Fluent, Inc. Q1 FY2021 Earnings Call

Good afternoon and welcome to the Fluent Inc First Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would like now to turn the conference over to Ryan McCarthy. Please go ahead.

Good afternoon and welcome. Thank you for joining us to discuss our first quarter 2021 earnings results. Joining me on today's call are Fluent's CEO, Ryan Schulke, and our CFO, Alex Mandel. Our call will begin with comments from Ryan Schulke and Alex Mandel, followed by a question-and-answer session. I would like to remind you that this call is being webcast live and recorded. A replay of the event will be available following the call on our website. To access the webcast, please visit our Investor Relations page on our website, www.Fluentco.com. Before we begin, I would like to advise listeners that certain information discussed by management during this conference call will contain forward-looking statements covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements made during this call speak only as of the date hereof. Actual results could differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the company's business. These statements may be identified by words such as expects, plans, projects, could, will, may, anticipates, believes, should, intend, estimates and other words of similar meaning. The company undertakes no obligation to update the information provided on this call. For a discussion of the risks and uncertainties associated with Fluent's business, we encourage you to review the company's filings with the Securities and Exchange Commission, including the company's most recent annual report on Form 10-K and quarterly reports on Form 10-Q. During the call, we will also present certain non-GAAP financial information relating to media margin, adjusted EBITDA, and adjusted net income. Management evaluates the financial performance of our business on a variety of indicators, including media margin, adjusted EBITDA, and adjusted net income. The definitions of these metrics and reconciliations to the most directly comparable GAAP financial measure are provided in the earnings press release issued earlier today. With that, I'm pleased to introduce Fluent's CEO, Ryan Schulke.

Thank you, Ryan, and good afternoon. Thanks to everyone for joining us today. As I shared with you on our last call, mid-March, Fluent operates in a dynamic and rapidly evolving marketplace, and we see a clear long-term strategic opportunity in further responding to the demand for higher quality digital experiences for consumers and more effective and sustainable solutions for marketers. In turn, we're motivated and energized as we thoughtfully accelerate the strategic transition of our business, where quality is a foundational principle. Through this process, we're committed to enhancing our media properties and consumer experience against an industry backdrop that is experiencing rapid change in many ways, including through a regulatory lens. We see the end game as delivering a fundamentally higher quality experience for consumers, which will enhance Fluent's brand equity with our clients and build enterprise value for our stakeholders. I previously contextualized this transition relative to our three strategic growth pillars. The significant progress we've made on-boarding and scaling larger, more sophisticated clients on our performance marketplace and increasing the monetization on our platform has motivated us to further redefine our media footprint in the form of our traffic quality initiatives. We see higher quality as the road to sustainable long-term growth and believe it will position us as an industry leader. Even though in the near term, we're knowingly foregoing some revenue opportunities, our earnings released today reflects revenue being down 11% year-over-year, media margin up 4% year-over-year, and adjusted EBITDA representing 7% of revenue. All of these metrics are consistent with the ranges we indicated on our last call. To further elaborate on our traffic quality initiative, we're shifting from a higher volume approach to a quality-based approach, which we believe will accomplish several important objectives. These objectives start with improving consumer satisfaction with Fluent's promotional programs, thereby improving conversion rates and ROI for our advertiser clients, driving increased pricing for our products, and ultimately enabling us to reinvest that incremental monetization into further improvements in our media sourcing. This represents the spinning of our flywheel. Putting some time context around this initiative, in the latter part of 2020 and in Q1 of this year, we cut back more significantly on traffic sources that did not meet our quality requirements, which sits at the crux of the reduction in our revenue in Q1. While we actively monitor traffic on an ongoing basis, we believe the steepest of cuts needed at this time are behind us. That said, given the traffic adjustments to date and the time needed to develop partnerships with those who are as committed to quality as we are while concurrently on-boarding and optimizing new supply, we do anticipate revenue in Q2 to be down year-over-year. While it's still early to call, we're currently anticipating revenue in Q2 trending similar to what we called for Q1, down 11 to 13% year-over-year. I shared on our last call that we anticipate the strategic transition will take a couple of quarters to re-establish prior trending levels and we continue to maintain that outlook, the natural cadence of these traffic initiatives, which are a known phenomenon in our industry. It's now net rebuild our supply base through both expanding existing partnerships and activating new partnerships, channels, and strategies to drive our rebuild. On this partnership front, we're leaning in with existing and new media partners who are aligned with our focus on quality and share our vision for building sustainable and profitable businesses together. We're working to forge deeper, more strategic sourcing relationships, where we can innovate, develop bespoke campaigns, and invest our time and energy in redefining our media footprint with confidence. There will be an exciting return profile on our efforts. On the media front, we're seeing compelling opportunities in areas we already belong and new channels and strategies that this initiative has prompted us to bet. Although it's early innings, we see green shoots in our rebuild base to demonstrate how important the strategic imperative is for Fluent. I'm personally leading our quality initiative along with two key co-founding executives, Matthew Conch, president of our performance media group, and Sean Colin, our executive vice president of product. We've been energized by our experience to date. As we can clearly see that redefining our media supply will open up significant strategic product opportunities that can further expand and deepen our addressable consumer audiences and overall market opportunity. Regarding our second growth pillar, our platform, I mentioned on the last call that monetization has increased significantly in 2020, approximately doubling from Q1 to Q4 and we saw that as a sustainable win. Monetization remains strong in Q1 of 2021 and continues to remain strong in Q2. This implies that as we build back our traffic supply, even smaller volume winds can have a more meaningful financial benefit than they would have a year ago. Another aspect of our platform I've spoken to is the expansion of our CRM efforts through which we have extended our relationship with consumers beyond their initial experience on our media properties and enhanced their lifetime value. A key initiative on this front has been our investment in the monopoly business, which is uniquely situated to provide telephony activations for Fluent clients through a live agent capability. You're seeing that business perform ahead of plan and grow strategic partnerships with clients in high-value verticals including senior care, financial services, and home services regarding our third pillar: our performance marketplace. We continue to see world-class brands leaning in with strong demand that will exceed our available supply. This strength further supports our efforts to redefine our media footprint. Fluent provides an innovative, high-value solution that addresses a massive market opportunity; the quality of our client base and demand from them validates this seven days a week. I'd like to restate that we're enthusiastic about our strategic course, and it remains our core tenet behind the current transition we're working through. Fundamentally, we're confident that the higher quality model we are forging is the right path to achieving substantial and sustainable growth while generating a revenue and earnings profile that will be more highly valued by the market. Our experience through this transition thus far confirms our confidence in the mission; we remain diligent in enhancing our brand equity, improving our own standards for the benefit of our clients, consumers, and shareholders. And with that, I'll turn things to Alex for the detailed financial review.

Thanks, Ryan, and good afternoon. Our team, led by Fluent's founding executives, has been focusing on driving the strategic transition of our business through our traffic quality initiatives. The outlook we shared for Q1 reflects a strategic investment into redefining our media footprint. The company generated $70.2 million of revenue during the quarter, which is a decline of 11% year-over-year but aligns with our projected outlook. We have noted improvements in monetization on our platform beginning in 2020, continuing into 2021. Our media margin for Q1 was $24.9 million, representing 35% of revenue, which is up 4% year-over-year, exceeding our expectations. The media margin benefited from strong monetization, alongside advancements in our programmatic data offering and CRM strategies aimed at enhancing consumer lifetime value. In the second half of 2020, as we tested design enhancements in our rewards programs, we faced higher costs associated with fulfilling rewards for consumers. While these fulfillment costs were not included in media margin, they are considered in our GAAP cost of revenue. Though fulfillment costs moderated in Q1, the improved media efficiency that positively impacted our media margin was offset by additional fulfillment costs, leading our cost of revenue as a percentage of revenue to rise to 72.7% in Q1 compared to 71.7% in the same period last year. We expect a further reduction in Q2 fulfillment expenses, which should positively affect costs of revenue and adjusted EBITDA. Operating expenses on a GAAP basis for Q1 increased by $1.5 million or 9% year-over-year to $19.3 million. However, this includes $1.7 million of non-cash accrued compensation linked to the monopoly acquisition, which is an incremental addition to G&A costs. If we exclude this item, overall operating expenses were relatively stable year-over-year. Last week, Fluent reached a settlement agreement with the New York Attorney General, finalizing this matter as disclosed in our SEC filings starting with the 2019 10-K. We will make the $3.7 million settlement payment this month, which was fully accrued as of December 31st, hence it does not impact our current or future profit and loss. Our adjusted EBITDA for the quarter was $4.7 million, about 7% of revenue, consistent with our previous outlook. We closed on a new $65 million credit facility on March 31st, which appears on our balance sheet but does not significantly impact our profit and loss for the quarter. This facility includes a $50 million term loan and a $15 million unfunded revolver, reducing our effective interest rate by 500 basis points, resulting in decreased interest expenses in Q2 and beyond. This facility also provides considerable financial flexibility and extends our debt maturity to 2026. As part of this transaction, we reported a $3 million loss on early debt extinguishment on our profit and loss account, including a $2.2 million non-cash write-off from capitalized discounts and financing costs from our prior loan. In Q1, we remained a non-cash federal taxpayer due to available NOLs, reporting a GAAP net loss of $6.3 million and an adjusted net income of $351,000, with our non-GAAP metrics detailed in today's earnings release and the 10-K filings. On the balance sheet, we ended the quarter with $34.1 million in cash and restricted cash, and our working capital, defined as current assets minus current liabilities, increased to $45.8 million, up $13.1 million year-over-year and $9.9 million sequentially. Total gross debt as of March 31st was $51.25 million, including the $50 million term loan and a $1.25 million note from the 2019 AdParlor acquisition, expected to be funded on July 1st. As we work to enhance the value of our customer acquisition solutions for clients and create value for stakeholders, we appreciate your support. Our strategic direction is based on the belief that a higher quality model will foster significant and sustainable growth, though immediate financial results will reflect this transition. We aim to improve Fluent's value proposition and brand equity, leading to a revenue and earnings profile that attracts greater market valuation. I am now happy to address any questions you may have.

We will now begin the question and answer session. To ask a question, please press star one on your telephone keypad. And our first question will come from Michael Graham of Canaccord. Please go ahead.

Yeah, thanks so much. And appreciate you guys taking the question. I think it's impressive and a good reflection that you're able to grow your media margin, even when revenue is coming down from the traffic quality initiatives. I had just a couple of questions to kind of maybe dive a little deeper into that initiative. One is can you just maybe put any color around, I know you said you think that the peak of the traffic cuts is behind you. Can you put any color around how much longer you think you need to kind of work through the initiatives? And I also just wonder if you might be able to characterize a little bit for us how much traffic has come down from sort of peak levels and where you think that that process bottoms out?

Yeah, nice to connect with you, Michael, and appreciate the question on the traffic quality initiative. So really, as we've been talking about it and per the last earnings calls, we did say we'd probably take a couple of quarters to get back to a prior trend level. So we are anticipating a stronger back half as we really start to strategically partner with both existing partners that are adhering to our traffic quality and compliance standards, as well as new partners that we're onboarding. There's a bit of an investment period in the sense of going out and establishing new relationships and testing into new types of channels and strategies. But we're seeing nice progress on that front and something that we do anticipate will take greater shape in the back half of the year. With respect to overall traffic volume, there are a couple of different ways to look at it. One of the things we highlight is that from Q1 of 2022 to Q4, we almost doubled the yield per visitor that we make users that we drive to our properties. So if you think about the 11% figure in terms of revenue, traffic actually went down quite a bit more than even that 11% number, but we're making a lot of it back through higher quality experiences and advertisers beginning to pay up for that. It does take some time for advertisers to recognize some of the quality that they're seeing and to pay up for it. But those are active conversations we're having, and we are seeing a material amount of movement with respect to clients, quote unquote, bidding up for our performance inventory.

Thanks for that, Ryan. And just to clarify, I know you, even with revenue down 11%, you had nicely positive EBITDA in the quarter. Then are you anticipating that condition persisting here as we go through the remaining quarters of the initiative?

I would say that we're willing to sacrifice a media margin dollars to really get strategic footing in the right places that are going to sustain over time and have a lot of scale behind it. So we will take a bit more of an aggressive attitude toward securing inventory and doing what we have to do, even at the expense of media margin. However, we will maintain a fairly disciplined approach to overall operating expenses below that media margin line to ensure that there's continuity with respect to the amount of revenue flowing through to the EBITDA.

Thank you. Next question comes from James Goss - Barrington Research Associates. Please go ahead.

Thanks, Ryan. Could you talk a little about what has been cut to this point and are other areas still on the block? And maybe what the new business mix looks like in the aftermath of the traffic quality initiative?

Yeah. Nice to hear from you, Jim. And I would say that it sort of falls into two buckets. One being publishers, supply side partners we were working with that either the type of content we were being featured within or the way they would run ad creative, or their lack of controls around ad creative was a big part of the conversation. So partners just not willing to adhere to certain guidelines that we outlined. And then secondly, maybe more importantly, any concerns that we had around consumer data, consumer privacy and things like that. Partners who were not adhering to where we really believe the market is going with respect to consumer privacy and data policies in general. Those were the sharpest cuts. I would say there's nothing I'm aware of that we haven't cut. And we're eager to be forging the path forward with the partners that are still with us, as well as the new ones we've been onboarding quite actively over the last few months.

So it didn't involve the verticals or serving the media or home services, as you mentioned, are those sort of things that rather involved which avenues you're using to promote the services you're choosing to promote?

Right. It represented publishers, even specific channels and ways to go out and get our ads in front of the general public to drive traffic to our property. So it's not a specific vertical to point to that would have been impacted more than another, for instance, at our core.

Can you discuss whether there are any global impacts as you've managed to enter certain European markets, particularly in that region?

We're doing a solid job in English-speaking markets; that certainly is something that we've focused on and will be a continued focus for scale. The English-speaking markets the EU is something that we haven't talked about in quite a bit, though we are re-examining how we may approach especially the Western European market and potentially things beyond that such as APAC. I would, I don't have anything to announce at this point. However, we are continuing to perform very strongly in new English-speaking markets. We do need to rejigger some thinking around how to better enter the Western European.

Okay. And maybe lastly I think you made a comment about the better half, second half looking a little bit better. So are you thinking the entire initiative will only take a couple of quarters to run its course, which was sort of the optimistic kind of thing of what you said several months ago?

Yeah, we do believe that we have good momentum, especially as we get toward Q3 and Q4. We believe that a lot of this is behind us. The company has been designed, and the culture is extremely agile. Our client demand is extremely strong right now. So as we lean into these higher quality suppliers and channels and different strategies on the product end, that we're deploying to go out and engage consumers, the conversations are happening more rapidly with our partners around quality, the ability to pay higher rates for some of these new traffic sources that we're onboarding. We anticipate that we'll be able to scale; nothing has changed materially in terms of our product outputs and our clients' demand for our products. It really is a couple of steps backward to be able to make many, many steps forward over the long term, and that's really how we're thinking about this. We believe that the back half will be stronger than the first half.

Next question comes from Bill Dezellem of Tieton Capital Management, please. Go ahead.

Thank you. I'd like to start with the contact center, exceeding your expectations. Would you please discuss that? And if it in any way ties in with the traffic quality initiative?

Yeah, Bill, good to hear from you. And we certainly are excited about that transaction and monopoly in terms of where things have gone. Fluent had historically been excellent at web-based execution. So if you think about the business in terms of how a consumer looks at the products and services that we're promoting on behalf of our advertising clients, we are really strong, as we've always said, in media and entertainment, such as streaming services, gaming, things like that. Also, a lot of direct-to-consumer commerce and subscription commerce, where it is a lower cost consideration for the consumer and therefore we're driving those trials that are converting into paid trials. Our advertising clients can see that in near real-time, and therefore there's a ton of demand there. Pre having the live agent capability in some of the more complex verticals like financial services, home services, and other types of professional services like legal or senior care products, we really weren't able to take consumers as far down that funnel without the live agent capability. These are more complex decisions and consumers are looking for more information. So that capability enabled us to partner and go further down the funnel with major players in these verticals and work with them to even an end sale or some sort of appointment set. Prior to having the live agent capability, we'd probably be working with them at some sort of qualified lead that we would drive or something like that, which results in more cap-based budgets. Also, with the CRM hooked in, we now are able to see which consumers are actually traveling that journey. They're qualified and motivated to purchase, whether it's a home security system or whatever the product or service may be that we're offering to them. We actually have real-time data flowing into us, so we know which consumers are converting on these types of higher value offers and products and services. So it's really been a boost from our standpoint in terms of the commercial outputs.

That's helpful. And what do you think is driving that when monopoly business exceeding your expectations?

I think it's been a combination of being able to just go further down the funnel and see it. Whereas at a prior stage, we really weren't able to take consumers that far down without the live agent capability. These are more complex decisions. Consumers are looking for more information. So that capability enabled us to start partnering and going further down the funnel with major players in these verticals and work with them to even end sales or some sort of appointment set. Whereas before we had the live agent capability, we were probably working with them at some sort of qualified lead that we would drive or something like that, which results in more cap-based budgets. Also, with the CRM hooked in, we now are able to see which consumers are actually traveling that journey. They're qualified, motivated to purchase, whether it's a home security system or whatever the product or service may be that we're offering to them. We actually have real-time data flowing into us, so we know which consumers are converting on these types of higher-value offers and products and services. So, so it's really been a boost from our standpoint in terms of the commercial outputs.

That's really helpful. And then I too will jump to the traffic quality initiatives. As I think about this, we really should be looking at it on a week-to-week, so sequential week basis. It sounds like, and assuming that characterization is accurate, have volumes of bottomed now?

Yeah. I mean, you can never say anything with 100% certainty, but from our point of view, we've worked through the traffic quality initiative. Anything that we were looking to move away from, we've really completed that. And we're looking at rebuilding better, as they would say. So, you know, I can't make an official call. However, I can say we have gone through things on our side and feel good about the types of traffic we are sourcing and the future partnerships we're establishing at the moment.

That's helpful. And I know it's a little bit hard to pinpoint a specific time, but I'm going to ask it anyhow. What week or weeks was the bottom reached when you cleared out all of the traffic you wanted to move away from?

Yeah, I'd say, you know, this type of initiative does have a life of its own, and it is very real-time, but I would say as late as the last week or two, we were, you know, upon review satisfied with where we were at. Not to say something couldn't pop up, but we've been fairly robust in terms of how we've gone about this. Will we get some potential false positives where we think a new source is doing great, but there's some things that we need to address from a consumer satisfaction standpoint, consumer experience potentially? But we really do believe we're working on a lot of the right things right now and beginning to establish some momentum behind it.

That's helpful. Given that you've provided the same guidance, the 11 to 13% decline in revenues, that implies that you kind of went through the first quarter in a bit of a week-to-week downtrend, but you're going to be coming out of the second quarter in that week-to-week uptrend. And so we're kind of looking now at the light at the end of the tunnel?

Correct. Yeah, that's an accurate summation.

Great. Thank you. And if you'll allow me, I'm going to ask one more question on this. Are there examples of other companies who have done similar traffic quality initiatives? And if there are, would you talk about their longer-term outcomes and what that ultimately meant for their business?

Yes. I've played less directly with some of the companies that have gone through these types of initiatives, but it is something that happens in our space. I know that Alex, being the former CFO of Lending Tree, is aware of a couple of his former competitors who went through initiatives like these. I'd love for him to maybe share a little more detail here. There are companies in our space that have gone through these types of initiatives. You're correct. Some historical examples going back to 2012 would include companies like Bankrate as they worked through lead quality initiatives in respect of a specific client vertical which related to insurance. Quinstreet also had a similar experience and addressed that with educational leads and another company, EverQuote, improved its traffic quality in 2018. We have seen other companies go through this, and that supports my earlier statement during the recorded remarks about this being a known phenomenon within our industry, and those companies have gone on to have successful uptakes from those various initiatives. They take different amounts of time and have different sets of circumstances, but in each case, those were companies that were able to turn the corner and make meaningful gains both operationally and in their stock prices in the 12 months following those initiatives.

Great. Thank you both. And congratulations on the refinancing.

This concludes our question and answer session. The conference has also concluded. Thank you for attending today's presentation, and you may now disconnect.