Demand Media's (DMD) CEO Sean Moriarty on Q1 2015 Results - Earnings Call Transcript

Demand Media, Inc. (DMD) Q1 2015 Results Earnings Conference Call May 6, 2015 4:30 PM ET

Executives

David Glaubke - Investor Relations
Sean Moriarty - Chief Executive Officer
Rachel Glaser - Chief Financial Officer

Analysts

Sachin Khattar - Jefferies
Sameet Sinha - B. Riley

Operator

Good day and welcome to the Demand Media Fiscal First Quarter 2015. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Mr. David Glaubke. Please go ahead.

David Glaubke

Good afternoon, everyone. On behalf of Demand Media, welcome to our first 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 fourth 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 the 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, adjusted EPS, and free cash flow. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in the 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 and thank you all for joining our first quarter earnings call this afternoon. Let me begin this call by reiterating our mission at Demand Media. 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’ve made significant strides since the beginning of the year and I’m very pleased to take you through some of the key highlights.

I’ll divide my comments today into three parts. First, I’ll discuss eHow and Livestrong, both businesses in transformation; second, I will discuss our growth opportunities in the Content Solutions, Marketplaces and Cracked businesses and the progress we are making so far; finally, I’ll talk to you about how we are improving and strengthening our operations with people, processes and sound investment strategies to return the company to growth and profitability. Starting with eHow which represented 28% of our total revenue in Q1. eHow was down 58% year-over-year, primarily as a result of the ongoing impact of traffic declines following algorithm changes by search engines as well as lower ad monetization.

In addition we have made very hard choices that have negatively impacted revenue in the short term but will significantly improve the experience for users and make eHow much more attractive for advertisers. This year, we have continued to remove duplicative articles, also focusing our talented creator pool on renovating articles by adding photos, rewriting content and testing with contextual companion videos. Since November, we’ve removed 2.4 million articles, including nearly 400,000 we took down just last week. We now have 760,000 articles live on site compared to 3 million before the takedowns.

Our approach to this renovation is methodical. We’ve identified an important subset of five categories that have the highest potential and we’re focused on improving the depth and quality of content in those areas. We have also redesigned the eHow website, made strides towards optimizing the mobile experience and they’re seeing promising growth from traffic sources such as Pinterest as we work to become less dependent on any one single algorithm. Additionally, we plan to launch a slate of everyday life act videos this quarter as well as an eHow app later in the year. This new products are only the beginning of eHow’s reinvention.

This turnaround isn’t easy and requires significant investment but stabilizing this high margin business will provide benefits well into the future and we believe that it’s worth the effort.

Now I’m excited to discuss Livestrong which is well into a transformation of its own and is a great example of the impact that rightsizing and improving content can have on audience and engagement. In Q1, Livestrong accounted for 11% of total revenue and achieved over 60% traffic growth compared to the first quarter of 2014. Registrations and app downloads are also up in the double-digits year-on-year. Livestrong has also built a set of well-designed apps like Livestrong Calorie Tracker for weight loss and the MyQuit Coach for smoking cessation, both of which saw double-digit growth in monthly average users during Q1 as compared to last year. In January, Livestrong had its biggest month ever for community posts. More and more people are finding Livestrong to be the destination of choice for health, wellness, and living their strongest possible lives.

Moving on to the second area of focus for today’s call, our businesses that offer the best near-term growth opportunities for the company. The first growth business to speak of is our Content Solutions business. Content Solutions revenue increased 16% year-over-year, representing 11% of our total Q1 revenue and 7% of our trailing 12-month revenue. Leveraging the same studio talent that produces content for our owned and operated media properties, the Content Solutions team develops and executes custom content marketing strategies for some of the world’s largest brands looking to tell their stories directly to consumers.

Our data and insights, publishing systems, workflow tools and contributor network allow us to provide high quality editorial and video content from strategy through execution and optimization. During Q1 the Content Solutions team signed several new customers and the pipeline remains strong. Our team has recently worked with creators to produce content as great as of Valentine’s Day, Love the Wine You’re With for a major wine marketer to a countdown to taxes checklist and Employee Appreciation Day Decision Free for Office Depot. It is still early days for this business and we plan to invest intelligently as the market takes shape but we believe this business can grow substantially for us over the long-term.

Another growth area for us is Marketplaces which represented 32% of our Q1 revenue and 25% of our trailing 12-month revenue and demonstrated strong momentum exiting the Q4 holiday season. Q1 year-over-year revenue growth for Marketplaces was 59%.

Society6 continues to deliver impressive growth in traffic, conversion rates and revenue. The product portfolio is well-balanced and diverse. In March, the team launched another new product, wall tapestries, bringing the total number of products available to 22. The site now has over 2 million unique designs that can be printed on these products, a 48% increase from a year ago. Saatchi Art by some of its artist from the virtual world into the real world this quarter, connecting artists and collectors in person at South by Southwest, the affordable art fair in New York, in a solo show in London for one of Saatchi Art’s most successful artists Hormazd Narielwalla. In addition, Saatchi Art’s app which launched late last year just went webby for best lifestyle mobile site and approximately, validating the transformative impact we are having on the experience of buying and selling art online.

Our third growth business Cracked represented 7% of our Q1 revenue and 6% of our trailing 12-month revenue. During the first quarter Cracked continued to focus on producing high quality video content including the second season of Rom.Com, a must watch video titled, If the Internet Was a High School and a production spree of 10 original videos in 10 days. Our after-hour series produced a video which had a record 175,000 views on YouTube in the first 24 hours. Cracked has grown to over 700,000 subscribers on YouTube and we exited the quarter with over 10 million streams on the channel.

We have also significantly grown views on the Facebook in the Cracked app. Our best performing video on Facebook Driver’s Ed For The Real World currently has over 4 million views. In addition last week we were awarded the People’s Voice Webby for Best Humor Site, marking the fourth year in a row that Cracked has won a webby.

Finally let me turn to how we are changing the way we operate our business. As I said on our last call, we are in the beginning stages of a six to eight quarter transformation and we still have a lot of work in front of us. The cornerstone of any company’s success is the strength of its people. So retaining and recruiting the strongest possible executive team has been one of my highest priorities. We recently announced the additions of our new CFO, Rachel Glaser, and our new Head of Corporate Development, Tawn Albright. I am thrilled to have these strong and seasoned executives to our existing leadership group. And I am confident that we now have a team ready to lead the company through this transition to a path of healthy and sustainable growth.

A very important operating principle for us is fiscal discipline. We are committed to maintaining a cash balance of at least $40 million this year, even as we invest intelligently in our businesses. We are carefully evaluating the changing landscape, navigating through our current challenges and building the business for the long-term.

Our core businesses consist of properties and growing lifestyle categories the people are passionate about, categories that are rapidly moving online and across mobile platforms. We see a real opportunity for market leadership, given the growing audience for high quality content in these lifestyle categories. And our businesses at scale can be strong and profitable.

While the picture should become more clear over the next few quarters, I feel very good about the steps we’ve taken and the impact we’ve seen so far.

Now, I will turn the call over to Rachel for the financials. When I first met Rachel late last year, I was impressed by her background. And as I got to know her over the CFO selection process, I became convinced that she was the right CFO and leader for us. She has been through a successful transformation at Realtor.com as an executive leader and knows firsthand what it takes. I am thrilled to have to her onboard. In a few weeks she has been here, she has already demonstrated a real appetite for the challenge and she will be an outstanding partner as we take on the transformation of our business.

Now, over to Rachel.

Rachel Glaser

Thank you Sean. It is a pleasure to be part of the Demand team and I am very happy to join you for this Q1 2015 earnings call.

Before I dive into the Q1 financial commentary, I thought I would spend just a couple of minutes talking about why I am excited to be here.

I joined Sean at Demand because I see a tremendous amount of potential in the assets of the company. We have a portfolio of businesses each with their own unique set of challenges, opportunities and strategies. We have businesses like eHow and Livestrong with a clear and articulated plan for improvement. Content Solutions, our burgeoning content market group in penetrating new territory and is just at the beginning of its growth curve when it can benefit from investment and tools and people. Our Marketplaces business has growing audiences and operates in large and attractive addressable markets where there is not yet a clear leader.

We are in the enviable position of having one of the largest audiences on the internet. Our fundamentals include a healthy cash balance and no debt. In short, we have the assets and talent to fuel future growth. I’m pleased to be part of the team that can unlock what I see as tremendous potential.

So, now let me take you through the results of the quarter. I’ll start with the straightforward numbers as outlined in our press release.

Total revenue in Q1 was $33.2 million, down 26% year-over-year, driven primarily by declines in the Content & Media business partially offset by growth in the Marketplaces business. Adjusted EBITDA in Q1 was $0.5 million, down 96% year-over-year, largely reflecting the impact of revenue declines in the higher margin Content & Media business. Free cash flow was negative $3 million for the quarter, reflecting challenges in Content & Media revenue as well as the timing of certain working capital payments.

Let me provide further color on these results starting with revenue.

As we expected, the Content & Media business continued to experience declines in ad monetization yield, in particular in the eHow business which is continuing to undergo the renovation we discussed on last quarter’s call. Overall, the Content & Media business declined 41% year-over-year to $22.5 million. Revenue per thousand visits was down 38% year-over-year to $23.87 due to lower ad monetization yields, a strategic reduction in higher yielding direct sold display advertising and the sales of our CoveritLive and Pluck social media businesses.

Peeling the onion further on Content & Media revenue, there are few puts and takes to call out. First, traffic continues to be depressed from the impact of ongoing search engine algorithm changes. Visits across all sites in Q1 were 943 million, down 5% year-over-year. Traffic declines were driven primarily by decreases in eHow, down approximately 34% while Livestrong traffic increased more than 60%. Mobile traffic across all properties grew roughly 41%. Lower traffic coupled with a decrease in monetization yields from our cost per click advertising accounted for approximately 55% of the Content & Media revenue decline versus prior year.

Second, as we have discussed previously, we have shifted from a direct branded ad sales effort toward a focus on programmatic selling. Our expectation is that while programmatic CPMs are generally lower as compared to branded, as we increase sales through the programmatic channel, we will optimize page yield at higher margins. Reduction in display revenue due to our strategic shift away from direct branded ad sales therefore accounts for 15% of the revenue decline in the quarter.

Third, we have been ferociously working to improve the quality of eHow content with a goal to restore traffic growth and improve our ranking in relevant search queries. The content reduction on eHow that Sean discussed which supports fiscal accounts for 13% of the revenue decline in the quarter.

Fourth, revenue loss related to divested businesses accounted for 12% of the revenue decline in the quarter. Normalizing for the removal of Pluck and CoveritLive, revenues from our Content & Media business would have been down 39% versus the 41% just cited.

Lastly, as previously discussed, during Q4 we removed three ad units from each eHow article to enhance the consumer experience and stimulate engagement. While this move accounted for the last 5% of the Q1 Content & Media revenue decline versus prior year, there are early positive signs that we are improving overall quality and experience. Following the reduction in ad units we have seen user engagement on eHow increase by 5%, based on the number of visitors clicking on related eHow articles.

Turning now to Marketplaces, revenue was up 59% year-over-year to $10.7 million as compared to 24% growth in Q1 2014 on a pro forma basis. This demonstrates acceleration and momentum in this business which was fueled in part by addition of SaatchiArt to this revenue stream that driven largely by Society6 growth versus prior year. Conversion rates increased this quarter driving total transactions up to approximately 182,000, a 31% increase year-over-year. Average revenue per transaction was $58.65, up 21% year-over-year primarily due to a shift to higher priced items on Society6 as well as the acquisition of SaatchiArt.

Turning to consolidated operating expenses, Q1 GAAP operating expenses were $42.9 million, down 16% year-over-year. Excluding depreciation, amortization and stock-based compensation, total operating expenses were $33.1 million, down $600,000 year-over-year on an absolute dollar basis. Excluding product cost for Society6, all of our other operating expense items were lower year-over-year on an absolute basis; specifically service costs were down year-over-year due to lower IT, traffic acquisition and ad serving costs partially offset by an increase in content renovation expenses.

Sales and marketing expenses declined year-over-year due to a smaller sales infrastructure as a result of our previous strategic decision to transition away from direct branded advertising sales, partially offset by increased marketing activities for our Marketplaces business. Product development expenses lowered year-over-year due to reduced headcount as we streamlined some of our operations and maintain disciplined hiring partially offset by increases in product development expenses for our Marketplaces business. And general, administrative expenses were slightly lower, partially due to headcount reductions.

At the end of Q1, total headcount was 16% lower than it was a year earlier. A little more than half of this reduction was related to divested business, net of Saatchi addition and the balance was due to careful management of expenses.

This takes up to Q1 cash flows. Free cash flow, defined as GAAP cash flow from operations, excluding acquisition and realignment payments, less capital expenditures and investment in intangible assets was negative $3 million in the quarter, reflecting challenges in Content & Media revenue as well as the timing of certain working capital payments. Our expectation is that we may continue to consume rather than generate cash for several quarters as we invest in writing the eHow shift as well as seeding our less mature businesses to position them for growth.

We are committed to disciplined oversight of expenses and investments. At March 31st, our balance sheet remains healthy, with $47.3 million of cash and cash equivalents and there is no outstanding debt. Before I conclude my remarks, let me give you a little color on what the environment is like here. As I was leaving the office last Friday night, there were teams still huddled around screens, conference rooms were unused and the sound of ping pong was coming from the common area. This place is buzzing with activity. There is energy, focus and ambition. People here want to win. The expression when the going gets tough, the tough gets going, keeps coming to mind and is emblematic of this spirit. I look forward to meeting you all and sharing updates with you as we embark on this journey.

Peter Kim, our Interim Chief Accounting Officer is alongside me right now and will help address your questions.

I will now turn the call back over to Sean for some closing remarks. Sean?

Sean Moriarty

Thank you, Rachel. Last week, the world lost one of the brightest of lights, Dave Goldberg, CEO of SurveyMonkey. Dave was a friend and mentor to many of us, and outstanding entrepreneur and business leader and an extraordinary human being. As we remember Dave, we show our deepest sympathies with his family, friends and colleagues. When we think of the standard for a life well lived personally and professionally, Dave set the bar.

This concludes our prepared remarks. Operator, please open the line for Q&A at this time.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. And we will take our first question from Brian Pitz with Jefferies.

Sachin Khattar

Hey guys, thanks. This is Sachin filling in for Brian. A couple of questions. So, the first is, have you seen any impact to traffic in the quarter following Google’s algorithm changes that took place, sort of public site [ph] changes that took place in the quarter? And two, can you just give us a sense of how much of your advertising revenue is coming from Google’s AdSense program versus sort of your other programmatic sources? Thank you.

Sean Moriarty

So, on the first part of your question, are you referring to current quarter?

Sachin Khattar

Yes.

Sean Moriarty

So, as we said earlier, we just recently took down 400,000 articles and at the same time, you know there’s been some talk of volatility out there, although I believe Google has not yet disclosed if in fact there was an algorithmic change. We have seen some downward volatility but again in the context of a takedown we initiated, so it’s a bit early for us to tell but we’re keeping a close eye on it as we go forward.

Rachel Glaser

And this is Rachel. The second question was regarding the percentage of our total revenue at Google AdSense. I don’t believe we’ve disclosed those numbers before but I can tell you that it’s less than 50% and it’s decreasing. So, our strategy is to continue to go with our monetization streams as we build businesses and as we add Marketplaces businesses which is completely independent of that.

Operator

[Operator Instructions]. And we will take our next question from Sameet Sinha with B. Riley.

Sameet Sinha

A couple of questions, starting with Content & Media. So, 400 articles removed, now you have about 700,000, do you think that’s the right number or is there a right number that you are asking for the number of articles in those five categories that you plan to focus on? And in terms of ad unit removal, can you confirm that that has been done or that is moved in the fourth quarter that was the final removal? And if you can also shed some light on just programmatic and the trend that you’re seeing over there, what sort of CPM designs are you seeing for the same ad unit versus direct? That’s the start off, and I’ve a couple of follow-ups.

Sean Moriarty

So, the first part of your question Sameet was really on the takedown and the number of articles. And I don’t think there is a magic number. What we’re looking at is every article that we are creating, meeting our standard of quality and does it help fulfill what robust resource within a particular category needs to be for eHow to be compelling to users. So, there is no magic number and quality is first. That said, we had a proportionally similar takedown for Livestrong, again predicated first and foremost on quality. And we were successful with that. So, we’re guided somewhat by prior success but most importantly it’s really about the quality of the product. And where we think we have the right coverage within the categories that we are. And we think that we’re substantially there at this point but again the bar we’re going to set is always going to be qualitative and we’ll end up where we end up. But I think from a pure numbers perspective, we’re probably in the zone, maybe slightly more condensed as we address the way the product works and as we consolidate certain Q&A articles into more robust topics where you’re article count would actually go down as measured by our article count but your information density and relevance would be the same or greater.

The second question I believe you had was with respect to the number of ad units and I can confirm we did in fact take down three as of Q4 last year. I think you also asked does that reflect some sort of fixed state for us and what I would say to that is, we’re constantly looking to see how we appropriately balance a great user experience with a great products for advertisers. And as the world evolves and the needs of advertisers change and as people move to mobile and video, it will probably result in changes to ad density because we need to really focus on experience first and again I go back -- I don’t think there’s a fixed appropriate number of ads. It’s really about, are we striking that right balance from quality of user experience and then quality of audience we’re delivering to advertisers and meeting their needs as well. So I wouldn’t want to get anybody stuck on a particular number at a given point in time, more focused on again quality of engagement and monetization trends longer term over time.

Rachel Glaser

And I’ll just to that quickly that number of units is one thing but also who, will we sell those units to is another thing that we are being open minded about, so that we just talked to the question before with percentage of revenue that’s coming from AdSense that we’ll look to be diversifying and maybe higher yield from other kinds of advertising in those same pieces of inventory.

I think your last question was on CPMs. We haven’t disclosed CPM but I can say just as any public servers, three or four kinds of selling activity that are out there. There is branded, there is remnant, there is programmatic and those things that you might call sponsorships. We have them all. We’ve shifted the branded sales team and they are selling more programmatic than they were before. Programmatic was there higher CPM than remnant was, but right now, the sell through is highest on remnant; we’re going to continue to move to get more to sell through to go through the programmatic selling sort of apparatus. And as we do that, we should see CPM improve.

Sameet Sinha

Finally on Marketplaces, obviously tremendous momentum continuing into Q1. How should we think about that business? It is -- I mean the way we see it is, it’s an e-commerce business, highly competitive category, growing fast and you’re doing all the right things in terms of increasing conversion traffic and using the product portfolio. But margins are still low, at what level of revenues does it become, get to break even on a standalone basis?

Sean Moriarty

It’s important to point out again, this is marketplace e-commerce, not retail e-commerce and these should be very good healthy businesses at scale. I think the question you ask is somewhat predicated on how quickly we believe we can grow and grow in a healthy manner i.e. if you wanted to get profitable very quickly, you could constrain growth to do that. We’re much more interested in building a differentiated large business which we know has healthy margins that scale than hitting profitability for profitability’s sake early in these growing categories. But based on existing performance, we feel that these businesses can be very good healthy businesses for us.

Rachel Glaser

And Saatchi is earlier in its lifecycle than Society6, so we told you some of the growth rates for Society6 and I think the category Marketplaces is, even though we don’t talk about segments but we’re seeing breakeven across the category. And going forward depending on how much we want to invest in one or the other could be -- to make it grow faster could influence that favorably or negatively but we already have the positive indicators that these can be really healthy profitable businesses for us.

Operator

And there are currently no other questions at this time. [Operator Instructions].

A - Sean Moriarty

If there is no more questions, we will talk to you all next quarter. Thank you for tuning in.

Operator

Ladies and gentlemen, this does conclude today’s conference. We thank you for your participation.