Redbubble Ltd

ASX:RBL

Earnings Call Transcript 2019-Q2

[Paul Gordon, Regional Counsel & Company Secretary (Australia)]

Good morning, all. This is Paul Gordon, Company Secretary for Redbubble. Welcome to this teleconference for Redbubble's Second Quarter Results for Financial Year 2019 and First Half Year Update. With me, I have Redbubble's CEO, Barry Newstead; and CFO, Chris Nunn. Redbubble released its second quarter results Appendix 4C to the market in an ASX announcement earlier this morning along with our half year update. Barry and Chris will present before we open up the floor to questions. This presentation and Q&A session are being recorded.Now before we start, I would like to call your attention to the safe harbor statement regarding forward-looking information in the ASX release accompanying the Redbubble results. That safe harbor statement also applies to this call and Q&A. Over to you, Barry.

[Barry Newstead, MD, CEO & Director]

Thank you, Paul. Happy new year. I hope everyone had a good holiday season and wish you all a healthy and happy 2019. Today, we are providing updates to the market on the results for July to December 2018, the first half of financial year 2019. The key information is in the ASX release, the 4C filing and the supporting presentation. We've updated our reports to reflect the integration of TeePublic into what we will refer to as the RB Group. Throughout the call, we will take mostly -- we will talk mostly about RB Group metrics, and when we refer to one or the other marketplaces, we refer to Redbubble or TeePublic as relevant.I'd like to kick off today's call by reiterating the strategic opportunity that motivates the RB Group. RB Group has been building leading global marketplaces for independent artists for close to 12 years, and we are still in the early days of achieving the revolutionary potential of our platform. The retail commerce opportunity in front of us is an immense one, worth over $250 billion. The huge potential market we are seeking to disrupt is essential to our strategic decision-making. At the core, RB Group is creating a new kind of retail commerce for customers. The RB Group offers its customers personalized creative adventures and delightful service for a range of quality products. This experience is in contrast to the sea of bland, undifferentiated product options available from many other consumer retail businesses today.Across both Redbubble and TeePublic, customers are going on creative adventures, leading to an often surprising treasure in the content discovered. This is how customers describe the experience whenever we interview them. They relish the human connection to independent artists to create truly unexpected content, which turns generic products into canvases for self-expression and meaningful gifting.How many retail experiences enable 279,000 selling artists the opportunity to shape the customer experience through their creativity and earn income from this? Redbubble is an emotive brand experience which has the potential for real stickiness. This will emerge fully as personalization is rolled out in the customer experience and is reflected in our marketing activities. It will take deep hold as artists and customers connect with each other on the human level.In addition, RB Group delivers delightful and consistent service across a wide array of apparel, home and lifestyle products. They're affordable and made-to-order geographically close to customers. As we grow, the supply model offers the potential to be as efficient as the best functioning retail supply chains with a much smaller environmental footprint. Our partners are investing alongside us as we grow. There were 3.3 million customers who experienced what the RB Group has to offer over the past 6 months and an increasing number are members and/or repeat customers. In fact, repeat customers -- repeat customer revenue grew 36% year-on-year.The RB Group strategy is to deliver on the differentiated customer value proposition through creating a personalized member experience for customers. This is enabled by the marketplace flywheel and the network effects of market leadership. In addition to the customer experience, the strategy aims to drive content growth from artist engagement, new products and content partnerships alongside fulfillment and operational scaling.We have seen traction in the Content Partnerships space, having invested in content management and enforcement tools and building relationships with license holders. We are now hosting 16 brands in our licensed fan art portfolio, including the initial launch of Cartoon Network partnerships over the past quarter. Whilst there are typically longer sales cycles and we remain in the early stages of the wider opportunity, our fan art team is making good progress.The momentum of the flywheel underpins RB Group's ability to solidify growth and profitability and extend our market leadership position. Over the past 6 months, RB Group has delivered on 3 strategic investment areas that support continued marketplace growth. First, we have been building the core member experience on mobile app and via Redbubble's iOS app. This work has and will remain a priority. Over the past 6 months, marketplace revenue for members grew 113%, reaching 25% of total RB Group marketplace revenue. Active members grew 61% to 3.1 million. Members are a powerful accelerators of the marketplace beyond the sales value they generate. They provide valuable data signals and diversify revenue away from paid and search channels. They are great brand ambassadors and help inspire the artist community and partners.The second strategic area focuses on realizing the benefits of scale in the marketplace and extracting economies of scale across a number of operating areas: customer support, infrastructure costs, supply chain management as examples. We saw strengthening margins and maintained operating leverage across the group in the last 6 months. On Redbubble, this has been achieved while improving customer Net Promoter Score and reducing shipping time for customers.Finally, with the acquisition of TeePublic, we solidified RB Group's leadership position in North America, accelerate the benefits of scale and enable highly aligned sister marketplaces to cross-pollinate learnings whilst positioning towards different segments.TeePublic has already made valuable contribution to RB Group's financial performance, including inside views to enhance Redbubble's performance over the last quarter. The integration is progressing smoothly.Before I hand over to Chris, I'd like to talk briefly about the financial performance of the business. Clearly, the changes to Google's search algorithm in October have been an external factor that slowed growth in the past quarter. These changes were in no way disastrous as year-on-year growth in the channel remains positive. While RB Group continues to diversify our channels' growth, as it has done for several years, organic search remains an important source of traffic in customer acquisition.As discussed in November, we have a number of areas where we have made improvements and several additional areas where work is ongoing. The exact timing of what -- when the benefits will emerge remains uncertain. But as in the past, we are confident that RB Group's unique content and customer experience will again position us for success in organic search and we will also continue to diversify our channels with priority focus on memberships, including app growth.Over the past 3 months, the team is focused across the P&L to deliver the results you see today. We did not achieve the revenue growth we have aspired to, but we focus on what we can control and show the progress that this business is making in a range of areas by delivering profitable paid channel revenue, excellent gross margins and disciplined control of the operating expenses line. We remain on a strategic path of steely resolve to focus on generating value from our efforts and continue to invest in the major areas that will position Redbubble to capture the large market opportunity that is available as we invest in a differentiated customer experience and the marketplace flywheel.I'll now pass on to Chris to speak more about financial performance of the RB Group and our expectations for the group in FY '19. Chris?

[Christopher Paul Nunn, Chief Financial Officer]

Thank you, Barry. As has been our practice, we've included with our 4C release for the December quarter an income statement for the quarter and the first half as a whole down to the EBITDA level, comparing both with the corresponding periods last financial year. TeePublic has been included for the last 2 months of the second quarter and first half. Whilst we do not expect there to be significant variances, all financial figures in this release remain subject to half year audit review. Final first half results will be released in the Appendix 4D in February.In the supporting pack, we've also provided some new key operating metrics, and as Barry mentioned, they reflect the refreshed view of how Redbubble Group, RB Group, is managed. Management believes they are more appropriate to tracking the company's strategy and its progress towards building a business of enduring value.Management is pleased with the improving P&L delivered in the first half. We've been able to actively manage those elements we can control in a way that has and will continue to mitigate the effect of any ongoing organic search weakness. Gross profit margin, in particular, is strong, and we see continuing upside that will enable us to balance margin improvement with growth objectives.At the top line, RB Group marketplace revenue, formerly known as product and shipping revenue, so not including artist revenue, was $142.6 million for the first half, up 39.4%. That is up 31.4% on a constant currency basis. FX has been a significant factor this year so far with the U.S. dollar, in particular, generally in the range of 6% to 10% stronger than the previous first half. This helps our revenue line but does the opposite, of course, at the cost lines, COGS, paid marketing and operating expenses. For Redbubble, the net impact of FX on EBITDA has been a positive $700,000 in the first half.A strong first quarter FY 2019 performance by Redbubble was followed by weaker revenue growth in the second quarter due to the impact of the organic search sales weakness. TeePublic maintained strong growth across the first half. Group revenue growth overall was supported by the strength and efficiency in paid channels on both platforms. As I'll expand on below, the cost of paid revenue continues to be efficient and very profitable.In the accompanying investor deck at Slide 8, we are showing respective year-on-year revenue growth rates for the 2 RB Group platforms. Both have been impacted by weak organic search, although it is more pronounced in Redbubble's case. Over time, we expect to merge financial metrics across the RB Group, although we anticipate continuing to show revenue growth by platform.On that point, we've moved our disclosure away from GTV towards revenue, which is a better indicator of Redbubble's top line financial performance. GTV has become increasingly distorted as the true measure of growth as we've progressively begun to collect sales taxes in more and more U.S. states. From collecting only in California 6 months ago, we're now collecting in 23 states, and even then it is only halfway to what we expect will be the ultimate position by the end of calendar year 2019. Whilst it's hard to isolate, our analysis suggests the impact of the sales tax impost on growth has been negligible. There is, in fact, some upside in that it further enhances the strong working capital advantage we generate from our model as we grow.As I mentioned, gross margin strengthened across the RB Group, that is both brands but Redbubble, in particular, through the combination of strategic pricing work and the flow-through of fulfillment and shipping cost reduction, the result from RB Group's supply chain strategy. The synergies to be extracted are continuing testament to the benefits of RB Group's increasing scale and the power of our market position.RB Group delivered gross profit of $51.9 million in the first half of FY '19, up 47.1%, up 38.5% on a constant currency basis. This contributed to gross profit margin of 36.4% based on marketplace revenue, which represents a 1.9 percentage points improvement on the gross profit margin for the first half of last year. Redbubble brand itself delivered 1.7 percentage points with the rest due to TeePublic's contribution of a higher underlying margin.As I mentioned earlier, paid channels have been a significant driver of growth, particularly in the second quarter. The paid percentage contribution to GTV was 50%, up from around 43% last year, largely reflecting organic weakness but also paid strength. Throughout the challenging second quarter, management maintained a disciplined approach to sourcing sales from paid channels and did not ramp up expenditure at the expense of efficiency. When measured as a percentage of marketplace revenue, RB Group's cost of acquisition continues to be low compared to other online marketplaces or platforms in a similar stage of life to Redbubble Group, even with the weaker unpaid growth. It was 10.4% of marketplace revenue in the first half, up 1.6 percentage points year-on-year. Redbubble's cost of acquisition remains constant at 10.9% across both courses.The group delivered gross profit after paid acquisition of $36.6 million in the first half, up 42.5%, up 34% on a constant currency basis. GPAPA outpaced both revenue growth and more importantly OpEx growth.Cash operating expenses for the half of $30.9 million, up 34.2%, 28.1% on a constant currency basis. Operating leverage remains evident for the first -- for second quarter and first half despite the weaker revenue. For the first half, Redbubble's operating expenses are running below the original budget, which was used to previously guide expected growth rate on a constant currency basis as management has taken prudent action to control expenses in light of weaker top line growth. This has been achieved despite capitalized development expenses being lower than forecast with the results of additional charge to the P&L and unfavorable impact of FX. Furthermore, investment in automation and business process design in customer support has been absorbed and it will aid in slowing future volume-based cost growth.The group delivered operating EBITDA of $5.6 million at a margin of 3.9% of marketplace revenue, an increase of 1.4 percentage points year-on-year. The group generated free cash flow of $25.6 million for the first half, up 41.4% from the $18.1 million the first half last year. The acquisition of TeePublic and associated costs have been excluded from the investing cash flows for that purpose.RB Group's cash balance at 31 December was $58.8 million. The closing cash balance was enhanced by $7.9 million with $57.2 million after cost raised for the acquisition of TeePublic in early November offset by the initial settlement payment of $49.3 million, that is USD 35 million, at that time. The final installment of USD 6 million is due in May 2020.Redbubble and TeePublic are seasonal business, don't forget, and the second quarter contained the significant holiday seasons. Much of the fulfillment expenses, artist margin and taxes associated with sales in November and December are not paid out until the March quarter. This seasonality is seen in the actual December '18 quarter cash flows and the forecast March '19 quarter cash flows in the Appendix 4C.Finally, before I pass back to Barry, I want to reaffirm what we have previously indicated by way of guidance. RB Group expects to generate a positive operating EBITDA and cash flow results for FY '19. Whilst the organic search channel continues to show lower growth on both platforms, management has taken strong action on the levers it can control. GP margins are strong, and the outlook remains good with further improvements on both platforms to give us the taxable flexibility on pricing. We have remained disciplined on paid marketing spend efficiency with the increasing paid acquisition costs as a percentage of marketplace revenue due to the slowdown in organic, and we've actively managed operating expenses although FX has worked against us, realizing the full benefit in floating terms.Thank you, and now back to Barry before we open for questions.

[Barry Newstead, MD, CEO & Director]

Thanks, Chris. RB Group remains focused on a strategy to enhance the differentiated customer experience and accelerate the marketplace flywheel.Looking at calendar year 2019, our priorities are as follows: grow the base of customers and members through deeply personal and creative adventures-inspired experiences; secondly, sustainably launch and sell products that artists want to design for and customers will love; third, build deeper relationships with authentic artists by sustainably increasing their commercial success, which includes launching an expanding fan art partnerships with the world's leading fan art brands.The teams across Redbubble and TeePublic are already delivering value in 2019. We're at the forefront of what is a revolutionary retail commerce and positioned to be the leading global platform for independent artists and customers looking for creative adventures.With that, we'll now take your questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Ivor Ries from Morgans Financial.

[Ivor Ries, Senior Analyst]

Just on -- if I could ask a question about the overall underlying traffic growth, right, that's both organic and paid that you experienced in that last quarter and whether we should assume that sort of growth rate going forward.

[Barry Newstead, MD, CEO & Director]

Yes...

[Christopher Paul Nunn, Chief Financial Officer]

Well, it is true to say that currently, that is the growth rate, Ivor. Obviously, as Barry pointed out, our work is to grow particularly in the organic channels and to remain efficient in the paid channels.

[Ivor Ries, Senior Analyst]

Yes, so -- I'm sorry. I haven't been able to find what the -- I haven't been able to go through all the documentation. So what was the true like-for-like growth rate?

[Christopher Paul Nunn, Chief Financial Officer]

Okay. The second quarter is on Slide 8 of the deck, second quarter growth rate marketplace revenue for Redbubble?

[Ivor Ries, Senior Analyst]

Yes.

[Christopher Paul Nunn, Chief Financial Officer]

18%, 12% on a constant currency basis. And for TeePublic, 41% on a constant currency basis. They sell all their stuff in U.S. dollars. There's no variation between the floating...

[Ivor Ries, Senior Analyst]

That's revenue. I'm just talking about traffic.

[Christopher Paul Nunn, Chief Financial Officer]

I don't have the information on traffic.

[Ivor Ries, Senior Analyst]

Okay. But I assume that there hasn't been any great change in the conversion rate, so your revenue growth rate will be roughly the same as traffic?

[Christopher Paul Nunn, Chief Financial Officer]

Yes, I can confirm that conversion rates are very, very consistent across the whole of the half year and very consistent with the previous half year, too.

[Ivor Ries, Senior Analyst]

Right. Okay. And if I can ask a second question, you obviously exercise great restraint in terms of cost in that -- in the last quarter of the year. Is it possible to run at this cost rate without choking off the growth initiatives that you need to put in place?

[Barry Newstead, MD, CEO & Director]

I think -- look, I think the main source of the operating expense discipline is really about us continuing to find ways to get more leverage in the model, right, and benefiting from economies of scale, particularly in places like customer support or infrastructure costs. So again, we believe that -- more than believe, we're confident that that's sustainable. And we also believe that we're investing at a reasonable level. Now clearly, one could make an argument for greater investment, but I think we've made the decisions around that -- around trying to find the right balance. And really feel like given where we're at, I think it's -- the imperative for management and for all the people in Redbubble's building is to make sure we're delivering maximum value, maximum growth and impact from the work that we're doing today and in a sense, that becomes permissions-based for our future work.

[Ivor Ries, Senior Analyst]

Yes. And if I may be so rude as to ask one more question before I get off the line, just on your G -- your gross profit margin there going up 2.5 percentage points, quite a big shift there and a surprise. Is that just simply improving for [ filler ] terms? Or is there some other element that work there?

[Christopher Paul Nunn, Chief Financial Officer]

[ For filler ] but included in [ for filler ] the whole range of cost of goods sold. So it goes from product to shipping even to transaction taxes. So it's work we do consistent in all 3 elements, Ivor.

[Barry Newstead, MD, CEO & Director]

And you mentioned earlier strategic pricing. So we continue to enhance our ways on which we optimize both the cost but also our pricing model.

[Christopher Paul Nunn, Chief Financial Officer]

Yes, so I was thinking it's in both aspects, both product pricing and shipping pricing as well as product cost and shipping cost. You're right. Thanks, Barry.

[Ivor Ries, Senior Analyst]

Right. And so can we assume -- can you maintain that going forward? Or is that just simply a function of the second half being much better part of the year for margins?

[Christopher Paul Nunn, Chief Financial Officer]

I think the -- I think as we said a year ago today and whatever it was that we were hit a little bit by certain events that made last year's number a bit lower. But I'm very happy that this year's number is a reflection of where we can take it and we can improve on this, as I mentioned in my speaking notes.

[Barry Newstead, MD, CEO & Director]

And I'll just add to that, sorry, just add to that a little bit that we start the new year with a real focus on actually exactly where we were the last year. We're really focused on getting value from our scale in terms of our -- in terms of on the cost side and also cross-pollinating the learnings between the 2 marketplaces in terms of places where we can add more margin. So I do think it continues to be a strategic priority to make sure that we're capturing the fair share of the gross profit margin in this business for the RB Group.

[Operator]

Your next question comes from the line of Grace Fulton from Goldman Sachs.

[Grace Fulton, Research Analyst]

Just a question around the organic growth through the quarter for Redbubble specifically. So at the Thanksgiving result, you said that it was down 3%, and then in the documents today, you said that there was minimum growth -- minimal growth across the quarter. So I assume that includes TeePublic. Can you just give an idea of how organic growth is tracked for Redbubble specifically?

[Christopher Paul Nunn, Chief Financial Officer]

I think we've actually specifically, in the release at least, excluded the TeePublic from the minimal growth. So minimal growth is the number for Redbubble. That's on a constant currency basis. So actually, in actual dollar terms, we're doing a little bit better than minimal, if you know what minimal means. So yes, on a constant currency basis, that's the measure on the Redbubble group. TeePublic remains strong.

[Grace Fulton, Research Analyst]

So Redbubble has returned to positive organic growth?

[Christopher Paul Nunn, Chief Financial Officer]

Yes.

[Grace Fulton, Research Analyst]

Okay. Also, could you just give us an update on your new product launches, when you expect them to come? And just sort of the focus on membership, can we expect to see an Android app soon?

[Barry Newstead, MD, CEO & Director]

The Android app is the most popular question at the moment. So I mean, I think we continue to actively look at the timing of launch for an Android app. It continues to be a question of timing. Aspiration is, I would like to go to Christmas 2019 with an Android app. So we -- that's current plan. We need to just make sure that we consider the various investment opportunities quarter-by-quarter through the year, but that's the ambition. In terms of new product launches, that is a priority, as I noted a minute ago. I think we've guided previously that the second quarter of the year would be a really good time where we started putting -- second quarter calendar year would be -- we'll start putting new products out. That is currently on our road map to do just that and to really reestablish, again, the important -- importance of new products within the growth story of Redbubble. So through the rest of this calendar year, you can expect to see us launching products.

[Operator]

[Operator Instructions] Your next question comes from the line of Owen Humphries from Canaccord.

[Owen Humphries, Senior Industrials Analyst]

Just a question about looking forward, obviously, you're now going through earnings breakeven either this year or next, and just a question around the expectation, so maybe just provide a bit of guidance to us in terms of how you plan to deploy that. Is it -- as you're going through cash flow breakeven, are we expecting to have earnings or have increased retained earnings? Or are we thinking about acquisitions? Or do we expect you guys to go hard at the marketing channel given the creative unit economics at hand? Just maybe just provide -- understand there's been a deviation in the consensus going out a couple years. Just maybe provide a bit of guidance about how you guys plan to deploy the excess capital you guys generate?

[Barry Newstead, MD, CEO & Director]

I think I'm probably going to -- I'd like to defer that one probably a quarter, maybe 2 quarters before we kind of get into that. I want to us to -- we're really focused on getting to that -- to the -- focused on things that we're focused on at the moment, and we're certainly focused on demonstrating that indeed the guidance around getting the operating EBITDA and cash flow positive position is indeed where we're getting to. And then I think we will probably have -- it will probably then be in a good conversation -- a good position to have the conversation about our different options for deploying capital beyond that. Clearly, our interest will always be around building a business of enduring value and generating -- looking to generate significant value for shareholders

[Operator]

[Operator Instructions] Your next question comes from, again, from Ivor Ries from Morgans Financial.

[Ivor Ries, Senior Analyst]

Yes, sorry for hogging the line, guys. Barry, I think you mentioned in your presentation you've got 16 brands now in the partnership portfolio, and I just wondered at sort of what point do you push the button on that portfolio and start marketing it more aggressively. Because I mean, looking at the site at the moment, it's not obvious that you have those brands. So when do you plan to sort of get more aggressive in promoting those partnerships?

[Barry Newstead, MD, CEO & Director]

Yes, great question. Thank you. I think the -- look, I think I referred to us -- I feel like this is a -- we feel like this is a major part of our future growth of Redbubble, and this is adding a really powerful new dimension in terms of the content that could be available in Redbubble. So we are -- with that in mind, we're really making sure that we deliver the cool aspects of that experience step by step. And the things that we've been focused on, to this point, are really about, first, about convincing the partners that we are the right partner to work within the space. I think we're starting to get some real traction with that. Second is getting artists to contribute content for the partnerships that we've signed, which I think we're making good progress and it is terrific art and artists are really getting excited about the partnerships as are the rights holders that we're in partnership with. So that's kind of where we're at. The next step is really showing our ability to launch more of these partnerships more frequently. And with that, will then come exactly we just talked about, which is the increased marketing of these partnerships, both Redbubble's marketing activities as well as collaborative marketing with a partner. So I think that we're going to see that continue to evolve through 2019. But I would say that given the scale of the opportunity and how new these partnerships are, we're really doing our -- making sure that we're building this with a very solid foundation underneath it. Last thing I want to do is really push marketing really heavily and feel like we don't have the artist community in the right place or the rights holder partnerships in the right place, or frankly, our operational capability set up to really manage the volume. I mean, each of those needs to be -- we've done really well. And we want us to -- we wanted, as I said, have that foundation. So as it kicks off, it doesn't sort of crumble underneath us. So it's a really exciting area, really important, very much aligned with the Redbubble model where we're bringing unique content to customers and having those independent artists really as a key intermediary there. So we're excited about its potential, but we're staying patient.

[Ivor Ries, Senior Analyst]

So more of a gradual phased rollout than a big bang.

[Barry Newstead, MD, CEO & Director]

Yes, I mean, that's right. We just want to -- well, clearly, if we have the opportunity to do -- if we feel ready, we will turn the dial up pretty significantly.

[Operator]

There is another follow-up question from the line of Grace Fulton from Goldman Sachs.

[Grace Fulton, Research Analyst]

Just in the release, you mentioned that one of the opportunities for revenue growth is on pricing strategy work. Could you just elaborate on what you meant by that?

[Barry Newstead, MD, CEO & Director]

Yes, so we continue to look at -- and we have for the last couple of years, but we continue to look at what the right prices are for our products and actually for our shipping as well. So what we've been doing is experimenting with different prices, in some cases, price reductions, in other cases, price increases, to really find the sweet spot in terms of where are we in terms of revenue -- actually, forget about revenue, our gross profit maximization. So we continue to do work on that front, running experiments within the marketplace to determine where the optimums are. And we -- I think we've made significant gains in that in the last [ half, which have ] made really sustained gains from that over the last couple of years. And so we're sustaining activity on that front, and TeePublic is doing the same.

[Christopher Paul Nunn, Chief Financial Officer]

I should say, Grace, that we -- I talked about it in my speaking notes about taxable flexibility. It's about that in the end, it's getting GP dollars. And as Barry said, it's not necessarily GP margin, but the opportunity is there to reduce pricing, which may affect the GP margin but significantly increase the GP dollars, then we take that kind of decision within that discussion.

[Operator]

[Operator Instructions]

[Barry Newstead, MD, CEO & Director]

It looks like we're done. Well, thank you everybody, for attending and for the questions that folks asked. We look forward to continuing to deliver -- we look forward to delivering our plans for 2019. And again, I want to wish everybody a wonderful year ahead, and we look forward to talking to you in April, the next quarterly update. Thanks, everyone.

[Operator]

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.