Leaf Group Ltd. (LEAF) CEO Sean Moriarty on Q1 2019 Results - Earnings Call Transcript

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About: Leaf Group Ltd. (LEAF)
by: SA Transcripts
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Earning Call Audio

Leaf Group Ltd. (NYSE:LEAF) Q1 2019 Results Earnings Conference Call May 8, 2019 5:00 PM ET

Company Participants

Shawn Milne - IR

Sean Moriarty - CEO

Jantoon Reigersman - CFO

Conference Call Participants

Maria Ripps - Canaccord

Jason Kreyer - Craig-Hallum

Henry Wang - Cowen

Operator

Good afternoon. My name is Christine, and I will be your conference operator today. At this time, I would like to welcome everyone to Leaf Group's First Quarter 2019 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 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. Any metrics discussed on the call without reference to a specific third-party source are based on our internal data.

You will find the letter to shareholders and a related release along with supplemental materials posted on the Investor Relations section of our corporate website 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 letter to shareholders, earnings release and our SEC filings. 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 letter to shareholders and 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 website.

A replay will also be available on our website. With that, I'll now turn the call over to our CEO, Sean Moriarty.

Sean Moriarty

Thank you, Shawn. Good afternoon, everyone, and welcome to our Q1 2019 earnings call. Before we jump into the Q&A, I'll provide a brief update. As many of you know, April was an eventful month for Leaf Group.

On April 15, we announced that the company had commenced a comprehensive review of strategic alternatives. The process is ongoing, and we will not be making further announcements until the Board has approved the course of action requiring disclosure. On April 16, Osmium unilaterally terminated their potential proxy contest with the company. We also announced that we have added Lanny Baker, the CFO of Yelp, to our board of directors.

Lanny brings a wealth of financial and operational experience in leading and advising consumer Internet companies and will be a great asset to us. I'm very pleased to welcome Lanny to our board. In Q1, while we delivered on multiple key initiatives and saw strong growth in several of our brands, we were not pleased with the overall business performance. Three main challenges impacted our business.

First, we experienced slower-than-expected growth of branded direct revenue in our media segment as we began to focus on much larger deals with longer sales cycles. Second, Livestrong's revenue was adversely impacted year-over-year by the August 2018 Google algorithm update. Third, Society6 results reflect the continued headwinds from a shift away from third-party marketplaces, international softness and ongoing promotional pressure. As we look forward, however, we see several positive trends that set the stage for stronger revenue growth in the second half of 2019 and 2020.

For instance, in Q1, our digital brand saw solid traffic growth, reaching more than 64 million monthly unique visitors and now ranked No. 51 in the U.S., up from No. 67 at the end of Q4. Leaf Group now reaches roughly a quarter of the U.S.

Internet population, providing ample runway for revenue growth and diversification. We saw a significant improvement in Livestrong traffic from February to March, and we believe traffic will continue to improve over the course of the year. Hunker ended the quarter as the largest single-site home brand in the U.S. at 11.5 million monthly unique visitors.

We also began to see the benefits of our new cross-platform sales strategy. In February 2019, we signed our largest-ever branded direct deal with Athleta, leveraging our combined fitness and wellness offerings. With respect to Society6, we have taken several important steps to restore growth. We made the decision late last month to seek new leadership for Society6 and are actively evaluating candidates.

In addition to ongoing product expansion, we launched our first fully localized site in Germany and plan to launch several more localized sites over the remainder of the year and into 2020. After integrating the Deny Designs, our Society6 B2B segment is delivering strong growth as our hospitality and retail partners are looking for unique and differentiated products. The Saatchi Art Group had a strong quarter in Q1, growing revenue 26% year over year. Our hospitality offering is gaining traction with designers and property owners and has tremendous growth potential.

The Other Art Fair posted healthy revenue growth with strong consumer demand at fairs this quarter in Los Angeles, London and Sydney. With that brief summary, we're now ready to take your questions. Christine, please open the line.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Maria Ripps from Canaccord.

Maria Ripps

It appears that Society6 third-party GTV declines accelerated in the quarter. Was that by design? Or what's driving that? And I think you'll be lapping the third P, the 3P transition impact starting this coming quarter. So as you went through this process of strengthening your direct relationships with consumers, can you talk about sort of underlying trends in volume and GTV, excluding the impact of third-party transition?

Jantoon Reigersman

Maria, this is Jantoon. So I'll take the first bit, and then I'm sure Sean will add something later. So let me answer your question first on the GTV impact of the 3P. So remember that we did a deliberate pullback last year, and the real first clean comparison you'll have year over year will be to Q3 this year.

And also remember that in Q1 of last year, so Q1 of '18, was effectively your high watermark. So if you think about, and this is probably in line with your second question. If you think about some of the data points for the quarter, right, so it's effectively third-party GTV is down 92% year over year. But again, this comes off the high watermark.

Internationally, there was a decline of 6%. But remember, we're now launching in Germany and starting to really focus on the international element. And then if you think about U.S. direct-to-consumer growth, it has remained consistent in the mid-single-digit range consistent with Q4 as well.

And then the other thing, I think, we highlighted in the letter is we are confident that we can get the growth back to historical levels. So if you think about it, it's really the third-party element that has been driving downwards. Overall, the business has remained steady, and we feel that we have ample opportunity to bring growth back in the second half of the year.

Sean Moriarty

Yes. Maria, I think Jantoon really did hit the high points. We've got, for every area, these headwinds we've identified, we've been working on now for a quarter or two, in some cases, a little bit longer. And certainly, while we are not happy with the performance, we know with good execution on each one of these fronts, we can get this business back to the growth rates that we've enjoyed historically and we believe the category presents for us.

We just got to keep doing the work.

Maria Ripps

Yes. That's helpful. And Sean, it seems like you've been live in Germany with a localized site for about a month now. Any early feedback you're able to share with us in terms of either traffic or sales volume pickup? And I know you expect sort of international growth recovery in the second half of the year, but sort of how should we think about international revenue progression through the balance of the year?

Sean Moriarty

Yes. So Maria, given that we're only four weeks in, it's too early. We're still testing and learning. That said, we're highly confident if you think about the pain points we are eliminating as we localize the sites.

So having local language support, making sure we address the top three or four methods of payment in a market, making sure that we're merchandising products that are not only high quality but we can deliver quickly to the customer. Every single one of those things we know is an obstacle to growth, and our localization efforts really allow us to solve for those friction points.

And we're very, very confident that certainly, over time, and we're talking quarters rather than years, we should be gaining meaningful traction as we localize these markets. The next step, once we've gone through this initial phase, which is probably a quarter or two after launch, when we really start to understand the behavior of the consumers within market, then we can really start to put the marketing effort behind those local customers in those specific markets.

So the other thing to keep in mind is this is very much test and learn right now. We're eliminating some of the basic friction points, but the real opportunity is going to come with market-specific marketing initiatives, which will pick up probably a quarter or two after each localized site launches.

Operator

Your next question comes from the line of Jason Kreyer from Craig-Hallum.

Jason Kreyer

I'm going to pivot over to media for a second here. Can you just explain the cadence of what you saw over the course of the quarter? One of the surprises on my end is the traffic numbers obviously had been under a little bit of pressure since the algorithm changed last fall. What we saw in Q1 seems to be a little bit more based on the RPV. So just wondering, I mean, is there anything specific that you can call out there?

Sean Moriarty

Yes. Jason, this is Sean. There's two pieces. First and foremost, as you spoke to, I mentioned it in our remarks, in the fitness and wellness offering we have today and with Well+Good and Livestrong we think allows us to really go after much bigger deals, deals that prior to putting the businesses together, we really couldn't compete for.

And so we did shift the strategy in the quarter to going after many of those bigger deals. And we think much of this is a timing issue. We, in retrospect, should have anticipated it, that larger deals are going to take a bit longer to close. But we're very, very confident over time in our ability to ladder up and get those larger deals.

But when those larger deals don't come through in a single 90-day period, as you might imagine, it can have significant pressure on RPV. The second part, as you point out, is that Livestrong traffic loss in the wake of that Google algorithm updated last August certainly has an impact in overall Media revenues. One thing I should call out, even though it's been several tough months since from an audience perspective, we had very, very healthy growth from February to March. I think we were up 30% in Livestrong audience.

And the team is doing tremendous work in getting that Livestrong business back to audience growth, which we believe is achievable, and we should see improvement over the course of the year.

Jason Kreyer

So just touching on the branded direct commentary a little bit. If we rewind a little bit, part of the reason for the Well+Good transaction was they really filled in a lot of the gaps as far as that branded direct offering. But correct me if I'm wrong, my understanding is that there wasn't as much of a mix tied to branded direct in the past, that that was going to be a strategic priority going forward. So maybe you can kind of frame the quarter in terms of did you walk, did you change the mix of advertising on the site kind of away from what you've been doing in the past and toward more branded direct and that's kind of what drove the surprise?

Sean Moriarty

Yes. No. Okay. Let me see if I can help you out on that because it's a good question.

So we, if you went back pre-Well+Good, if you go back a year ago, we had a fledgling branded sales team, and we're effectively selling the Livestrong property only in the fitness and wellness category. What we've done since is put those businesses together as a single group. We scaled up that branded sales team. Many of those sales professionals are also relatively new to the organization.

And we're going after bigger deals. So if you look at from a mix perspective, what happens when you ladder up is if you're spending more of your energy against those larger deals when before your bread-and-butter was much smaller deals and you really haven't expanded your sales force substantially and you've got a lot of new members, then there's the potential for a timing gap as you shift that revenue mix. We, in retrospect, were a bit optimistic that we'd be able to make that transition without much of a gap. But certainly, we're on the wrong side of timing.

Keep in mind though, we are very, very confident in the strategy and the approach. We signed our single-largest brand deal ever in February with Athleta who had actually been a prior customer of both brands. And the scope of that deal absolutely reflects the value of both of these brands in an integrated fitness and wellness offering. It would not have been achievable to get a deal of that size without both properties and common leadership.

Jason Kreyer

All right. I appreciate the color there. I'm not sure I asked the question the right way, but you answered it the right way. The last one just kind of on that topic.

If we look at the Media component outside of branded direct, maybe you can comment on what you're seeing as far as the trajectory of your programmatic advertising. Has that kind of been stable? Or did that cause a little bit of pressure as well?

Sean Moriarty

Yes. So keep in mind, there is some seasonality to Media businesses. Q4 is particularly strong. And Q1, particularly January, is a bit softer.

So that's something you should keep in mind, is just the inherent seasonality of these consumer-driven media businesses against the ad cycles of the advertisers that we typically have. The other thing I'd call out though is when you think about the flow-throughs on Livestrong in a world where its audience substantially declined last August and we're just now starting to recover traffic, the incremental traffic that we lost provides very, very high-margin revenue. And so you really have to factor that in your analysis, right? That incremental audience and those incremental dollars are extremely high margin on the edges. Jantoon, anything I missed there?

Jantoon Reigersman

No. So I am obviously agreeing with what Sean is saying. Just to reiterate, we just, it's mostly a Livestrong-driven delta rather than whether there's any issue around your ad stack, right? So the ad stack is performing very healthy. We'll keep on driving that up, and we feel that there's still ample room on the RPV side in the second half of the year as well.

Jason Kreyer

OK. In regards to just the traffic changes in February, March, is there something you're doing differently? Should we view this as a proof point that we are now starting to work through those algorithm changes in a bigger way and will continue that trajectory? So if there's any way you can frame that because it seems like not only was Livestrong really solid, but kind of up and down all your properties, you had really solid gains in March.

Jantoon Reigersman

Yes. So remember we're, I think there are a couple of things. So one is remember that when we did, when the algorithm happened, we also changed it from 85,000 to 55,000 articles right at the time. So we did a deliberate approach of repositioning Livestrong as a brand, number one.

Number two is we've also been doing investments in the content side of things. And these obviously, with the experience that we have as a company and the historical context of how to really drive traffic, these are important renovations that we're doing and we will keep on doing for the remainder of the year. So I think these are two important drivers of the strength of the platform that we have.

Sean Moriarty

And the other thing I'd add is the editorial strength. If you look at the leadership of Livestrong and Well+Good from an editorial perspective, it's absolutely fantastic. That team has been substantially upgraded since Well+Good has become part of the company and Alexia Brue has taken on a larger leadership position. Kate Spies, who heads up editorial, is absolutely fantastic and has built a wonderful team underneath.

It's really delivering. So our ability to really create high-quality, on-message, engaging content is much better than it's ever been before.

Jantoon Reigersman

Yes. And the same obviously applies toward Hunker as a brand that is also growing rapidly.

Jason Kreyer

Great segue into my last question. So just more strategically on Hunker. Can you talk about maybe the vision for that property, I don't know, maybe in near-term and a longer-term vision? It seems like this is a fantastic asset. I don't have a whole lot of perspective on how that's contributing today specifically.

But any more details on kind of blending media and marketplace components together there or something else strategic that maybe we're not thinking about?

Sean Moriarty

Yes. So it's been really just more than two years ago since we launched Hunker, and it's extraordinary that we've been able to build the business to this 11.5 million monthly uniques in the home category. But when we launched the site, what we saw, and really consistent with the Leaf Group mission, was the opportunity to build fresh, new brands, and as we talk about all the time, for those passionate consumers who wanted a brand that not only met them at their point of passion but that was really accessible, right?

If you think about our brands, they are high-passion brands, in high-passion categories, for really that aspirational middle-market customer, which is a really, really big audience. We've executed on that well with a site that can provide really interesting insights on architecture and design and interior decorating but also provide a lot of really functional information geared to the first-time or early cycle homeowner.

That's a big, big audience in the U.S. market. And that was the original branded editorial impulse, and it's hit home. I think, over time, we are going to be thinking about how we can turn it into much more of a platform, always having tremendous editorial credibility and great content but also taking that content and that inspiration and taking it a bit further and allowing people to get things done as we diversify revenues.

We're really in the revenue-building stage, Jason, on that business. It's primarily ad-supported with some sponsorship, and we're also experimenting with blending content and commerce from a lead gen perspective. So still somewhat early. But it's a wonderful, young brand, in a fantastically large category with lots of room for innovation, and we're figuring it out as we go.

But we agree with you. We think it's a crown jewel in the making.

Operator

Your next question comes from the line of Tom Champion from Cowen.

Henry Wang

It's Henry on for Tom. I'm curious how you're thinking about M&A for the rest of the year. Are you considering entering any new verticals or maybe just focusing mostly on ramping your existing portfolio?

Sean Moriarty

Tom, it's a great question. As we've talked about, M&A, accretive, strategic M&A is really core to our strategy. At the same time, as I said earlier, we're not satisfied with the results of this quarter, and we believe that M&A is best used to expand our market leadership in the categories that we're in from a position of strength at the core.

And so our focus primarily right now, while we continue to have a very healthy and active M&A pipeline and we expect that to continue, we want to make sure that we've got this Leaf Group platform and our businesses all performing at the levels that we expect for them.

So our focus on our priority at this point is to get these businesses all performing at the levels that we expect and you should expect from them.

Henry Wang

Got it. And just curious if you'd give some more color on what might have driven the softness in international GTV this quarter and maybe what your top growth initiatives are for international looking forward.

Sean Moriarty

Sure. So from a macro perspective, particularly with the UK being a meaningful international market, Brexit I don't think has helped any kind of U.S. based global digital commerce players in the UK Western Europe also, we're not the only ones to note some broad market softness.

But I think the biggest challenge is one that's within our direct control, which is if we are going to be engaging customers across the globe, we need to be able to do that in their native language with their top methods of payment, merchandising those products that resonate most deeply with that audience and then being able to deliver those products, high-quality products, to them very, very quickly.

And so despite the fact that there is some macro headwinds, which kind of always comes and goes in businesses like this, our job is really to make sure that if we're going to operate a global platform, that our businesses are as relevant and as are easy to use and consumer-friendly in every single market that we offer as they are in the United States.

And that needs to be the bulk of our effort. We're highly confident despite any macro trends, these are young businesses with lots of room to grow, and if we're delivering for customers in the way that we should be, that we should be able to grow through some of those macro headwinds that emerge from time to time.

Henry Wang

Got it. And just the last one for me. Just curious, do you had any updates on the promotional environment for the Marketplace side of the business? I know in the past, you've mentioned that's a pretty iterative process, and you've run tests around discounts and free shipping. And I was wondering if those had any impacts on the business.

Sean Moriarty

Yes. So we definitely, and I think this is true for many folks like us in an age of near-instant delivery at least from the big commodity platform e-commerce players. We've increased our shipping promotions because it started to become an expectation, that you get even personalized, custom-made-for-you product pretty darn quickly. And at the same time, we're doing an awful lot of work on pricing optimization because realistically, pricing and promotion should go hand-in-hand.

We think there's an awful lot of room to not only maintain but improve margin. Still sending the right signals to consumers around promotions in a world where it has unfortunately become for virtually every e-commerce player a bit of a buy signal without giving up too much margin in the process. And so we're doing an awful lot of work with our promotional calendar, moving toward more dynamic pricing. And over time, and this doesn't get done overnight, but over the next few quarters, we should make real progress there and just become a much smarter merchandiser, pricer and promoter in the products that we offer.

We know we're offering differentiated, unique, often one-of-a-kind products through our Marketplace brands which should give us a lot of room as we become more sophisticated and the platform becomes more capable to deliver stronger financial results for the business.

Henry Wang

Great. Thanks, guys.

Operator

There are no further questions at this time. That concludes the Q1 2019 Leaf Group earnings call. Thank you for joining.