline and gross profit growth in Q4 setting the stage for more balanced growth and profitability into full year 2019. Saatchi Art Group also had a strong quarter with revenue up 49% year-over-year in Q3, primarily driven by the increased numbers of fairs. Our quarterly adjusted EBITDA improved to a positive 0.1mln driven by solid growth in Media segment contribution margin and improved leverage in Marketplaces. Q3 Media segment contribution margin increased 37% year-over-year to $6.6 million or 39.2% of Media revenue. On the Marketplace’s s side, segment contribution was positive $0.3 million a $0.7 million improvement from a loss of negative $0.4 million. Corporate expense of $6.8 million represented 16% of revenue, down from 19% in Q3, 2017. Q3 free cash flow was 0.9 million, up over $2 million, compared to a negative of $1.3 million in the third quarter of 2017. At the end of the quarter, 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. Having reached adjusted EBITDA profitability one quarter ahead of expectations, we are starting to reinvest our flowthrough to further expand our young brands. We expect to be adjusted EBITDA profitable on a full year basis in 2019, 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 Maria Ripps of Canaccord. Please go ahead.

[Maria Ripps:]

Good afternoon and thank you for taking my question. It’s great to see progress on profitability side. How should we think about balancing profitability and investment beyond this year? I guess, what are some areas that you think you can – where you concern more next year to accelerate growth beyond localization of sites like you mentioned?

[Sean Moriarty:]

Thanks, Maria. This is Sean. There is a few areas of focus. We called out, one was Society6 on the call around international focus which has been a secondary focus for us until recently. You will see us push deeper into the European markets where we know there is tremendous upside for the Society6 business. One thing to keep in mind, actually, while we will make some incremental investment there, it’s actually relatively it’s much more of our operational focus on the region than it is significant capital outlay. We are going to continue to cultivate Hunker as a brand. We think it has enormous opportunity. It’s growing very, very nicely. Only 18 months into its existence and certainly the Media properties overall continuing to develop extremely high-quality content that keeps consumers coming back is a priority for us. But overall, we feel like, we’ve got the right balance where we can drive quality, we can drive growth and we can also – while we are doing that, have an improving profitability picture.

[Maria Ripps:]

Got it. Thank you, Sean. And maybe, can you talk about your strategy around shipping? To what extent can free shipping drive volume? And what are some trade-offs between offering product discounts versus free shipping?

[Sean Moriarty:]

Sure. Certainly, if you look at Marketplace commerce or retail e-commerce promotions amount and I think the key for us and something we’ve been working on over the course of the past year-and-a-half is, intelligent promotional discipline, which is how do we make sure that we are providing a compelling opportunity for consumers, particularly first time consumers to come and buy something from a Society6 or Saatchi Art or Deny in a world of washing promotions, we know that it’s something you can’t ignore completely, but you need to be very disciplined in that approach. Free shipping is something that consumers do expect from time-to-time. We are increasingly judicious about when and how we offer that. There is no question it will spike your new customer acquisition, but there is also no question, it puts an awful lot of margin pressure on the business and we want to provide consumers a compelling reason to buy from us beyond just promotions. And so, what you will see, you are already seeing it flow through the margin improvements at Society6, are substantially a consequence of putting this promotional discipline into practice. And over time, you will see those promotions become much more granular and targeted. So we will be looking at promotions. We are already looking at promotions, for example, like product sites. We are looking at promotions based on where a customer is in their life cycle with us if they’ve only purchased one type of products for us perhaps we offer a promotion against a new product that we think is going to match very well with what they are interested in. And so it really is this blend of art and science that’s ever evolving. That said, we’ve made an awful lot of progress over the course of the past 18 months in making sure that we are becoming more intelligent and we are not just kind of chasing that promotional calendar to the point of diminishing returns. I think that’s true really of every online retailer. The key is, to have a brand that matters, products that are highly differentiated, and use promotions intelligently and judiciously, to get that first time customer over the finish-line or you increase the frequency of purchase with your existing customers, but not to the point where you’d be diluting your brands or constraining your margins.

[Jantoon Reigersman:]

And then, maybe one thing to add is just to give you some home expenses. We’ve been obviously very disciplined and while we are been disciplined, obviously Marketplace’s gross profit has been up 15% year-over-year. So, it’s really developing actions Sean was talking about.

[Maria Ripps:]

Thanks a lot. That’s very helpful.

[Operator:]

Your next question comes from the line of Jason Kreyer of Craig-Hallum. Please go ahead.

[Jason Kreyer:]

Good afternoon, gentlemen and congratulations on hitting the EBITDA profitability, especially a quarter ahead of you had targeted. Two questions from me on the Media business. So, just wondering, obviously there was a little bit of headwind from Livestrong there, but can you maybe run through some of the puts and takes on the individual properties? And then the second question, just on Well+Good, if you do like a five or six months look back there, since you made the acquisition, what have they contributed to that business thus far? And then, what incremental contributions do you expect forthcoming?

[Sean Moriarty:]

Sure. So, let’s first think about some of the puts and takes that you are talking about. So I think our Media business is very diversified by now, right. So, with Livestrong, Well+Good, with Hunker, so, we have a variety of very good strong brands. As you can imagine, we’ve been speaking about moving up the up stack for quite some time and there is a lot of opportunity for us to continue to move up that up stack. So, the strength that you see in RPV numbers and our preview is obviously a good metric to understand how we are moving up that up stack shows you also the importance of the Well+Good integration. So, as Sean mentioned on the call earlier, we’ve now fully integrated our sales team and the sales team that historically was a Well+Good sales team is selling direct across a variety of brands, right, including Honkers. And so, those are really hard for us to separate any or dining versus getting growth here. It’s really one big Media team in many shapes and forms. And so, Well+Good’s best-in-class sales efforts and the relationships they’ve been able to build are now really blending to see to allow us to move some of the other brands also up stack. So, I think it’s a combination of both Well+Good’s strength and that was been able to give up in terms of what they were really good at which is direct sales as well as the strength of the individual brands like a brand of Hunker that has a lot of opportunity to grow up stack.

[Jason Kreyer:]

That’s helpful. Thank you. Wanted to touch on the moves that we talked about a quarter ago where you kind of deemphasized some of the third-party traffic for the Marketplace segment. Can you kind of walk through at all, what kind of an impact that had on Q3? I am just trying to break down that impact on the Marketplace business versus some of the international slowdown?

[Sean Moriarty:]

Sure, as we mentioned on the last call, Jason, we’ve pulled back from third-party Marketplaces. We believe there is an intelligent way to play and participate in those Marketplaces. But we felt that what we were seeing is kind of a really broad based effort from a standpoint of design and product assortment that we were getting a kind of lower value customer that we like. And we weren’t getting, you don’t get the same opportunity to market and build the customer relationship and we said, it makes sense for us to take the next few quarters retrench and then go back into those third-party marketplaces with a more focused plan after some reflection. So, from a transactional volume perspective, when you look at – again in a business where the U.S., Australia, and Canada are actually growing very, very nicely for us in that high-teens range. Most of that transaction pullback has been a consequence of that third-party pullback that I talked about. We also getting then – international also contributes a bit to that as well, again, mostly to Europe. Some of that – again, it’s hard to pin down exactly. But we think it’s Brexit-related and then, when you get into the non-English European markets, the fact that we have not yet localized certainly over time is going to be a headwind. Again, that’s something we are going to address in 2019 in a big way. So, we feel really confident that, as we get into 2019 the combination of the localization efforts and the reentrance in a much more focused way in the third-party marketplaces, you will see that reflected in transaction volume again.

[Jantoon Reigersman:]

And I think the one piece to add is, on the third-party marketplace this really means, so we’ve effectively dropped this from high-single-digits to low-single-digits year-over-year and remember also, the next couple of quarters, effectively through Q2, we will anniversary that strategy to work. So, just keep that in mind as you look forward.

[Jason Kreyer:]

Okay. last one from me, just sticking with the Marketplace business, so, it seems from my end that you’ve largely completed the integration between Society6 and Deny Designs, you’ve really brought the products across both platforms. Just wondering what you’ve seen in those few months and stores have been integrated, like, what benefits do you get? And how that’s operational integration is complete? And then, what kind of purchasing patterns you’ve seen on that new product you’ve introduced?

[Sean Moriarty:]

Sure, let me take the first part of the question. I think, when you look at the Society6 now post Deny integration from a consumer perspective, it’s a much richer broader offering for the consumer, right, when you think about over 70 products now getting even deeper into the home décor category. So, I think the brand resonates more and speaks even more to the consumer base we have. Also keep in mind that the new products we offer, again deeper in the home décor category, also appear in search results. So, we are also bringing a whole new audience to Society6 on the basis of what they might be looking for from a products perspective and we think over time, given the diversity of designs and the quality of products, that’s going to have really strong effects with respect to audience relevance and breadth. And so, we are really excited about that. Also, we’ve talked in the past about B2B both from a Society6 perspective before the Deny acquisition and then after and we’ve got much more depth when we are talking on the business-to-business side with a full complement of products. We didn’t have - neither company actually had before and that even broader artist community. And both of those are paying dividends. From standpoint of operational focus, now that these businesses are fully integrated, it’s just about going out to market and gathering the upside that the combination represents.

[Jason Kreyer:]

Okay. Great. Thanks for your time guys.

[Sean Moriarty:]

Thank you.

[Operator:]

And our final question comes from the line of Tom Champion of Cowen. Please go ahead.

[Tom Champion:]

Hi guys. Good afternoon. As you think about monetizing your 55 million odd unique, are there any categories of Media content or e-commerce that look like logical adjacencies? This seems like a particularly relevant topic given you hit your EBITDA target early and Hunker seems to be gaining scale. Just curious your thoughts on that.

[Sean Moriarty:]

Yes, Tom, this is Sean. Our whole focus is to build these digital first brands and high passion categories and right now, those categories’ focus are Art and Design and Fitness and Wellness. To your point, we have a really strong Media platform, everything from publishing to content management to the quality of writers and editors we have on the platform and an outstanding full stack monetization team from everything from the algorithmic and programmatic stuff, all the way to premium brand sales. And so, I think the opportunity for us to expand into other categories of passion is there. But I think that, the key for us always is to be disciplined and to see if the next best opportunity for us is to go even deeper in an existing category either with a new brand or further investment in an existing brand or actually to move into an adjacent category also of passion. And again, one of the things we are learning every day at these groups, is the interests and desires and focus of this millennial to Gen X substantially female consumer who is educated, who is affluent and has a bias towards actions on all the things she cares about. And I think, with that, if we are true to understanding our own customers well, and what they also would like from Leaf Group and we left back drive our decision as opposed to overthinking what we are not yet in this category and maybe we should go there. We need to make sure that we are great stewards of capital and we invest in those business opportunities that put us further down the path overall as opposed to saying, gosh, we like this category and maybe we will jump into it. And so, you will always see that discipline from us and that will guide what we do. But broader, when I think a bit more broadly out three to five years, there is no question if we execute well in our categories of focus today, that it will be a natural extension of our business to enter these adjacent categories as well. But we want to make darn sure we are doing that from a position of overall strength and we’ve got a lot of room to grow in the categories we are already in. We have begun to scratch the surface of opportunity that’s there.

[Tom Champion:]

Got it. Okay. Thanks a lot guys.

[Operator:]

And that concludes the Q3 2018 Leaf Group Earnings Call. Thank you for joining.