Leaf Group's (LFGR) CEO Sean Moriarty on Q4 2017 Results - Earnings Call Transcript

Leaf Group Ltd. (LFGR) Q4 2017 Earnings Conference Call March 1, 2018 4:30 PM ET

Executives

Shawn Milne - IR

Sean Moriarty - CEO

Jantoon Reigersman - CFO

Analysts

Jason Kreyer - Craig-Hallum

Operator

Good afternoon, my name is Christina, and I will be your conference operator today. At this time, I would like to welcome everyone to Leaf Group's Fourth Quarter 2017 Earnings Call. On the call with me today is Sean Moriarty, CEO; Jantoon Reigersman, CFO; and Shawn Milne, Investor Relations.

Shawn Milne, you may begin the conference.

Shawn Milne

Good afternoon everyone. On behalf of Leaf Group, welcome to our Q4 2017 conference call. I'm pleased to have Sean Moriarty, our Chief Executive Officer, and Jantoon Reigersman, our Chief Financial Officer on the call with me today.

Following the Safe Harbor statement that I will make, Sean will update you on our business, and then Jantoon will provide more details on our quarterly financial performance and key operating metrics. Any metrics discussed on the call without reference to a specific third-party source are based on our internal data. After the prepared remarks, we will open up the lines for Q&A. You will find a related release along with supplemental materials posted on the Investor Relations section of our corporate Web site located at ir.leafgroup.com.

Before we get started, we need to make the following Safe Harbor statement. We would like to remind everyone that during today's conference call, management will make certain forward-looking statements which are subject to various risks and uncertainties that could cause actual results to differ materially from our current expectations discussed in such forward-looking statements.

In particular, comments about our anticipated future revenue, earnings, operating expenses, operating metrics, and growth rates, as well as statements regarding our business strategy and objectives, plans, intentions, operating outlook, planned investments and the impact of recent acquisitions are considered forward-looking statements. Factors that could cause actual results to differ materially from anticipated results are detailed in our press release, furnished to the SEC.

I would like to point out that during the call, we will discuss certain non-GAAP financial measures while talking about the Company's financial and operating performance, including adjusted EBITDA and free cash flow. Reconciliations of these non-GAAP financial measures to their most directly comparable GAAP measures can be found in the financial tables included at the end of our press release. Lastly, I would like to remind everyone that today's conference call is being recorded, and that it is also available via webcast through the Investor Relations section of our corporate Web site. A replay will also be available on our Web site.

With that, I'll now turn the call over to our CEO, Sean Moriarty.

Sean Moriarty

Thank you, Shawn, and thank you everyone for joining us this afternoon. We appreciate the opportunity to share our fourth quarter results, and provide thoughts on our 2018 outlook. Additionally, our new CFO, Jantoon Reigersman, who joined Leaf Group on December 11th, will follow with more details on our financials.

On February 12th, we successfully completed our follow-on public offering, generating $23.3 million in net proceeds to the company, further bolstering our strong balance sheet. We are enthusiastic about our long-term growth opportunity as our brands continue to gain share in large fragmented markets that are rapidly moving online.

As we deepen and strengthen our house of brands, we are well positioned to serve this mass affluent customer base that includes an increasing population of millennials looking for digital-first lifestyle brands in our core categories. Saatchi Art, including The Other Art Fair, is increasing its online leadership position in the $57 billion art market, a market that is migrating online at a 20% annual pace. Society6, Deny Designs, and Hunker are well positioned in the $31 billion online home décor market as this category is significantly transformed by new online distribution models. LIVESTRONG continues to thrive as a leading health and fitness media brand, and we see increasing opportunity to drive growth in this $1 trillion-plus category.

In Q4, Leaf Group delivered 17% top line growth with revenue of $39.7 million, driven by 24% growth in marketplaces and 3% growth in media. In addition to strong top line growth, we drove significant margin improvements with EBITDA of negative $400,000 in the quarter, an 84% improvement year-over-year. Our Q4 results cap a 2017 in which Leaf Group returned to revenue growth and drove operating leverage while investing meaningfully in our leading brands.

In addition to delivering solid marketplace revenue growth in Q4, we focused on disciplined promotional activity at Society6, especially during the peak holiday period which continued to be marked by heavy discounting amongst big-box retailers. Our strategy paid off with 26% growth in marketplaces gross profit year-over-year in Q4.

Saatchi Art inclusive of The Other Art Fair had a great Q4, with revenue up 56% year-over-year. We continue our expansion of The Other Art Fair in 2018 with the launch of fairs in new U.S. cities including Los Angeles and Chicago. Our media brands continue to grow audience as content quality improves and social engagement increases.

Additionally, we continue to make progress on monetization as our new brands gain further traction in programmatic channels. Revenue for our core media business, which includes LIVESTRONG, Hunker, Cuteness, and eHow grew 14% year-over-year. In an environment where many digital publishers are being pressured by dominant online distributors and platforms, LIVESTRONG maintained its healthy growth in the quarter with revenue up 28% year-over-year, marking its eighth straight quarter of year-over-year traffic growth, and sixth straight quarter of year-over-year revenue growth.

LIVESTRONG continues to work with top influencers in health and fitness, reinforcing trust, and deepening engagement with its core millennial female audience. Overall, media segment operating contribution increased 38% year-over-year to $5.5 million. As we look ahead to 2018, we're well positioned to grow our portfolio of brands through key strategic objectives. First, we'll push deeper into the home décor market as we integrate Deny Designs with Society6, offering more great new products at higher price points, while driving cost leverage through combined scale. Additionally, marketing efficiency should improve significantly through dynamic pricing and continued focus on personalization, cross-selling, and up-selling opportunities.

On the media front, given the strength and growth in our core properties, we expect to drive further yield optimization, including growing our pipeline of branded direct revenue. Additionally, we will continue to seek opportunities to diversify revenue for our key properties. For example, LIVESTRONG's MyPlate app doubled the number of paying subscribers in 2017, and is on track to double again in 2018. Lastly, with our audience of over 50 million unique monthly average visitors for the quarter, we will increasingly connect our collective consumer base to relevant content and commerce opportunities across our brands.

At Leaf Group, we continue to pursue our mission of building creator-driven brands for passionate audience in art, design, and lifestyle categories. Our Q4 results further validate our strategy, and we start 2018 with healthy and growing businesses, a motivated and capable team, a strong balance sheet, and sustainable profitability on the horizon.

I will now turn the call over to Jantoon for remarks regarding the financials.

Jantoon Reigersman

Thank you, Sean. I appreciate this opportunity to share our Q4 financial results. The company's diverse portfolio of brands makes for an exciting opportunity, and I look forward to helping drive financial growth for Leaf Group.

On to our Q4 results, first, total revenue in Q4 was $39.7 million, up 17% year-over-year driven by 24% year-over-year growth in our Marketplaces segment and 3% in our Media segment. Second, adjusted EBITDA was negative $400,000 in Q4, an 84% or $2.2 million improvement versus the prior year period. Third, free cash flow was negative $1.8 million for the quarter, ending Q4 at $31.3 million in cash.

Beginning with our Marketplaces segment, Q4 revenue was $28.1 million, up 24% year-over-year. Q4 revenue growth was driven by a 21% year-over-year increase at Society6 inclusive of Deny Designs, and 56% growth for Saatchi Art inclusive of The Other Art Fair. In Q4, gross profit for the Marketplaces segment was up a strong 26% year-over-year on a GAAP basis, underscoring continued value creation in our Marketplaces segment.

As Sean previously mentioned, we focused on driving profitable revenue growth during the key holiday period and remained disciplined in our promotional efforts. At Society6, excluding Deny Designs, we scaled back discounts against a heavy promotional period last year. As a result, gross margin for Society6 was 28% in Q4, up 200 basis points year-over-year, with gross profit up 16% driven by increased efficiency in pricing and promotional strategies.

Saatchi Art had a strong quarter with revenue up 56% year-over-year in Q4, inclusive of revenue from The Other Art Fair. The year-over-year increase in revenue was driven by successfully expanding the number of fairs hosted by The Other Art Fair, improving traffic at Saatchi Art and the commission change we implemented online in Q2 2017.

Turning now to our Media segment, Q4 Media revenue was $11.7 million, up 3% year-over-year, and up a strong 6% quarter-over-quarter. Our core media business, which excludes our international sites and the wind down of our custom content business, grew 14% year-over-year, to $11.5 million, a strong 800 basis point acceleration from Q3. Revenue from Other Media, which includes our international sites and the former custom content business, was $200,000, down 85% versus prior year. We expect the wind down of other media revenue to become less of a drag on reported media results in full-year 2018. Total visits to our media properties in Q4 were 697 million, up 8% versus prior year. Approximately 55% of these visits came from mobile. The revenue per visits or RPV for our media properties was $16.73 for Q4, down 5% versus the prior year.

The drop in overall RPVs was an expected result of moving content away from eHow.com. We expect RPVs to grow in 2018 as we market our new sits through advertisers. On a quarter-over-quarter basis, RPV in Q4 was up a strong 6% driven by yield improvements on LIVESTRONG.com, and a seasonal lift from a strong holiday period. Q4 adjusted EBITDA improved 84% year-over-year to a negative $400,000 driven by expanded Media segment operating contribution, revenue growth, and expanded gross margins in our Marketplace segments offset by headcount additions. In Q4, Marketplaces segment operating contribution was $1 million or a 3.5% margin versus negative $100,000 a year ago. This reflects our continued focus on improving gross margin through disciplined merchandizing [indiscernible] set by continued investments in these young and growing platforms.

The Media segment operating contribution in Q4 was $5.5 million, up 38% year-over-year, representing a 47% margin, which is up 12 points from 35% a year ago. These improvements were driven by our efforts to further streamline the business and success in improving yield. Lastly, corporate operating expenses were $6.9 million or 17.3% of revenue, down from 19.1% a year ago. We continue to expect to realize significant leverage in our corporate overhead costs as revenue continues to grow. On February 12th, we completed the sale of 3.4 million primary shares at $7.50 per share generating net proceeds of $23.3 million for the company. We intend to use the proceeds for general corporate purposes and continue to screen the market for strategic and disciplined M&A.

As of December 31, 2017, we had federal net operating loss carry-forwards of approximately $190 million which expire between 2021 and 2037, and state NOL carry-forwards of approximately $65 million which expire between 2019 and 2037. The gross balance of these NOLs were not impacted by the recently passed new federal tax legislations. Finally, we reiterate our expectations to be profitable for Q4 2018 on an adjusted EBITDA basis.

That concludes the financial summary, and we will now turn the call back over to the operator to open the lines for any questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the Jason Kreyer from Craig-Hallum. Your line is open. Please go ahead.

Jason Kreyer

Gentlemen, good afternoon and thank you for taking my questions. Just wanted to start out with Jantoon, you've been there three months now. Maybe you can give me a little bit of a review on what you've seen so far, and your thoughts, and just some concept of some strategic priorities going through 2018 as you kind of take over the financial aspect of this?

Jantoon Reigersman

Hi, Jason. Thanks so much for your time. Thanks for the question. And look, I think there are two parts to the answer, one is a company answer and one is a personal answer. If you think of the company answer, so there are obviously many factors that I can mention, but I'm really going to focus here on four pieces. So one is, I think Leaf Group at the moment is just a unique company at a unique stage of its growth. After several years of really turning around the business, we're just at a stage where we can really have a significant growth going forward. And it's obviously very exciting for me to join at that time. The company has some incredible, valuable brands underneath them that are still young and growing, and have tremendous opportunity. And we have all the right talent in the firm to really exploit these brands properly.

And I think one of the things I knew coming in was the strength of the bench in the first, so the real strength of the talent base. What I did not realize was that I started digging deeper in the firm over the last effectively, call it 80 days, is how deep that bench went; also as you go lower in the organization. So really the quality of the people, the strength of the culture is tremendous, and allows us, I think, really well to execute upon the strategy that we're setting out, the strategy of really becoming market leaders within our different categories and thinking through the different way we're going to monetize this, and really set the company up for growth.

So, the other piece I also want to mention is that there are few publicly listed companies that are at this stage that we are in with the growth potential that we have, with the clean balance sheet that we have, and the opportunities ahead of us. And so for me personally to join at this point is very, very interesting. And to have a role where I can effectively where a capital allocator had, an investor had, an operator had all at the same time is very unique, so.

Jason Kreyer

Well, perfect. Thanks, Jantoon. I appreciate it. And on the Media segment, obviously a great improvement on a year-over-year basis, can you touch on the factors that drove the rebound? And then more specifically we've started to see some change in the add monetization, specifically at Cuteness. And so just wondering if you can touch on the ad monetization strategy of those eHow verticals?

Sean Moriarty

Hey, Jason, it's Sean Moriarty. Let me see if I could take at least the first part of the question around the improvements in media overall. Then perhaps Jantoon can provide some color on the improvements in ad monetization generally, but also specific to Cuteness, so a few things going on in the media business. We've been talking about this now I think for several quarters. LIVESTRONG, over the course of the past two years, has really turned into a very, very high quality fitness and wellness site. It has been growing consistently. So certainly as our single largest media business its continued strength benefits the overall segment, and we're super happy with that.

And secondly, and we talked about this quite a bit as well. We took eHow from a very broad-based general purpose site spanning some 24 categories, and have really focused it on as a DIY site, but at the same time launched these great new brands in these high passion categories. And over the course of the past year-and-a-half, and I think our most recent launch was less than a year ago, with Hunker in the Home category, those new sites we launched have grown very, very nicely from an audience perspective. And so the overall trend has been really strong. And the team, by the way, has done a great job going through a complex transition, building bright, shiny new brands that are not only growing audience but are capturing the attention of advertisers.

And then the longer that we're out there in the market with these high quality focused brands in these great categories we expect the company will be rewarded for it. And Cuteness is an example of that, right. The pets category is a very high passion category. There are many high quality advertisers and brands online, and Cuteness, with a very engaged audience and a very large one, is starting to captivate the attention of those advertisers.

Jantoon, to the extent that I missed anything with the specifics or about that monetization waterfall which we've talked about before, please…

Jantoon Reigersman

I think there are just two pieces to add, which is just in general. We obviously had increased traffic. We had higher monetization, not just on LIVESTRONG, but also within the programmatic channels of these new brands, right. So these new brands are building up. They're young, growing brands, and so we're getting better and better at monetizing these specific brands within these different channels. And we're very effective in how we go up and down within these channels to continuously optimize for our monetization stack.

Jason Kreyer

Thank you. Switching over to Marketplace, the nice increase in profitability on that segment, I would assume that was mainly driven by just the reduced promotional activity or I guess more disciplined and promotional. But if there's anything I'm missing there that you can touch on, that would be great. And then maybe you can talk about where that can scale to over time?

Sean Moriarty

Sure. Yes, Jason, it's Sean again. There is no question that the focus on promotional discipline even admits you know, pretty noisy continued promotional channel, pay dividends for us from a profitability standpoint. But I think it's as important as not more important to note that these are businesses that are scaling and growing nicely, and they have positive operating leverage. When you have healthy repeat buyers, when your core business is growing, then the profitability picture is going to improve as well. And so, we re focused on that right balance of good, solid operating discipline, particularly in a pretty noisy promotion-driven, channel-driven by Big Box retailers, but really healthy growth, because these businesses shift in very large categories, and we are very much at the beginning of the journey for these businesses. And so, we think it's responsible for us to balance that growth and profitability simultaneously. But certainly the effects we are seeing are just a consequence of the team doing a great job with promotional discipline. It's the overall growth in the business. And again, as I point out, that's because we've got healthy repeat customers that people come and buy from us once they're very satisfied with the value. They really appreciate the service. They know the differentiation of these models. We're doing things that other folks aren't doing. Certainly are doing as well. And so, the company has been rewarded for that as it should be.

Jantoon Reigersman

Yes, the other piece I want to add, because that's really based on the Society6, where the promotional activity obviously last year was greater and we pulled back from there in '17. On the Saatchi side, we've also seen a significant growth driven by an increased number of fairs, improved traffic, and also increase in average order value. So I think both platforms are really very focused on how we are growing and growing systematically in a controlled manner going forward.

Sean Moriarty

And Jason, I think you asked the question of where do we go from here, how big can these businesses get? And I think we operate these businesses in the near-term, but we have substantial significant long-term expectations. I think what I continue to point to, is the sheer size of the categories we are in, and then the differentiation of the businesses that we offer. So like, as we said on the call, the fine art category is $57 billion, it's massively fragmented and it's mostly offline. And we have an online leading brand in Saatchi Art, well, young brands is growing very, very nicely, and it's highly differentiated because it offers an emerging artist from across the globe to reach that audience of art lovers and collectors. And so, the long-term opportunity for these businesses is enormous. If you look at the Society6, again, this is an artistic community-driven platform, but it provides products in the home décor category, which in the U.S. online alone is $31 billion. So from a standpoint of headroom to growth, from a category perspective, there is not. In the quality of our execution, our products, our services and our discipline will really determine how much success we have within these categories, because there is plenty of room for these businesses to get a whole heck of a lot bigger and more profitable than they are today, and we are determined to achieve that.

Jantoon Reigersman

Yes, the only thing I want to add is that just a notion of looking forward is you'll never see us grow this proportion one year and then negative the next year. So we're really focused on systematic stable growth going forward, right.

Jason Kreyer

Perfect, thank you. Just the last one for me on marketplace; in the release you had mentioned some opportunities within your retail partners and wholesale opportunities, just wondering if you can give me just a little bit more detail on what your game plan is there?

Sean Moriarty

Yes, so because we have such good breadth of design, hundreds of thousands of artists and millions of designs, and the ability to take that design and put it on now over 50 products and over the course of the year that will expand considerably as well. We know that's as an attractive opportunity to work with retail partners who don't have nearly the flexibility to provide, particularly on a relatively quick turnaround, something that's new, exciting, fresh, and different. And so, at the high level we expect that there -- we know there will be opportunities to work with retail partners who are looking for that diversity of inventory can fulfill it on their own, and you know, Society6, Saatchi Art, and Deny Designs are great potential partners. So really that's the high-level concept. We'll provide more color as we go. Jason asked some specifics on who we are working with and how we are doing. In certain cases, that's limited by the nature of the relationship, and in some cases those conversations are early stage, but we will provide a more color as we go, because we believe it's a very large opportunity. They weren't almost uniquely positioned to address.

Jason Kreyer

Perfect. Thanks a lot, guys. I appreciate all the commentary.

Sean Moriarty

Thank you very much.

Operator

That concludes the fourth quarter 2017 Leaf Group's earnings call. Thank you for joining.