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Demand Media (NYSE:DMD)

Q2 2014 Earnings Call

August 07, 2014 4:30 pm ET

Executives

David Glaubke - Senior Director of Corporate Communications

Shawn J. Colo - Co-Founder, Interim Chief Executive Officer and Interim President

Mel Tang - Chief Financial Officer and Principal Accounting Officer

Analysts

Sameet Sinha - B. Riley Caris, Research Division

Brian Patrick Fitzgerald - Jefferies LLC, Research Division

Operator

Good day, and welcome to the Demand Media Fiscal Second Quarter 2014 Earnings Conference Call. Today's conference call is being recorded. At this time, I'd like to turn the call over to Mr. David Glaubke. Please go ahead, sir.

David Glaubke

Thank you, and good afternoon, everyone. On behalf of Demand Media, welcome to our second quarter 2014 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 Shawn Colo, our Interim Chief Executive Officer; and Mel Tang, our Chief Financial Officer. Following the Safe Harbor statement that I will make, Shawn will update you on our business. Mel will then 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, page view 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, during this call, we will discuss certain non-GAAP financial measures while talking about the company's financial and operating performance, including revenue, ex-TAC, adjusted EBITDA, adjusted EPS and certain free cash flow metrics. A reconciliation 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, before we begin, I'd 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 be available on our website.

With that, I'll now turn the call over to Shawn Colo, our Interim CEO. Shawn?

Shawn J. Colo

Thank you, everyone, for joining and welcome to our 2014 second quarter results call. It has been an incredibly active second quarter for Demand Media. This past Friday, we completed the spin-off of Rightside to Demand Media shareholders. The executive team spent a significant amount of time and energy to accomplish this goal, and we are confident that each company is poised to deliver value to our respective customers, partners and shareholders. I would like to say thank you to all of the people who have worked so hard over the years to build the domain name business. I have enjoyed working closely with Taryn and Tracy and the Rightside management team to position that company for continued success, and wish them the best of luck in their new life as a public company.

I will not dig into the operating results for Rightside on this call, as they will be hosting their own earnings call today at 2:30 with call-in details available on the rightside.co website.

In early July, we completed the divestitures of our CoveritLive and Creativebug businesses, as well as streamlined our Pluck operations, reducing Media headcount by approximately 9% in the process and eliminating 2 remote office locations. As I said, it's been an incredibly active quarter.

Now on to the results. As we stated in prior earnings calls, our primary objectives this year are to build great products and improve the overall consumer experience for our sites. This focus on the user, not just on the production of content units, will allow us to build a more sustainable business going forward.

LIVESTRONG trends, in particular, this quarter demonstrate that this user-centric strategy has the potential to deliver long-term stability and growth. We remain focused on our core initiatives for the year, which include driving growth across Society6 and Content Solutions, as well as significant enhancements to eHow.com. But first, I'd like to begin with a brief recap of our LIVESTRONG business to put these core initiatives in context.

A year ago, we shifted our focus away from a volume-driven publishing model and began systematically improving the site. Content audits were performed and articles were edited and enhanced with original photos from our studio, resulting in a drastically improved library of just over 100,000 articles, down from about 500,000 articles at its peak. And we spent a considerable amount of time improving our community tools, such as the MyPlate Calorie Tracker, to enable a seamless mobile-to-desktop community experience.

As of June, LIVESTRONG is now the third largest site in the health vertical according to comScore, with 12.8 million unique visitors per month. During the second quarter, this site drove a record number of new registrations.

LIVESTRONG channels also grew on YouTube with a subscriber base of more than 500,000 subscribers. We continue to expand the brand reach and experience across multiple social platforms.

Also during the quarter, LIVESTRONG's mobile visits, including tablets, exceeded desktop visits for the first time. Over the next few quarters, we expect to spend several million dollars on content and product improvements, with a particular focus on the mobile experience.

While Google, Facebook and other platforms are and will be an important source of traffic for us, as well as other websites, we believe that delivering a quality user experience is what ultimately will drive sustainable growth. And with registrations during the quarter at the highest level in 3 years, and all-time highs for community engagement, our quality metrics are clearly heading in the right direction.

Importantly, the LIVESTRONG momentum gives us confidence to move forward with our enhancements to eHow, our largest media property. eHow has a very simple mission: to build the most helpful place on earth. We are striving to be the best DIY destination that delivers great content, useful tools and an engaged community of experienced voices to help consumers on a broad range of topics.

We remain in the very early innings of the work plan on eHow, but did make some improvements during the quarter, which we think are worth noting. We have completed the first phase of renovating our home page to make it a new daily destination. We also added a helpfulness score to articles, which highlights the number of people who liked or shared a particular article. Looking ahead, we plan to further roll out this score across the site and to continue to iterate on our design features for desktop and mobile.

We also started the process of gathering user feedback, which you can see as a helpful/not helpful button on article pages, to measure content improvement and builds consumer confidence. We see about a 54% positive helpful rating across our library and approximately 77% for upgraded articles. Moreover, we are getting better insight why content might not be helpful, such as article needs more photos or the article's too general. In the next few quarters, we intend to integrate this feedback from users to significantly enhance content published to eHow.

From a community standpoint, the second quarter saw the launch of new blogger profile pages, which promote the contributor's site, as well as their social connections. Our goal is to drive greater engagement with content creators by providing them with a way to reach a much larger audience than they can on their own in order to grow their own businesses, and also providing them with more data and insights on how well their content is performing. I look forward to sharing more community and engagement stats for eHow in the coming quarters.

For LIVESTRONG and eHow in particular, much of the content development is done in large part through our Studio platform. Presently, there are more than 1,500 freelancers who are active within the Studio. Our product team in Austin, Texas is hard at work building features such as enhanced writer dashboards and new quiz and list formats. By providing our subject-matter experts with more data and better tools, we can improve quality, engagement and virality on content Owned & Operated sites, as well as for our Content Solutions customers.

Currently, Content Solutions serves more than 40 publishers and brands with our high-quality, multi-format, insight-driven content that continues to drive over 30 million unique visitors every month for these clients. Our data shows that, over time, our Content Solutions clients see an average of 5x the ROI than they'd have with a traditional media campaign.

Also clients are increasingly focused on mobile-specific content and we continue to develop our original photography within our Studio to meet our clients' needs.

Shifting gears to CRACKED.com, the site continues to garner recognition for the quality of its content. We won 2 Webby Awards last quarter, one was the People's Voice and the other for best writing for video series. CRACKED has over 700,000 registered users and a highly loyal and engaged audience in the sought-after 18- to 34-year-old demographic.

CRACKED has a development slate of premium scripted video content to be developed in future quarters. We are excited about the audience and advertising revenue opportunity as we push further into video with a trusted brand and exceptional writing and production teams.

Let's move on to Society6. Our team made great progress this quarter in developing tools for our member community and launching new products for our consumers. We continue to ramp membership with more than 550,000 members at the end of the quarter, up more than 9% quarter-over-quarter and 100% year-over-year. Our members continue to upload new original designs, and the number of unique artists who uploaded work to the site grew 22% year-over-year. We now have 1.6 million pieces of unique artwork on the site.

During the quarter, we rolled out 3 new consumer products, V-necks, Samsung Galaxy S5 cases and biker tanks. We are focused on improving conversion rates with site search and mobile enhancements. And one example is our new Artist Shop, which delivered a 10% increase in mobile conversion this quarter.

We are also increasing revenue per visit with improved optimizations, such as our "frame this print" button that is expected to add an incremental $1 million of art print revenue annually.

Customer satisfaction remains high with repeat buyers accounting for 28% of revenue during the quarter. We will continue to focus on areas like vendor selection and improved order fulfillment to increase customer satisfaction even further.

Finally, we are exploring ways to reach new customers through increased marketing, artist collaboration and strategic partnerships.

With that, I'd like to turn the call over to Mel to review the second quarter financials. Mel?

Mel Tang

Thank you, Shawn. As Shawn mentioned, during the quarter, we saw signs that our focus on users and improvements to our content and products are beginning to yield positive results. Specifically, we saw positive data points on LIVESTRONG, where we have been investing and implementing changes over the past year. And while we still have important investments to make, our strong free cash flow and healthy balance sheet provide us the financial flexibility to continue to stabilize our businesses and reaccelerate growth.

Let's discuss our consolidated second quarter results, inclusive of Rightside, in more detail. Revenue, excluding traffic acquisition costs, or TAC, was $87.1 million, down 10% year-over-year, driven by the cumulative impact of traffic declines to key properties, lower aftermarket domain sales and our shift away from direct display advertising. This was partially offset by Society6, Content Solutions and international revenue growth, as well as 13% year-over-year growth in Registrar revenue.

Adjusted EBITDA was $10,700,000, reflecting the impact on higher-margin revenue from traffic declines and lower domain sales, as well as a mix shift to lower-margin commerce and Registrar revenue. If we exclude gTLD operating expenses of $2.3 million and associated revenues, adjusted EBITDA would have been $12.8 million.

Free cash flow is $9.8 million. It increased both sequentially and over the prior year, reflecting lower fixed asset CapEx and purchases of intangibles and the timing of certain working capital payments, offset by lower adjusted EBITDA.

Turning to our Owned & Operated business. Year-over-year, Q2 Content & Media revenue ex-TAC decreased 24% to $45.9 million. Owned & Operated revenue was $38.8 million comprised of Owned & Operated page views of 4.5 billion, up slightly, driven by mobile and international property page view growth, offset by desktop page view declines.

Owned & Operated RPM was $8.64, reflecting a mix shift to mobile traffic and programmatic ad sales, as well as lower domain sales, offset partially by commerce revenue from Society6.

Now on to network. Network revenue ex-TAC was $7.1 million, reflecting lower year-over-year revenue from our domain monetization and Pluck social tools businesses and our previously announced decision to sunset our IndieClick network, partially offset by growth in our Content Solutions business. With respect to network page views and RPM. Network page views are 1.4 billion and network RPM ex-TAC was $4.96, primarily related to the removal of lower monetizing network page views from our IndieClick network, offset by growth in Content Solutions revenue.

On to our Registrar. On August 1, we announced the successful separation of Demand Media into 2 standalone entities. As Shawn mentioned, Rightside will be hosting their own earnings call today at 2:30 p.m. Pacific Time, so I will keep my comments brief. Revenue was $41.2 million, up 13% year-over-year, driven by 10% year-over-year growth to 15.6 million domains under management, fueled by growth in new registrations. Annualized revenue per domain, or ARPD, of $10.65 increased 3% year-over-year due to a mix shift to higher Name.com ARPDs.

Similar to last quarter, I will provide a high-level revenue and EBITDA estimate for our standalone Content & Media business.

In Q2, advertising revenue was approximately $31 million. This is down 33% year-over-year, primarily due to lower desktop traffic to our Owned & Operated properties and our strategic shift to programmatic ad solutions, which currently have a lower CPM than higher-touch direct ad sales.

Commerce and other revenue, which is comprised of all transaction-based and other nonadvertising revenue, was approximately $12 million. This is up 98% year-over-year due to revenue from Society6 of $6.6 million, which more than offset declines in our Pluck social tools business.

With respect to standalone adjusted EBITDA margin, we estimate that it was approximately 25% in the quarter.

Turning to consolidated operating expenses. Q2 GAAP operating expenses were $102 million, up slightly year-over-year. Excluding depreciation, amortization and stock-based comp, total operating expenses were $81.8 million, up 14 points as a percent of revenue and driven by the following: higher cost of services due to increased registration costs related to growth in our Registrar business, as well as $4.9 million of product costs associated with S6 sales, partially offset by lower TAC year-over-year; lower sales and marketing expense due to our decision to transition away from direct display advertising sales and a reduction in marketing activities; lower product development expense due to reduced headcount as we streamline some of our operations; and slightly higher G&A expenses, primarily due to incremental costs of $1.4 million related to the spin-off preparation fees, offset by lower facilities costs.

Excluding the spin-off, restructuring and nonrecurring costs, total operating expenses, excluding depreciation, amortization and stock-based comp, would have been approximately $79 million, up 12 points as a percent of revenue compared to last year.

In the second half of the year, our standalone adjusted EBITDA margins will be negatively impacted as we accelerate our investments in renovating our LIVESTRONG and eHow content libraries. This is expected to result in additional operating expenses of approximately $2 million to $3 million.

Which takes us to Q2 cash flows. Cash flow from operations was $12.5 million due to lower adjusted EBITDA, as well as spin-off and restructuring expenses, partially offset by the timing of certain working capital payments. Discretionary free cash flow was $10.8 million, reflecting lower adjusted EBITDA, offset by lower fixed asset CapEx as compared to last year's headquarter build-out. In the quarter, we had strong free cash flow of $9.8 million.

A brief update on our balance sheet and liquidity. At June 30, we had approximately $245 million of liquidity, comprised of $131.6 million of cash and equivalents and $113.8 million available under our credit facility, net of our outstanding letters of credit. On July 14, we announced the divestitures Creativebug and CoveritLive. The total consideration received was approximately $20 million, comprised of approximately $15 million in cash and $5.6 million in a seller note. These businesses were not expected to contribute materially to revenue or EBITDA for the rest of 2014.

As such, our balance sheet today remains extremely healthy with approximately $45 million in net cash today.

In conclusion, we are encouraged by the positive trends at LIVESTRONG and look to translate this early success into other areas of our business. Our strong free cash flow generation and healthy balance sheet will allow us to continue to make the investments necessary to deliver revenue growth.

Finally, I wanted to congratulate everyone at the Demand Media and Rightside for the successful separation of the businesses, marking a significant milestone in the evolution of the company. Furthermore, I want to personally thank all the teams involved for their incredible effort in making this spin-off happen. From IT to legal to accounting to HR and everyone else, again, a big thank you.

That concludes my prepared remarks. I would now like to open the line for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question will come from Sameet Sinha with B. Riley.

Sameet Sinha - B. Riley Caris, Research Division

Can you update us on your programmatic initiatives? You had indicated that, in the second half of the year, we should see some benefit. Any indications in July? Can you comment on kind of RPM increases from that, if any? Secondly, also just talking about the investment that you have spoken about, I guess, it involves just higher-quality content, more focused on music -- sorry, videos and photos. What sort of an impact? I think I missed that. Third is in terms of O&O, sequential decline in dollar value has slowed. Can you update on what Google as a percentage of revenue was and how we should think about that stream going forward?

Shawn J. Colo

Hey, Sameet. So first of all, just talking about programmatic briefly. I think the team has been working really hard to get our infrastructure in place to really start growing that business. And I think we've seen some real traction in terms of onboarding clients. I think we tripled the number of live deals during the quarter, now we've got a couple hundred brands and agencies who are looking at our inventory. So that's kind of the first step is make awareness, let the customers know we're out there in market with product. And then starting to work closely with them to deliver the returns that they expect. So the focus is really kind of driving up that usage, and in fact, we're really not trying to push pricing right now beyond what the current trends have been. And Mel can add some more color on that, too. Mel, do you want to talk about that? We can go through them in sequence or do you want to...

Mel Tang

Yes, I think just in terms of the CPMs we're seeing in our programmatic, they are stable, they're inching up slowly. Again, I think the focus, as Shawn mentioned, is really just opening the marketplace and ensuring that there's adequate liquidity on both sides, which will drive up pricing over time, in our view.

Shawn J. Colo

And the market, from a product standpoint, continues to emerge and you're starting to see new formats evolve and grow, and ultimately, that's where the market needs to get to in order to start to get pricing going in the right direction. So we like the trends, we like the execution from the team so far. And so I think that's the programmatic update. From an investments going forward standpoint, I think what we talked about in our remarks was continuing to do some of the work that we've been doing in terms of improving content to our Owned & Operated sites. And that's going to take the form of article audits, where we're adding more photos, where we're adding more clarity, we're building product. That makes the creator aspect more social. And as I talked about with LIVESTRONG, we went through that -- we spent about 12 months going through that process, specifically. I mean, it wasn't just constant improvement that, I think, moved the needle for LIVESTRONG this quarter. It was content and product and user experience. And so going forward, we're going to continue to make content investments, not only for eHow, but also LIVESTRONG, too, in terms of being able to grow the business.

Mel Tang

I think your last question on Google as a percentage of revenues, again, the percentage of eHow traffic were -- clearly, has the largest contributor. It's about 40%, which is roughly consistent with where it's been over the last few quarters. As a percentage of total revenues, it's about 1/3, just under 30%, actually. And then overall, if you just think about search, traffic coming from search engines as a percentage of 4 Owned & Operated sites, it's about 2/3.

Operator

[Operator Instructions] The next question will come from Brian Fitzgerald with Jefferies.

Brian Patrick Fitzgerald - Jefferies LLC, Research Division

You mentioned LIVESTRONG had strong mobile growth. Could you repeat that stat? I wasn't sure if it was traffic or revenue that now exceeded desktop. And then can you talk about maybe the monetization rate differential you're seeing between mobile and desktop? And then maybe one more on video. In terms of distribution, what portion of your video traffic, I guess, in across all brands and then maybe LIVESTRONG and CRACKED, particularly, is direct nav versus YouTube distribution?

Shawn J. Colo

Okay. Let me try to answer the first question. On mobile, the stat we quoted was related to visits, and it's 55% of visits in the quarter to LIVESTRONG were mobile. And then I'm going to take them out of sequence. But I think on the video question, video is still predominantly off-network for the most part, and YouTube in particular. We do see some decent amount of video streams on our Owned & Operated properties. And for CRACKED, in particular, CRACKED is developing their own slate of premium scripted series, which is really where video is kind of headed on the web. So CRACKED is doing probably the best in terms of video execution from our Owned & Operated video standpoint.

Mel Tang

Just returning to the mobile monetization question that you had. It's still holding around 50% of nonmobile -- of desktop in terms of CPM and revenue per visit.

Operator

And that does conclude the question-and-answer session. I'll now turn the conference back over to you for any additional or closing remarks.

Shawn J. Colo

Okay. Thanks, everybody, for making time today. And look forward to keeping you updated on our progress in future quarters.

Mel Tang

Thanks, everyone.

Operator

Thank you. That does conclude today's conference. We do thank you for your participation today.

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Source: Demand Media's (DMD) CEO Shawn Colo on Q2 2014 Results - Earnings Call Transcript

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