Leaf Group Ltd.
Q3 2015 Earnings Call Transcript

Published: 6 Nov 2015

[Operator:]

Good day and welcome to the Demand Media Fiscal Third Quarter 2015 Conference Call. Today’s call is being recorded and at this time I would like to turn the call over to Jeff Misthal, SVP of Finance and Investor Relations. Please go ahead sir.

[Jeff Misthal:]

Good afternoon, everyone. On behalf of Demand Media, welcome to our third 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 is 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. After 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 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 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 would 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 would like to remind everyone that today’s conference call is being recorded and that it is also available via webcast on the Internet 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 Sean Moriarty, our CEO.

[Sean Moriarty:]

Thanks Jeff. Good afternoon and thank you all for joining us for our third quarter earnings call. Our mission at Demand is to build platforms to enables communities and 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, several of which are growing nicely and a few that we are stabilizing for future growth. Today we’ll discuss our significant accomplishments in Q3 and the work-in-progress to give you a better sense of what is ahead. Over the next year our focus is on building the products and services that consumers and advertisers want, need and value, in order to grow audience and generate profitable revenue for all our businesses. I’ll start with our market place businesses, which had another strong quarter giving us great momentum heading into the holiday season. Revenue increased 63% in Q3 versus the prior year. As growth continues to accelerate, we expect market places revenue to become comparable to content and media revenue over the next year. The Q3 results for our market place businesses were driven largely by Society6, which saw higher traffic, conversion rates and average order values, due in part to a well expected back to school campaign. Society6 had a live presence on 10 of the largest college campuses in the country, including UCLA, Ohio State and University of Texas. In addition, we had significant media campaigns at another 40 schools. The Society6 brand was prominent at campus welcome fairs, student stores and campus newspapers. The Society6 product lineup is very strong in tech accessories to core and apparel, all well alighted with the needs of a student headed to college. Society6 introduced two new products in Q3 with successfully launches of laptop sleeves and iPhone 6s cases. Society6 currency has 2.5 million unique designs from artists, up 53% year-over-year and 25 different physical products. Quality product is an important differentiator for this business and we are focused on selecting best-in-class vendors who partner with us to fulfill our expanding product assortment. With vendor consolidation and increased volumes, we are starting to create scale in this business. As testimony to the confidence we have in our vendor partnerships, our iPhone 6s cases were available for presale on the day the phones were announced by Apple were ready to ship on the day the phones were released. Saatchi Art also made good progress in the third quarter with revenues up 8% sequentially versus Q2. Saatchi Art is generating strong growth in the supply side, and now is more than 60,000 artists selling original art work in the platform, valued at over $1.25 billion at retail. To drive demand for this incredible supply, Saatchi Art designed and produced a catalog that shipped to over 100,000 U.S. households in October. Early indications are that the catalog is at a positive impact with more visits to the site, higher demands for our unique art advisory service and increased gross transaction value since the catalog was mailed. On the Content & Media side, studioD demonstrated meaningful growth in the third quarter with revenue increasing 43% year-over-year. Leveraging Demand Media’s creator and publishing platform, studioD offers a wide range of content solutions in a fast growing content marketing space. studioD continues to create high quality content for some of the world’s larges brands. Renewal rates for these content customers are approximately 70% and many of them are transitioning to monthly recurring contracts with increased total contract value. Turning to Cracked, which saw our revenue grow 11% year-over-year in Q3. Cracked has a loyal and passionate audience with over half of its visitors navigating directly to the site and another 34% coming from social media sources. Cracked has been a leader in premium content creation at Demand Media with an editorial team devoted to producing superior content in all formats, particularly video. In September Cracked videos were viewed over 16 million times across YouTube and Facebook, including 13.5 million views on YouTube. Cracked’s YouTube subscriber base continues to grow, up 54% year-over-year, reaching nearly 900,000 subscribers, while its personal experience series is also hitting new engagement highs. This quarter Cracked editor Robert Evans travelled to interview Syrian war refugees and authored a brilliant article striking an extraordinary balance of insight, levity and empathy. We are exciting about these growing businesses and we will continue to invest in them to unlock greater value and accelerate future growth. We are equally pleased with our efforts in Q3 to stabilize and revitalize eHow and Livestrong. During the first phase of our transformation, we removed millions of duplicative low quality articles from eHow and Livestrong. As we enter the second phase we are focused on creating content experiences from sources with authority and credibility that are differentiated by their quality and depth, not volume. At eHow rather than investing heavily on renovating older articles, we are focused on top content creators and influencers who bring with them the authority, credibility and following to grow audiences and engagement organically. For an example of this new type of content have a look at How to Build a Tufted Ottoman Coffee by Sarah Dorsey and you will get an immediate sense of the quality, depth and authority in this article versus those produced under our former model. This article features infinite scroll, a detailed shopping list and 14 complete steps, each with a photograph or illustration. This is content we are proud of and is consistent with what consumers should expect from us going forward. eHow’s recent content creation efforts also include original view production. In Q3 one of eHow’s DIY videos had over 3.3 million views and was shared over 135,000 times. Best of all, this performance was entirely organic. We did not pay one cent or dime for promotion. eHow is making great strides in product and user experience and in Q3 shifted to a single page layout mobile. The layout creates better user flow and we’ve seen a healthy lift in RPV. The same emphasis on content quality and authority prevails in Livestrong. Livestrong already has a large and engaged audience with over 50 million visits on average per month. Now Livestrong’s priority is improving user experience by developing fresh and engaging content as we get closer to our seasonal peak for visits in Q1. In Q3 Livestrong welcomed Kayla Itsines to the platform. Kayla is an Instagram fitness sensation with more than 3 million followers and she will be contributing blog posts, workouts and Pinterest pins to Livestrong. The Livestrong team is also investing in new conditions centers, article guides focused on common medical conditions that are written by leading medical experts. The first seven condition centers were launched in the third quarter, and another 28 condition centers will roll out by the first half of 2016. The Fibromyalgia Center for example was offered by Dr. Nancy Baxi, a board certified internal medicine physician with nearly two decades of experience. And the Sleep Apnea Center was written by Dr. Eric Kezirian, an international leader in the Surgical Treatment of Sleep Apnea, currently teaching at the Keck School of Medicine at USC. Livestrong is also enriching premium content on its tracker app, launching a new workout feature in Q3 on the iOS platform that 70,000 members have already tried. In addition, Livestrong added a robust community experience to its tracker app on the android platform, garnering 85,000 new downloads since June. Our final example of our commitment to producing authoritative content is our recent acquisition of LEAFtv. We are very excited to welcome Geri Hirsch and Erin Falconer, founders of LEAFtv to our team. LEAFtv features high quality how-to videos in the categories of stylish living, food and fashion. The team has created an incredibly appealing and distinct lifestyle brands, focused on millennial women. Even as we have made consistent improvements to our products, we have become a much linear and more efficient company. Rachel will review the financial impact of our efforts, but let me briefly outline what we’ve accomplished. First, the eHow team added talented leaders in the product and content areas, while reducing the overall size of the organization. Last quarter we introduced Mitchell Pavao as our new General Manager for eHow. Since then he has brought on two strong leaders, Brett Woitunski to lead products and [indiscernible] to lead content. Second, we have consolidated two remote offices into our corporate headquarters in Santa Monica, resulting in a reduction in headcount and the early termination of two leases without breakup costs. Third, we added leadership talent to our media sales team. We are very pleased to welcome Daniel Bornstein as Senior Vice President of our Platform Revenue growth, responsible for all media sales. Demand Media is recognized as a pioneer in the Programmatic Ad Sales model and that model has been the backbone of our Content & Media monetization for nearly two years. While Programmatic will remain an integral part of our ad stack, we also see significant opportunity to improve branded sales, particularly as more advertisers are gravitating towards main and sponsored ad placements. We are making appropriate investments in our sales organization to capitalize in these opportunities. Fourth, we’ve consolidated technology platforms and data centers driving significant savings and providing increased stability, efficiency and security. Finally, we continue to simply our portfolio by eliminating non-core web properties from our demand and vertical network. During the quarter we sold several of these small sites, including GolfLink and Arcade Town. I’ve been at Demand Media for four quarters now. During this time there’s been sustained and rapid growth in our market place businesses and we have worked hard to stabilize our content and media properties, particularly EL. The most difficult and costly work is substantially behind us and we are now building from a stable foundation. We will deliver major improvements to the user experience across our properties over the next year, putting us on a path for growth. I am optimistic that the next phase of this journey will bring tangible, measurable results that will validate our investment decisions and transformation roadmap. Thank you for your continued interest in our story. I’ll now turn the call over to Rachel for prepared remarks regarding the financials.

[Rachel Glaser:]

Thank you, Sean. As Sean discussed, we are very pleased with the growth in the four key businesses Society6, SaatchiArt, Cracked and studioD and while the financials of our other businesses are not yet in positive growth territory, we are excited about the direction they are heading and the promise of future yield. Total revenue in Q3 was $28.5 million, down 31% year-over-year, marked by a 63% growth in the Marketplaces businesses, offset by a 53% decline in the Content & Media business, in line with our expectations. It is worth noting that the sequential decline in Content & Media is down 4% versus Q2, while Q2 revenue is down 7% versus Q1. So the decline is decelerating and we are cautiously optimistic about what is ahead. Adjusted EBITDA in Q3 was negative $3.6 million, largely reflecting the impact of revenue declines in the higher margin Content & Media business. Free cash flow was negative $3.1 million for the quarter. Let me dive a little deeper on our revenue, focusing first on two of our growth areas, marketplaces and studioD. Marketplaces revenue was up 63% year-over-year to $12.6 million. Both Society6 and SaatchiArt increased traffic improved conversion rates and grew average order value. Total transactions were approximately $204,000, a 42% increase year-over-year. Average revenue per transaction was $61.95, up 14% year-over-year, primarily due to a shift to higher priced items on Society6, as well as the acquisition of SaatchiArt in August of last year, which has significantly higher average revenue per transaction. studioD generated 13% of the company’s revenue in Q3. studioD’s business performance is characterized by triple digit increases in customer hedges, increasing win rates, newer rates currently over 70% and a transition to recurring monthly revenue streams that will improve cash flow. studioD revenue grew 43% year-over-year. Cracked revenue also grew 11% versus the prior year. Despite growth in both studioD and Cracked, the Content & Media business continued to experience declines down 53% year-over-year to $15.9 million. As we have discussed on prior calls, traffic to eHow has been significantly impacted by search engine algorithm changes and we estimate that the reduction of search engine traffic to eHow in Q3 accounts for 37% of the total Content & Media revenue decline or $6.6 million. Another significant factor impacting revenue for eHow and Livestrong were two actions we implemented to improve the overall consumer experience for these properties. But first, it’s the removal of millions of duplicative and non-performing articles on eHow and Livestrong, accounting for $2.9 million revenue decline in Q3 or 16% of the total Content & Media decline. The second action was our decision to reduce the ad density on eHow pages. Our goal was to create a better experience for our users and over time we expect to see increases and return visitation and more time spent engaging with the content, which ultimately will improve the yield. We estimate that this reduction in ad density accounts for $1.2 million or 7% of the total revenue decline in Content & Media in Q3. Continued downward pressure on Adsense CPC, a trend for many Google Adsense publishers drove approximately $2.3 million in revenue decline in the quarter or 13% of the total Content & Media decline. Visits across all Content & Media sites in Q3 were approximately $781 million, down 26% year-over-year. Overall revenue per 1,000 visits for our Content & Media properties was down 36% year-over-year to $20.33. Lastly, divested businesses accounted for another 10% of the Content & Media year-over-year revenue decline in Q3. This decline primarily resulted from sales of our social media business Pluck and CoveritLive. During Q3 we sold several small websites that had modest traffic and revenue including GolfLink and Arcade Town. On the positive side, sell-through rates for our direct and programmatic desktop channels increased year-over-year. The TPM is improving in these channels and they are a growing percentage of our overall revenue. We have made strides in our native display advertising efforts and the demand from advertisers for sponsored content program on all three of our core media properties is creating a terrific pipeline for future revenue. In Q3 native display is up 77% quarter-over-quarter with advertisers such as Citibank. Another positive in Q3 is that as a result of our new content strategy and product improvement efforts, we saw significant increases in traffic to eHow coming from the social sources, primarily Facebook and Pinterest. While these increases are coming off a small base, we see this as a meaningful opportunity as we bring on contributors with strong social influence and for its new distribution partnerships. In Q3 we also brought one distribution partner into the mix that has a complementary audience and is generating incremental traffic to eHow. Turning to consolidated operating expenses, Q3 GAAP operating expenses were $42.5 million, down 12% year-over-year excluding turbulent payment taken in Q3 2014. Excluding depreciation, amortization and stock based compensation, total operating expenses were $33.7 million. Operating expenses excluding product costs for Society6 were down $2.1 million or 8% year-over-year as we have diligently focused on creating an efficient operating structure for sales, product development and G&A. As Sean outlined earlier, there were a number of initiatives implemented in Q3 that were focused on strengthening our foundation and improving operating efficiency, even through the certain targeted reductions in force, in areas where our business model has shifted. Partially offsetting these reductions were the acquisition of LEAFtv and investment in our direct, branded ad sales force to capitalize on incoming demand from advertisers. At the end of Q3 total headcount was 21% lower than it was a year earlier. In connection with these headcount reductions, we incurred roughly $1.6 million of one-time severance benefits and retention costs, which we add back to adjusted EBITDA. These one-time costs had a negative impact of $0.08 per share in our GAAP EPS. In addition to headcount savings we had banked about $600,000 of annualized lease savings from office closures. The data center migration will result in a roughly $1.6 million in operating expense savings annually. In line with our other efforts we performed the review of our internally developed capitalized software in Q3 and recorded a charge of approximately $700,000 as additional depreciation expense or $0.03 per share in our GAAP EPS. This takes us to Q3 cash flows. Free cash flow defined as GAAP cash flow from operations net of acquisition and realignment payments, capital expenditures and investments in intangible assets was negative $3.1 million in the quarter. We have continued to invest in the transformation of our Content & Media businesses, despite steep revenue declines and have maintained the necessary resources to allow our team to focus on rebuilding higher quality, engaging content and consumer experiences. Capital expenditures, including investment in internally developed software was approximately $1 million in Q3. Our Q3 cash balance includes $5.1 million from the early repayment of the promissory note we received in connection with the sale of our CoveritLive business, along with modest cash with sales of GolfLink, Arcade Town and several other small non-core media properties. Also in the quarter we released an indemnification hold back amount relating to the acquisition of Society6 and is for a $7.4 million in cash and issued approximately 122,000 shares of common stock. We are committed to maintaining an appropriate cash balance to invest in revitalizing our media properties and to feel our growth properties for continued acceleration. This will include judicious management of our resources, continued rationalization of non-core assets and investment in ROI positive ventures that will draw in positive cash flow. That brings me to a few comments on our 2016 outlook. In Q4 of last year we embarked on substantive actions to plan and stabilize eHow. Many of these corrective actions impacted our P&L significantly as we have described on this and earlier calls. We believe that makes Q3 of last year the peak in terms of year-over-year comparisons for our Content & Media business and Q3 of 2015 is possibly the trough. We are optimistic that we are headed into a year of recovery and revitalization in our Content & Media businesses and that together with anticipated continued growth in our marketplace businesses gives us reason to believe that 2016 is going to be a growth year for the company and will be reflected in our financial performance. Even with today’s financial picture, we believe there is significant value dislocation in how the market is viewing Demand Media. As CFO of the company I would be remiss not to punctuate this point. We have endeavored to be more transparent with you about the component parts of our business, making some of the part analysis pretty simple. Let’s do the math. First, we have a marketplace business that is approaching $50 million in annual revenue and growing over 50% year-over-year on an organic basis. Second, we have an integrated content marketing business that is on our run rate to do $15 million annually and currently growing over 40% year-over-year, for our recent private market valuations for similarly sized and provision competitors in this space that have alluded to be well north of $150 million. Third, we have media properties that reach nearly $50 million unique users in the United States on average per month and the revenue has been declining in recent quarters. We are on solid footing for our return to growth. Given these facts and our operating plan that we have put in place, we firmly believe that at today’s trading price, we have the potential for considerable upside in value. We look forward to discussing that thesis with you in follow-up meetings and future calls. With that, I will turn the call back over to Sean to answer any questions.

[Operator:]

[Operator Instructions]. We will take our first question today from Brian Fitzgerald with Jefferies. Please go ahead.

[Unidentified Analyst:]

Hey guys, this is John on for Brian. Thanks for taking my questions. Just curious if you guys have seen any impact from ad blockers. The iOS 9 had the ad blockers on the mobile come up and it kind of got us a lot of questions. Just curious if you guys have seen any impact from that? Thanks.

[Sean Moriarty:]

Yes John, it’s a great question. It’s still somewhat early and ad blockers really aren’t new. They’ve existed in the desktop world, certainly popular amongst the millennial tech savvy audience and something we’ve been able to manage through on the desktop side and so far on mobile we think that’s something that we can manage. Although we do watch it closely, one of the things that I would call out as you’ve seen obviously, a lot of conversation in industry and volatility around ad blockers in the app store, where they fit and what their place is and I think it’s much more of a consequence of generally speaking a mobile experience that have become highly compromised because of over implantation of ads, particularly at low quality, just really slowing down the experience and quavering the user and we believe that if our products are very high quality, we’re respectful of the user, we’ll be able to monetize very well on mobile without really running a follow of an ever increasing trend of ad blocker adoption. There is also several industry kind of movements of foot around whitelisting those publishers and digital players who are very kind of solid citizens and good actors and because an entire ecosystem depends on being able to put high quality content in front of audiences. So again, it’s something we watch closely. We believe we can certainly manage through and we also think that the industry is going to manage to as well.

[Unidentified Analyst:]

Thank you so much.

[Operator:]

And our final question today will come from Sameet Sinha with B. Riley and Company. Please go ahead.

[Zach Cummins:]

Hi, good afternoon. This is Zach. I’m sitting in for Sameet, so thank you for taking my question, so. I have two questions for you. First question is, media reports have indicated you are participating in Google’s DFP’s first look program. Can you talk about that and how you plan to scale the program and question number two is, do you have plans to expand into some of the new publisher platforms such as Facebook’s instant articles or Twitter and Google’s partnership.

[Sean Moriarty:]

So, what we did is – I’ll take the second question, I’ll let Rachel take the first. Generally speaking, I think its incumbent on any branded publisher, particularly those that are specific to certain verticals, to avail yourself of every single relevant scale of distribution platform areas. Certainly there rise of social and the innovations within these social platforms, whether you’re talking about Facebook’s instant articles, Snapchat, Discover or any of the others are all relevant for us to be pursuing and as we start to do more work integrating with these platforms, which is where audiences are or will be going, we’ll share with that with you. But it’s a dead on question and certainly an area of focus for us. And what you will see from us over time is increased diversification of distribution of partners and platforms around.

[Rachel Glaser:]

And do you mind repeating the first question about Google’s DFP.

[Zach Cummins:]

Yes, I was just wondering if you could actually just talk about your involvement in the plan and how you plan to scale that program.

[Rachel Glaser:]

Well, so I’ll start with just noting that we are one of Google’s sort of top publisher partner. So they do a lot of – they talk to us on lot certain kinds of programs. So it feels pretty fortunate to have that relationship with them. We haven’t gotten into the details of it because we are still in the planning stages, but we are doing a lot of with our header bidding. We are doing I think really terrific at yield optimization and so we work really closely with our partners to make sure that we are getting the highest yield starting with REM [ph] at the bottom of the tier and working out way up through the exchanges up to the top tier with them, through our direct selling effort. So we’ll keep you posted on how that’s looking for us. We think we’ll see a potential to optimize up the stack doing partnerships with Google like that.

[Zach Cummins:]

All right, great, thank you. I appreciate it.

[Operator:]

And thank you very much. That will conclude our conference call for today. I would like to thank everyone for your participation.

[Sean Moriarty:]

Thank you very much. We’ll be talking to you again soon.