Leaf Group Ltd.
Q2 2015 Earnings Call Transcript

Published: 6 Aug 2015

[Operator:]

Good day and welcome to the Demand Media Fiscal Second Quarter 2015 Conference Call. Today’s conference is being recorded. I will now turn things over to Mr. David Glaubke. Please go ahead sir.

[David Glaubke:]

Good afternoon, everyone. On behalf of Demand Media, welcome to our second quarter 2015 conference call. You can find our related release along with supplemental materials posted on the Investor Relations section of our corporate website located at ir.demandmedia.com. On the call with me today are Sean Moriarty, our Chief Executive Officer, and Rachel Glaser, our Chief Financial Officer. Following the Safe Harbor statement that I will make, Sean will update you on our business and then, Rachel will provide details on our second quarter financial performance and key operating metrics. Following the prepared remarks, we will open up the lines for Q&A. Before we get started, we need to make the following Safe Harbor statement. We’d 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 and planned investments 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’d like to point out that during this 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. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in the financial tables included at the end of our press release. Lastly, before we begin, I’d like to remind everyone that today’s conference call is being recorded and it is also available via webcast on the Internet through the Investor Relations section of our corporate website. A replay will be available on our website. With that, I will now turn our call over to Sean Moriarty, our CEO.

[Sean Moriarty:]

Thanks David. Good afternoon and thank you all for joining us for our second quarter earnings conference. At Demand, we build platforms across our media and marketplace properties to enable communities of creators to reach passionate audiences in large and growing lifestyle categories. We’re helping advertisers find innovative ways to engage with their customers. We own a diverse but complimentary portfolio of businesses with varying growth profiles. We will take you through each of these businesses today and discuss the progress we have in our turnaround of eHow Next, we will our long term philosophy as we position Demand Media for growth and profitability. Lastly, Rachel will take us through the financials. First up, content and media. Livestrong which contributed 11% of the company’s total revenue in Q2 achieved an all time for the second quarter traffic dating back to 2011 with total visits of 42% year-over-year. The Livestrong apps MyPlate for Calorie tracking, MyQuit for smoking cessation and MyWater for tracking water consumption are seeing strong engagement with monthly average users up 30% year-over-year. In the first half of the year, calorie tracker users logged almost 8 million workouts, up approximately 40% year-over-year and nearly 68 million food items up 11% year-over-year. Although the increased traffic on Livestrong has not yet translated to increased revenue to the declining ad monetization yields, we expect this strong momentum in traffic and user engagement will lead to future revenue growth as mobile monetization catches up and we develop new advertising offerings such as native or sponsored content. Moving onto Cracked which is one of the most loved brands in the humor category. In Q2, Cracked generated 10% of the company’s revenue. The CollegeHumor/Cracked Network was the number one Humor property in June, comScore. It has maintained this leading position throughout 2015. The Cracked side has always had a strong and loyal core audience and the team has responded well to recent changes in audience behavior with mobile now contributing more than 50% of visits and investments in video content this year beginning to pay off. Video views on YouTube, Facebook, and the Cracked site itself were up more than 75% year-over-year as the team builds out series like Honest Ads and Internet Party and launches new series such as the Stumbling Dead. Cracked has also seen success resurfacing content relevant to trending events. For example, the team reposted a 30 second guide to how the [Indiscernible] ruling affects you after the Supreme Court ruling on June 26th. Subsequently Crack saw over 3 million visits that we get. On the commercial side, Cracked has created a very successful native [ph] advertising campaign for secret, Procter & Gamble’s deodorant brand which had more than 680,000 on the site and strong engagement with more than 1,300 comments. The team’s native advertising campaign for Hulu was also well received by Crack’s audience and I am very encouraged by the team’s ability to successfully introduce new advertising products without compromising the user experience. Now let’s discuss our Content Solutions business StudioD, which has experienced positive year-over-year growth over the last three quarters. In Q2, this business generated 12% of the company’s revenue. StudioD creates custom content for third party brands and agency partners, including several Fortune 1000 brands and publishers as well as our owned and operated sites here at Demand Media. The team is also building a content marketing and publishing platform driven by predictive insights and performance analytics and has made meaningful inroads this quarter, including large deals with brands like Choice Hotels. One of our existing clients Famous Footwear recently reported a 400% ROI on the work we’ve done for them. And Choice Hotel said we are excited to bring Demand Media on as true content partners, not only are they reliable productive organization but they focus on data driven strategy and shows that our investment in them is also an investment in our corporate goals. This speaks to the power of our content marketing services and the potential of this business. Turning now to our Marketplaces business which generated 35% of the company’s total revenue in Q2. Art and Design is a [Indiscernible] growing online category and Society6 and Saatchi Art are well positioned to capitalize. The Marketplaces business is experiencing strong growth, up 59% in Q2 led by Society6. Three products released in Society6 this year,[Indiscernible] leggings and all-over print t-shirts made up more than 8% of total sales in the second quarter and we expect to continue to roll out one to two new products per quarter going forward. Other two designers on Soceity6 have uploaded more than 2.3 million unique images and designs for the site up 45% year-over-year, an indication of the robust creator community we have cultivated. Saatchi Art has also developed an extensive global artist community with over 50,000 artists offering more than 500,000 works of original art available at price points ranging from $100 to $30,000 and the team is now focused on driving demand to meet this supply. Our curators have built personalized collections for buyers across the world from an interior designer updating a hospital in Dubai with 200 prints to a major American Art Collector discovering new artists on the site. Our customer service specialist works with artists and collectors to move original works of art across the U.S. Europe, Latin America and Asia every single day. The combination of a vast selection of high quality art, world class curation, white glove customer support and expert shipping service differentiates Saatchi Art in the online arts space and positions us to disrupt the art and design category over the next several years. I’ll now turn to eHow and discuss our progress. eHow generated 21% of the company’s revenue in the second quarter compared to 46% in Q2, 2014. As such we do not believed eHow should be viewed as the sole proxy for Demand Media’s overall health as this is an incomplete and narrow picture of our business today. However, eHow remains an important business for us and we see real value and investing meaningful in eHow turnaround. We are very excited to welcome a new leader to eHow, Mitchell Pavao. Over the course of his career Mitchell has consistently delivered impressive results through his strong product leadership. As SVP of Product and Technology at Myspace, Mitchell was responsible for the development of core products in the new streaming music service for IOS and Android as well as overseeing strategic partner integrations and site growth. Under his product leadership Myspace saw marked improvements in traffic and revenue growth with traffic increasing more than 400% during his tenure. Prior to Myspace Mitchell also lead product and technology for SpinMedia’s portfolio and prior to that co-founded two successful online media companies PureVolume and Virb. Mitchell is joining us in an optimal time with much of the initial renovation of eHow behind us. The team is now ready to focus on building rich immersive products, showcasing do-it-yourself creators across key categories. While eHow has traditionally provided [Indiscernible] content primarily optimize for search engines. We are now building the site optimize for humans with authentic content and tools with the do-it-yourself community. We are committed to featuring contributors like Kerry Walker and Lucy Elkins on our platform. Kerry recently wrote an eHow article on Flower Arranging that was picked up by House Beautiful. And Lucy’s inspired do-it-yourself IKEA table Hack for eHow was featured on several leading media sites including BuzzFeed and Apartment Therapy. In addition to creating first rate content Kerry and Lucy each of tens of thousands of followers on Pinterest and Instagram. Although traffic of eHow has been declining overall traffic originating from social channels primarily Pinterest has been growing both in absolutely visits and as a percentage of total traffic providing an important example of how we can diversify our traffic sources beyond the search engines. With respect to search engines the announced rollout of Google Panda 4.2 last month was big industry news. Although unlike previous major Panda update and maybe several weeks before we see any meaningful impact on our media sites if any. That said, we’re are in the business of building great products for people not search engines and we will continue to make full progress on this mission in all of our media businesses including eHow without over relying on any single distribution partner or channel. To conclude I certainly want to acknowledge the challenges we are facing at demand right now, in particular eHow’s revenue has decline significantly as we’ve removed duplicative articles and reduced ads significantly to improve the user experience and continues to require additional investment to rebuild. Largely as a result of these investments across our portfolio we have seen a decline in EBITDA on the second quarter. We’re also revising our expectations with respect to cash over the second half of the year as Rachel will discuss in further detail in her remarks. Despite these challenges we’ve great opportunities ahead of us. We have strong lifestyle brands that reach 50 million unique users in the U.S. alone each month and we’ve a strong of leaders with experience to navigate the journey that we know is still ahead of us. Our philosophy remains the same. We are operating our businesses to be high quality product driven properties that we believe can be profitable at scale. We have made substantial progress this year. We streamlined the company for better efficiency, made tough decisions on eHow despite the negative short-term impact and reoriented the company around our creator centric mission. I’m confident by focusing on this mission and operating philosophy we will create long term value for all of our stakeholders including our creators, employees, and shareholders. I’d now like to turn the call over to Rachel for remarks on the financials.

[Rachel Glaser:]

Thank you, Sean. The financial results of Q2 are consistent with what you would expect given the stage we are in with a turnaround of our eHow property and the early stage nature of our marketplaces businesses. Total revenue in Q2 was $29.8 down 31% year-over-year, driven primarily by a 47% declines in the Content & Media business partially offset by a 59% growth in the Marketplaces business. Adjusted EBITDA in Q2 was negative $2.8 million, largely reflecting the impact of revenue declines in the higher margin Content & Media business. Consequently free cash flow was negative $4.6 million for the quarter. More on cash flow in a bit. Let me provide addition color on these results starting with revenue. As we expected, the Content & Media business continue to experience declines down 47% year-over-year to $19.3 million. Since the majority of this decline is associated with the eHow property, my comments will focus primarily on eHow. Perhaps the most illustrative metric for the eHow property is impression volume, which is the product of a number of visits to a site, times the total pages have viewed per visit, times the number of viewable ad unit on each page. Total impressions for eHow were down 71% year-over-year and down 34% versus prior quarter. As we have discussed on prior calls traffic eHow has been significantly impacted by search engine algorithm changes. These algorithm changes have been very punishing often pushing eHow well below the first page of organic search results for how to queries and we estimate that the reduction of traffic eHow as a result of these algorithm changes accounts for 35% of the total Content & Media revenue declines or $6 million. We’ve also seen our traffic and revenue decline as a direct result of decisions that we made ourselves to change the strategic direction of the business and the business model itself. These decisions included the take down of $2.4 million eHow articles and the removal of four ads unit on every eHow desktop page. We estimate that these decisions resulted in a loss of approximately $14 million of annualized revenue in 2015. The article takedown and ad unit reduction together accounts for an estimated 21% of the total Content & Media year-over-year revenue decline in the quarter. Also notable is that our two divested social media businesses Pluck and CoveritLive accounted for another 17% of the Content & Media year-over-year revenue decline in the quarter. Overall, for all Content & Media properties revenue per 1,000 visits was down 40% year-over-year to $21.48. Visits across all Content & Media site in Q2 were about $897 million, down 11% year-over-year. While eHow visits were down approximately 49%, Livestrong visits increased by 42%, mobile visits across all of our Content & Media properties grew roughly 27%. There are several bright spots stuck into Content & Media financials. Our Media sales efforts are strong and continue to grow quarter over quarter. Our team remains lean and nimble developing highly scalable and marketable products which has helped secured and maintained partnerships with large Fortune 500 premium advertisers in the financial and automotive space that are seeking to advertise in our top performing categories. Our revenue from direct and programmatic selling efforts is up 16% quarter over quarter. Combined sell through rate for our direct and programmatic desktop channels increased year-over-year and were sold at a higher CPM as well. In addition, we have made strides in our native display advertisement efforts and our facing 40% ahead of the first half of last year. Our second bright spot is StudioD which generated 12% of the company’s revenue in Q2. A portion of the StudioD’s revenue is generated from content we create for publishers where we sharing the revenue yielded by the pages containing our content. The newer and faster growing revenue stream is custom content that we create for brands such as Choice Hotels as Sean mentioned earlier. Though currently a small portion of our overall Content & Media revenue, this customer content marketing business is growing fast with the year-over-year revenue growth of 44% in the second quarter. Turning now to marketplaces, revenue was up 59% year-over-year to $10.5 million. On a pro forma basis marketplaces revenue was up 40% year-over-year as compared to 32% in Q2, 2014. This growth was primarily due to increased traffic, strong conversion rates, new product introductions and increased average revenue per transaction on Society6, as well as the addition of SaatchiArt to this revenue stream starting in August 2014. Total transactions were over $183,000, a 46% increase year-over-year. Average revenue per transaction was $57.14, up 9% year-over-year primarily due to a shift to higher priced items on Society6 as well as the addition [ph] of SaatchiArt which has significantly higher average revenue per transaction. Turning to consolidated operating expenses, Q2 GAAP operating expenses were $44.3 million, down 8% year-over-year. Excluding depreciation, amortization and stock-based compensation, total operating expenses were $32.7 million, Operating expenses excluding product cost for Society6 were down $2.1 million or 7% year-over-year as we have diligently focused on creating inefficient operating structure for sales, product development and G&A. At the end of Q2 total headcount was 19% lower than it was a year earlier, approximately 40% of which was due to managed reductions in G&A, cost of sales and product while our balance was related to divested businesses net of the Saatchi additions. Specifically service costs were down about 12% year-over-year due to lower payroll and IT cost partially offset by an increase in expenses associated with the effort to enrich content on our eHow property. General and administrative expenses were down nearly 10% year-over-year due to decrease headcount and a decline in audit fees. Headcount and G&A function was approximately 23% lower year-over-year. Product development expenses were approximately 7% lower year-over-year due to headcount reductions as we streamlined our Content & Media operations. Sales and marketing expenses increased approximately 6% year-over-year primarily due to investment in performance marketing for our Marketplaces businesses which is ROI positive in the period for those businesses. This takes us to Q2 cash flow, free cash flow, defined as GAAP cash flow from operations, net of acquisition and realignment payments, capital expenditures and investment in intangible assets was negative $4.6 million in the quarter, reflecting challenges in Content & Media revenue. We had continue to invest in the transformation of our Content & Media businesses despite steep revenue declines and have maintain the necessary resources to allow out team to focus on rebuilding higher quality engaging content and consumer experiences. Our balance sheet remains healthy with $42.3 million of cash and cash equivalent at June 39th and no debt outstanding. On July 17th, we files an 8-K regarding the final payments we made in connection with our acquisition of Society6 which included the issuance of approximately 123,000 shares of common stock and the payment of $7.4 million in cash. Although this brings our current cash balance below the $40 million threshold that Sean has previously discussed we are continuously exploring opportunity to replenish our cash balance which may include negotiating an early repayment of the promissory note we received in connection with the sale of our CoveritLive business. Nonetheless, our cash balance may at time fall below $40 million through the remainder of 2015 depending on the investment needs of our businesses at any given point in time. Management continues to be extremely committed to prudently managing cash without sacrificing strategic investments that we believe promote the growth of our businesses. Switching gears briefly before I can conclude, I’m very pleased to introduce Wendy Voong who joined us this week as Chief Accounting Officer. Wendy spent many years at at Ernst & Young and I’ve had the pleasure of working with her while as a CFO and she was the Senior Manger for that audit engagement. Wendy comes to Demand after spending three years at Activision most recently as the Senior Director of North America Accounting and Reporting Wendy’s experience spans operational accounting as well as compliance and external reporting which makes her uniquely suited for our Chief Accounting role. In closing, the current financials of the company whilst still challenged are marked by very promising signs of growth and recovery in most of our businesses. Our portfolio of assets includes a variety of complimentary properties with loyal audiences and growth potential. It is too simplistic to look at the downward trend of the eHow business and assume that as the proxy for the overall health of the company. In fact, that financial downtrend is not I’m asking eHow’s potential as it turns around but also overshadowing the other elements of our business that are blossoming on their own trajectory. So stay tuned as we continue on this journey. This concludes our prepared remarks. Operator, please open the line for Q&A at this time.

[Operator:]

Thank you. [Operator Instructions]. Our first question will come from Brian Fitzgerald with Jefferies.

[Unidentified Analyst:]

Hey guys, thanks. This is Sachin [ph] sitting in for Brian. First question, couple of questions here. And the first is can you give us a sense of maybe the profitability split between media and the Marketplaces business and so at what point of scale in the Marketplace businesses can you start to see Marketplace give – contribute a maybe a greater share of profitability to [Indiscernible]. And then the second question is to the extent possible can you guys discuss the post article related to the sale of the Content businesses? Thanks.

[Rachel Glaser:]

Hey Sachin, its Rachel. So I’ll take the first one of those and then Sean will answer the second one. You know we don’t disclose any profitability for our two revenue categories. Clearly the Content Media businesses have a higher margin than the Marketplaces businesses that the Marketplaces businesses you know do have healthy profit margins as well. We think that we’re starting to see scale already in Soceity6 as we’ve gotten more vendors to come online and consolidate those vendors so that we are able to negotiate better pricing for the product that support those businesses. I mean as they grow I think you’ll start to see some healthy profit flow off of that business as well.

[Sean Moriarty:]

And the second question was on the New York post article I believe early last week. Like any portfolio company we get unsolicited offers or indications of interest for our businesses frequently. That said, we believe in the growth prospects of our businesses and any conversation that we would have subsequent to inbound interest would have to be from a creditable party and evaluation that would reflect this. At this time none of our businesses are actively being shunned.

[Unidentified Analyst:]

Okay. Great. Thanks a lot.

[Operator:]

[Operator Instructions] and we’ll move to Sameet Sinha with B. Riley and Company.

[Unidentified Analyst:]

Hi, this is Zac [ph] sitting in for Sameet. First question I had to ask you is can you help us think about the content distribution strategy, could you just distribute to other domains, partners or even social platform such as Facebook or Twitter.

[Sean Moriarty:]

It’s a great question. With Studio, these content channels we effectively do that, where we are creating content for publishers, who have a brand that has substantial distribution reaching it in of itself. You know with our existing O&Os [ph] you know our primary method of distribution has been audience aggregated by search, but as we talk about earlier that’s changing, right. A healthy media business has diversity of traffic across all channels. And you see some of that change evident in the growth of interest as a channel for eHow, but we are nowhere close to where we need to be and where we ultimately will be with building out multiple healthy and strong distribution channels beyond search. Quite frankly the single greatest contributor to that opportunity is the quality of the product and the content that you have and so we’re focused on product experience and quality of content over anything else. At the same time, we are constantly looking at the distribution channels that exist today whether they are social channels or channels that’s been around forever that quite frankly we can do a lot more work with which is emailed but engagement independent of distribution channels is always a consequence of the quality of the product and the quality of your content.

[Unidentified Analyst:]

Okay. Thank you. And one other question from me, many internet companies seem to be giving up on premium display at sales due to headwinds created by real time bidding. What are your thoughts on this?

[Sean Moriarty:]

Yeah, you know I think that – so there is no question that the move to programmatic and real time bidding is very real and programmatic execution will be the majority of execution driven substantially but not completely by real time bidding as we go forward and many traditional advertisers and publishers move in that direction, I feel very good about the fact this company was a pioneer in moving to programmatic early. That said, premium advertisers are also always going to want to premium audiences and they are going to what premium audiences in the context of ad units that really reflect that premium experience that are well integrated and that result in a better user experience. So I don’t think that goes away completely from a massive percentage basis you are going to see that shift, but ultimately premium products will always command premium dollars from premium advertising, so I don’t think that completely goes away.

[Unidentified Analyst:]

All right. Thank you.

[Operator:]

[Operator Instructions] There are no further questions for today. So that does conclude today’s conference. We thank you all for your participation.