Fluent, Inc. Q1 FY2024 Earnings Call

Good afternoon, and welcome. Thank you for joining us to discuss our first quarter 2024 earnings results. With me today are Fluent's CEO, Don Patrick; Interim CFO, Ryan Perfit, and Chief Strategy Officer, Ryan Schulke. On our call today, we'll begin with comments from Don and Ryan Perfit, 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 at 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 provision 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, 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, management will also present certain non-GAAP financial information related to media margin, adjusted EBITDA and adjusted net income. Management evaluates the financial performance of our business on a variety of indicators, including these non-GAAP metrics. The definition of these metrics and reconciliations to the most directly comparable GAAP financial measures are provided in the earnings press release issued earlier today. With that, I am pleased to introduce Fluent's CEO, Don Patrick. You may begin.

Good afternoon. Thank you all for joining our call today. I'm here together with Ryan Schulke, our Chief Strategy Officer, Chairman of the Board and company Founder; and Ryan Perfit, our Chief Financial Officer. I'll make some brief comments about our first quarter results that reflect the strategic pivot we are making in evolving our 2024 growth strategies, focused on leveraging our leadership position in owned and operated marketplaces as a competitive advantage. In concert, a proprietary technology platform is proving to be an effective springboard from our owned and operated marketplaces into new high-volume, high-growth syndicated performance marketplaces that we believe represent long-term strategic runway that will ultimately be margin accretive to the core. In the earnings release today, we reported quarterly results that continue to demonstrate meaningful progress in our new performance marketplaces while also reflecting our post-FTC settlement transition with the corresponding impact on our owned and operated marketplaces business and financials. Overall, our financial results remain consistent with the road map we laid out in previous earnings releases. Our first quarter financial results were as follows: revenue of $66 million, which represents a 14.6% decline versus Q1 2023. These results were driven primarily by the impact of our FTC settlement and related strategic and financial decisions impacting revenue streams that we felt were no longer strategically compelling or did not meet our evolving quality standards in our owned and operated marketplaces. Revenue results were positively offset by the new performance marketplaces, continuing to accelerate with strong double-digit growth, albeit off a smaller base. Our media margin of $22.1 million was an increase of 1% year-over-year versus Q1 2023. At 33.6% of revenue, we saw media margin increase almost 500 basis points from 28.6% last year, consistent with our strategic plan and a direct reflection of shifting our business mix to a higher margin performance marketplaces. Adjusted EBITDA of $0.7 million represents 1.1% of revenue, reflecting seasonality as well as our continued investment in what we see as a strategically compelling market-proven and sustainable growth agenda. As outlined in our last earnings release, we expect to see year-over-year revenue decline in the first half of 2024, given: one, the residual impact of exiting our nonstrategic businesses, which won't be fully cycled until the second half; and two, our new performance marketplaces, which while still growing aggressively year-over-year, will have sequential quarterly declines based on the high seasonality of the verticals we presently serve. To be clear, we're ahead of expectations on our new performance marketplaces. Our foundational strength in owned and operating marketplaces provides us valuable access to consumers where we build meaningful relationships that are very attractive to our world-class brand partners. Fluent's performance pricing model provides our partners with a differentiated marketplace that meets their customer acquisition growth needs while being strategically aligned with their goals. The revenue margin pressure on our owned and operated marketplaces are being driven by three significant headwinds, two ongoing and one new. In previous earnings releases, we've detailed one, the impact of our post-FTC settlement; and two, continued macroeconomic headwinds that our advertiser clients continue shifting their consumer acquisition strategies to a clear prioritization on return on ad spend given the consumer volatility in the market. Our strategic adjustments to these headwinds have been grounded in our commitment to enhance the quality of our consumer experiences relative to the engagement and satisfaction with our owned and operated marketplaces while driving higher quality outcomes for advertisers. Our third headwind is that in spite of the fact that Fluent has led the industry in establishing and executing leading-edge protocols, which we believe are the best-in-class model for the entire industry, we are seeing certain competitors accelerate activity via noncompliant marketing practices that violate the FTC Act and guidance. In the immediate term, these noncompliant competitive practices put us at a market disadvantage in scaling certain media channels. We are not naive. And we certainly expected some competitors to try to financially take advantage of the situation, albeit at their own business and regulatory risk. But we also felt the FTC would more expeditiously and aggressively address the noncompliant marketers across the industry. It remains our view that these practices by our competitors will not continue indefinitely, and the FTC enforcement along with our regulators at the state and federal level and a very active class action plaintiff bar will eventually eliminate the troublesome practices of some of our competitors and level the playing field. Regardless, our strategic resolve remains as we've seen in the near-term financial impact as an investment in distinguishing our brand in the market and creating a distinct competitive advantage. Given the realities of the current market, we will continue to deemphasize growth of our owned and operated marketplaces and manage expenses over the next several quarters until our competitive set accepts and appropriately responds to the new FTC requirements. The strategic growth engine of our business is grounded in our performance marketplaces, and we're accelerating the Fluent brand into very large marketplace opportunities that unleash our core capabilities in dynamic and growing markets. To date, we've established vertical expertise in health, retail and ticketing. Those businesses are more seasonal than our owned and operated marketplaces, which have impacted our trend line in the quarter. While we are coming to the stronger season, we will continue to grow market share, which will have Fluent Enterprise returning to year-over-year growth in the second half of 2024. Our AdFlow and call solutions performance marketplaces are both driving strong double-digit revenue growth. We expect these businesses to continue to scale, become more meaningful bottom line contributors, and we're excited by the early success. AdFlow is our media solution we launched in the large and rapidly growing commerce media market, a market that is expected to reach $150 billion by 2030. Currently, 43% of U.S. brands have commerce media budgets and that is expected to increase to 75% by 2025. We're headed to where the puck is going and our foundational AdFlow strategies continue to show dramatic year-over-year revenue growth driven by new partner wins, which are enabled by leveraging our proprietary technology, machine learning and data platform capabilities that have yielded excellent results in these dynamic marketplaces. We're excited by these early results as they represent a new and growing opportunity for world-class brands to reach consumers seeking higher quality engagement at the optimal purchase moment. Year-to-date, we've added new AdFlow partners in both retail and ticketing while also expanding into the grocery vertical. We expect this growing business will provide us broader brand partners access as we scale. We also see significant breakthrough before us that we'll detail further next quarter where we are now working with our commerce partners to expand the marketplace, see our AdFlow solution to expand beyond post-transaction, to include enhancing consumer engagement, retention and loyalty across our partners' commerce platforms. In our call solutions business, we've proven our operating model and established our financial metrics and our new business extension in the heart of the health vertical focused on the Affordable Care Act market. Our business is growing double digits, and we'll continue to scale our vertical market expansion by growing existing partners and adding new partners who are already recognizing our competencies. ACA is a high-sequential and high-growth opportunity where we believe Fluent can differentiate ourselves within a highly fragmented market. We find this attractive strategy, given the margin potential exceeds the Fluent core. Importantly, our performance marketplace go-to-market model remains highly differentiated from the competitive set. We're uniquely positioned in the industry to leverage the inherent analytical capabilities we've established over a decade with our owned and operated market platform. So while our market-leading owned and operating marketplaces continue to stabilize, it essentially enables and fuels our pivot into higher-quality consumer engagement. We are quite enthusiastic regarding the strategic and financial roles that our performance marketplaces are playing in our longer-term growth agenda. Importantly, as we grow market share, margin accretion will follow. We will continue to make strategic bets and investments, building higher quality digital experiences for our consumers while creating more effective and sustainable customer acquisition solutions for our clients. Our solution set is dramatically strengthened and our performance marketplaces are bringing thoroughly endorsed by our brand partners, the signature of marketplace credibility. We are confident that we're elevating Fluent's brand equity position within the industry. Moving forward, we're targeting growing revenue from our emerging businesses by greater than 50% in 2024, which should have Fluent returning to year-over-year consolidated growth in the second half. Importantly, as we enhance our market position, we are confident that we'll begin growing our total gross profit more rapidly than our revenue in the back half of the year. To date, we are ahead of expectations in our new performance marketplaces. And with that, I'll turn to Ryan Perfit to provide more detail on our financial results.

Thank you, Don, and thanks to everyone for joining us today. I'll now provide some additional color on our Q1 earnings. In Q1, we generated $66 million in revenue, down 15% from prior year and down 9% sequentially from Q4. As expected, our owned and operated marketplace business continued to experience the effects of a challenging macroeconomic environment and changes in business practices to reflect regulatory requirements in connection with the FTC consent order. These challenges influenced sequential reductions in spend by key clients in the media and entertainment, retail and consumer, and staffing and recruitment sectors. However, we are optimistic that the owned and operated business will stabilize in the back half of the year as we continue to set a high standard for industry compliance on behalf of our clients. Our new syndicated performance marketplaces grew exponentially over Q1 of last year, but were down slightly from Q4 2023 due to expected seasonality. The fundamentals are strong in our syndicated performance marketplaces, and we are confident in the prospects for growth in this business as we look to the back half of the year. For the full year, we believe a better macroeconomic environment will allow for moderate sequential growth in our owned and operated marketplaces, and we expect our performance marketplaces to continue to grow at strong double-digit rates year-over-year. In Q1, media margin was $22.1 million, which represents 33.6% of revenue compared to $22 million or 28.4% of revenue last year. We are pleased to see that media margin as a percentage of revenue improved despite decreased revenue in the business, which highlights the growth of our new performance marketplaces. On a GAAP basis, our aggregate operating expenses for Q1 were $20 million, a $2.1 million decrease year-over-year. Of note, our operating expenses in Q1 2024 and Q1 2023 include restructuring and other severance costs of $665,000 and $480,000, respectively. This includes severance related to a reduction in force during the first quarter to better align our cost structure. G&A in the quarter also includes an accrued compensation expense related to the acquisitions of $782,000 for the three months ended March 31, 2024, and $623,000 for the three months ended March 31, 2023. Q1 2023 also includes $1.4 million of litigation and other related costs. All of these costs fall outside of the normal course of business and thus, are excluded from our adjusted EBITDA calculation. Our Q1 adjusted EBITDA was $665,000 or 1% of sales, a year-over-year increase of $217,000. In 2024, we expect media margin growth in the second half driven by our new performance marketplaces to push adjusted EBITDA as a percentage of revenue into the high single digits. The company cannot provide a reconciliation to expected net income or net loss in 2024 due to the unknown effect, timing and potential significance of certain operating costs and expenses, share-based compensation expense and the provision for or benefit from income taxes. Interest expense in the first quarter increased to $1.4 million from $698,000 due to higher average interest rates on our Citizens term loan and as an effect of increased amortization of debt financing costs related to the Citizens facility. For the quarter, our income tax expense increased to $908,000, an effective tax rate of 16.9% from $101,000, an effective tax rate up 0.3% in the first quarter of last year. We reported net loss of $6.3 million and an adjusted net loss, a non-GAAP measure of $4.2 million, equivalent to a loss of $0.30 per share. Moving to the balance sheet. We ended the quarter with $11.7 million in cash and cash equivalents. Total debt as reflected on the balance sheet as of March 31, 2024, was $31 million, representing a slight increase from $30.5 million as compared to the balance at December 31, 2023. As a reminder, on April 2, we entered into a credit agreement with SLR Credit Solutions that provides for a $20 million term loan and a revolving credit facility of up to $30 million that matures on April 2, 2029. The SLR credit facility had an opening outstanding principal balance of $32.7 million, and we used $30 million of the proceeds to repay our prior credit facility with Citizens Bank. In addition, we just closed a $10 million equity financing from investors, including our founders, our largest shareholder and our CEO. The additional liquidity reduces our dependence on the SLR credit facility during our strategic pivot and reflects our confidence in the strategy. Working capital, as defined as current assets minus current liabilities, was negative $2.1 million at quarter end. This represents a decline from $29.2 million at December 31, 2023, due to the required presentation of the entire $31 million debt balance as current, related to potential financial covenant noncompliance under our credit agreement. In Q1, we invested $1.8 million into capitalized product development and technology as compared to $1.1 million in Q1 2023. As we look into 2024, the management team continues to focus on the stabilization of our owned and operated marketplaces while we continue to grow the new syndicated performance marketplaces that provide our clients with high-quality customer acquisition opportunities. We're confident that our growth strategy will produce substantial long-term financial benefit in 2024 and beyond. We appreciate your ongoing support. We will be happy to take questions at this time.

First, I just wanted to ask you about your media margins, which have been pretty strong the last couple of quarters despite sort of revenue softness, sort of it seems like a big part of that is coming from kind of growth in your emerging businesses. But how should investors think about sort of some of the levers of media margin maybe expansion going forward? And do you anticipate further improvement from the current levels?

Thank you for the question, Maria. When considering media margin, there are three factors to keep in mind. The first is revenue, which has seen a decline in our owned and operated segment, though this is being partially offset by our new performance marketplaces. Notably, the new performance marketplaces have higher gross profit margins, helping to counterbalance the downturn in that area. The third factor, which will influence Q1 and especially Q2, is the seasonality of these new marketplaces. They are linked to retail, ticketing, and healthcare, which typically perform better in the second half of the year. Q1 is generally slower, while Q2 and Q3 are typically stronger. Consequently, we expect our gross profit to continue to rise in the latter half of this year, remaining stable in Q2, but possibly decreasing slightly in Q2 compared to Q1 due to the seasonal patterns of these new marketplaces.

And then can you maybe talk about the performance of the gaming vertical, just given how important sort of that is for your revenue base? And maybe more broadly, are there any sort of new functionality or ad products that you have or working on to be able to maybe better serve some of their advertisers within this vertical?

Great question, Maria. So gaming continues to be our largest vertical by far. If you guys remember, in the beginning part of Q3 last year, one of our largest clients pulled back and we were able to replace that demand and also keep it steady as we go. So it has been a solid vertical for us and has been basically at the same revenue margin over revenue rate over the last couple of quarters. The players tend to change a little bit on the top 5 list based on whether they're leaning into growth or more on return on ad spend, but that continues to be a very strong vertical for us. We have been working specifically on ad products, both specifically in our syndicated performance marketplaces around gaming. We also have been doing some things in the in-app solution that we expect to roll out. And we've really been pushing that demand into the other marketplaces to continue to serve that market.

I'm curious why media and entertainment, which has been an important area, seems to have been deemphasized, especially considering the intense competition in the streaming space.

Thanks for the question, Jim. In the past, when we broke out verticals, we had a number of things in media and entertainment. And as those scale, we started to break those things out between streaming services, gaming, etc. So part of that context, Jim, might be just that we've moved things into broader categories a couple of years ago, and now we're breaking them out based on the importance of that. Overall, our brand is still focused on return on ad spend over growth, but it hasn't been very vertical-specific. Year-over-year, there's strong growth in subscription and in health and in loyalty and in retail. Gaming is, as I mentioned before, basically flat. And there's been some weakness in the streaming services business just around, they're really focusing on retention and not so much on acquisition.

And when you talk about sort of reducing the emphasis on the owned and operated sites in favor of syndicated marketplaces, could you describe that process a little more and talk about the time frame and just how the execution would take place?

On our operating marketplaces, as you know, Jim has been with us for 12 years. It remains a fundamental part of our business and provides us with distinct competitive advantages to build upon. Having that foundation is essential for us as we enter new syndicated performance marketplaces. Essentially, we have been utilizing the demand and technology infrastructure we’ve developed, particularly around our analytics and data capabilities, across our owned and operated properties and extending them into these syndicated marketplaces. This allows us to move faster and scale more rapidly than if we were starting from scratch. Over the past few years, we've made some adjustments to our workforce. We reduced headcount and then brought in new talent focused on the performance marketplaces. We have approached this thoughtfully based on the performance of our business. We have also begun consolidating our advertising business across all solutions. We now offer a broader range of services to the esteemed brands we work with, including options beyond owned and operated services, such as our AdFlow modules and health solutions. This has been a gradual transition over the last few years as we expand those businesses, but it all hinges on the foundational competencies and competitive advantages we have developed in our owned and operated areas.

Are there certain financial metrics that will shift and adjust based on this transition?

Good question. You'll see two things, Jim. One is, as the owned and operated marketplace stabilizes, which, as we pointed out, is in the second half of this year. You'll start to see the revenue growth return based on the growth in the new performance marketplaces. So when we say that we're down close to 14.6%, obviously, the owned and operating marketplaces are down deeper and our performance marketplaces are growing aggressively just at a lower pace. So you'll start to see that revenue shift in the second half to be in growth overall for Fluent. And then you'll continue to see the margin improvement. All of these syndicated marketplaces at margins higher than our core, and you'll start to see margin expansion at the same time.

The last question is the $10 million equity investment. Could you tell me how that was affected? What was the nature of the investment? Did you mention any specifics?

Yes. Jim, this is Ryan Perfit. This is a private placement with five individuals. We sold prefunded warrants, totaling $2.955 million at a purchase price of approximately each. We expect shareholder approval in July.

I came in late, so I apologize if some of these questions are repeats. And if so, just let me know and we can talk off-line. But first of all, would you please discuss how the media margin was up 1% with the revenues being down? I mean that seems like a surprisingly favorable outcome?

Bill, thanks for the question. We discussed the three factors affecting our numbers at this time. Revenue from the owned-operated marketplaces is declining more than 14.6%, but this decline is being partially offset by growth in new performance marketplaces like AdFlow, call solutions, and purpose health. These new performance marketplaces also have higher gross profit margins compared to our core offerings. While growth in these areas isn't as fast as the decline in owned and operated during Q1, the margin mix from these higher-margin businesses allowed us to keep margins flat, showing a 1% increase compared to a year ago.

So in essence, it's a mix phenomenon most specifically?

That's right. The business mix which we believe especially in the second half will be a big advantage to us because the new performance marketplaces right now are more seasonal than our core. So you'll see that accelerate in the second half.

Please discuss the signs that indicate your new initiatives are successful. You mentioned they are growing quickly, though likely from a smaller base. There must be some relevant data points regarding the long-term implications.

I will primarily focus on external factors. As you know, it all comes down to the brands and their willingness to engage with us. We have seen significant success with performance marketplace brands joining us. Importantly, they are requesting more from us than what our current solution offers. For instance, AdFlow was previously entirely focused on post-transaction elements. Now, brands want us to leverage that same technology to enhance loyalty, retention, and engagement on their commerce sites. This indicates that brands are not only showing interest through their investments but also pushing us to be more proactive in aiding their growth. Our recent earnings release highlighted the substantial size and rapid growth of the commerce media market, suggesting that we are positioned well to capitalize on these trends. Ultimately, our success relies on the brands' engagement and our ability to attract new ones. Internally, we are tracking numerous operating metrics to determine the right targets for achieving scale, evaluating our performance based on revenue, costs, and engagement. We are fortunate to have a clear strategy and continuously monitor our progress to ensure we are meeting or exceeding our internal goals.

And so let me ask about the restructuring and severance expense in the quarter, the $665,000. Would you dive into that? Help us understand what you're doing behind the scenes there, please?

Bill, this is Ryan Perfit. That happened in January, and it was a reduction in force essentially aligned around where we are making our investments. So as was mentioned previously by Don, taking resources away from the owned and operated as we focus on building out syndicated performance marketplaces.

And so no, there was not a reduction in force with these new performance marketplaces?

No, Bill.

And then income tax you actually paid or had $900,000 of income tax, even though you had a pretax loss. What were the dynamics that led to that?

There's a lot of pieces to go into that. Obviously, our tax income is different than our income on our Q. Last year, we had an impairment of goodwill and tax credits from research and development tax credits. So there were a number of things that pushed it down to nearly zero last year as compared to this year. But at 16.9%, we're still below the 21% level for our income rate.

And then do we have time for me to do a couple more?

Sure.

So first of all, I guess you have referenced that your competitors in the owned and operated market have not been following the FTC guidelines or rules after they were following them earlier after your settlement. Has there been any change, either more compliance or less compliance here in the first quarter relative to the fourth quarter?

I would like to clarify a couple of points. First, compliance is related to our owned and operated marketplace, not our new performance marketplaces. The discussions regarding the new performance marketplace are not connected to this compliance issue. Secondly, we observed our competitors trying to understand the settlement and the new rules and guidelines set by the FTC after our settlement in May. However, we did not see them fully adopting our compliance levels. Instead of fully complying, over the last four to five months, we have seen them revert to more noncompliant behaviors. We can speculate on the reasons for this, including the lack of further clear action from the FTC and the industry challenges they face. This situation appears to create an opportunity for them to prioritize financial performance over compliance in the short term. We remain committed to maintaining high standards. We know that in the long run, when the industry regulates itself more strictly, we will be well-positioned to regain market share. However, we did misjudge the industry's direction; we expected it to continue moving toward compliance, but we did not foresee this regression in the last four to five months.

Don, have you heard any comments out of the Federal Trade Commission referencing that firms that demonstrate some increased compliance and then less compliance ultimately become more scrutinized with that bad behavior because they essentially showed their hand that they cannot claim ignorance because they were actually trying to move towards the guidelines and then went backwards? And so ultimately, the FTC views that lack of compliance even less favorably. Have you heard anything like that?

We're really pleased not to be in constant communication with the FTC anymore, as we were for four years, speaking to them nearly every day. Currently, we are not under inquiry; instead, we're focused on reporting. The positive aspect is that our interactions are centered around our dedication to compliance now. Bill, everything you mentioned is logical. During the inquiry phase, there was significant scrutiny on our actions and the reasoning behind them. We consistently aimed to do the right thing driven by business performance, but I can see how the FTC would have a more challenging discussion if they viewed it from an economic standpoint, complicating any potential settlements.

It will be interesting to see how that develops. In relation to your media margin for the first quarter, it was $33.6 million, which showed a slight increase from the fourth quarter at 33.1%, even though first quarter revenues are typically lower compared to the fourth quarter. I understand that in response to my initial question, you mentioned the mix with the growth of performance marketplaces. However, you also noted that these performance marketplaces have seasonality that might impact this. Could you provide more detail on the media margin percentage on a sequential basis?

It is indeed a very good question. These businesses are scaling, particularly the AdFlow sector, where we have been investing in technology and analytics. What you're witnessing is a significant increase in volume in Q4, but our ability to generate revenue per session has continued to rise in Q1, despite a decrease in volume. This increase in monetization is promising. As you know, with this business model, we share revenue with our partners. The more we earn, the more our partners earn, which ultimately leads to their success as well. So the focus is really on enhancing the margins and monetization of that business.

So that should have very favorable implications for the second half of the year when the seasonal strength in the revenues picks up? That is how you are viewing it also then?

Yes, absolutely.

Thank you. I’m showing no further questions in the queue. I would now like to turn the call back over to Don for closing remarks.

Thank you for joining our Q2 2024 earnings. We remain steadfast in our strategic pivot, leveraging our owned and operated marketplaces, and competitive advantage to launch and do adjacent high-growth, high-margin performance marketplaces that will enhance Fluent's brand equity and also create shareholder value. Thank you for your continued support, and we look forward to giving you an update after Q2.

Ladies and gentlemen, that concludes today's conference call. Thank you for your participation. You may now disconnect.