VerticalScope Holdings Inc

TSX:FORA

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Operator]

Thank you. Good morning, all. I would like to welcome you all to the VerticalScope Holdings Inc. Q3 2023 earnings call. At this time, I'd like to introduce myself as Brika, and I will be the moderator for your call today.

[Operator Instructions] And now, I would like to pass the conference over to your host, Diane Yu, Chief Legal Officer of VerticalScope, to begin. So Diane, please go ahead.

[Diane Yu, executive]

Thank you, operator. Good morning, everyone, and welcome to VerticalScope Holdings Third Quarter 2023 Earnings Call. I'm joined by Rob Laidlaw, our Founder, Chair and Chief Executive Officer; Vince Bellissimo, our Chief Financial Officer; and Chris Goodridge, our President and Chief Operating Officer. We'll begin with commentary on the quarter before opening the floor to questions.

Before we begin, I'd like to remind everyone that today's presentation contains forward-looking information that involves known and unknown risks and uncertainties and other factors that could cause actual events to differ materially from current expectations. These statements should not be read as assurances of future performance or results.

Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements to be materially different from those implied by such statements.

A more complete discussion of the risks and uncertainties facing the company appears in the company's management discussion and analysis for the 3- and 9-month period ended September 30, 2023, which is available under the company's profile on SEDAR+ as well as on the company's website.

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this presentation. The company disclaims any intention or obligation, except to the extent required by law, to update and revise any forward-looking statements as a result of new information, future events or for any other reason.

Our discussion today will include references to adjusted financial measures, including adjusted EBITDA, free cash flow, free cash flow conversion and MAU, which are non-IFRS measures. All references to currency in this presentation shall refer to USD unless otherwise specified.

Now, I will turn the call over to Rob Laidlaw, Founder, Chair and CEO of VerticalScope. Rob?

[Robert Laidlaw, executive]

Thanks, Diane. Good morning, everyone, and thank you for joining us today.

We were very pleased with how our business performed in the third quarter. Through disciplined financial management and improving top line, we delivered $6.8 million of adjusted EBITDA in the quarter against a challenging macroeconomic backdrop. We are very optimistic about the future of our business and particularly the Fora platform as we continue to see improvements each month throughout the quarter.

Speaking first to our advertising business. We are continuing to see sequential improvements in the business despite a tough ad market. Ad spends have been pulled back compared to prior years as advertisers continue to be very cautious.

While we are optimistic about Q4, it's still early days and a bit difficult to say with any certainty where the very important holiday shopping CPMs will land. Discussions of a potential recession continue to weigh on advertisers' minds, and I believe we won't see meaningful recovery in the macro for a few more quarters.

Thankfully, with the changes we have made to our advertising layouts, the introduction of video advertising and with improving MAU trends, we are seeing stability transitioning into growth in the coming quarters.

While our headline MAU number of minus 8% in the quarter continued to be negative, we are cautiously encouraged by the trend within the quarter, particularly with our [ forum ] communities. Users are increasingly discovering the authentic perspectives shared by enthusiasts on our forum platform, and this authenticity is proving valuable and sought after as the Internet becomes inundated with mass-produced AI-generated content.

The result is that our [ forum ] community MAUs have turned positive in September at plus 5.6% and ramped up in October to plus 19.7%. We remain bullish on the long-term value of the content and data held within our community forums and expect to see continued strength from the Fora platform, which makes up about 70% to 75% of overall MAUs.

We were also very excited in the quarter to fully launch our Fora Communities mobile app. The app brings together over 1,000 [ forum ] communities from the convenience of one mobile app. It's now downloadable from the Google Play Store and Apple App Store.

Importantly, it has allowed us to discontinue access to our platform and our data by third-party mobile apps while giving our users the ability to discover new Fora communities. We continue to work on the app. It's still early days, both fixing bugs and adding new features. User engagement, retention and monetization have been strong, and we're confident in its long-term future as an integral part of our platform success.

Next, our adjusted EBITDA of $6.8 million in the quarter was down 3% year-over-year. However, when excluding the streamable.com, our adjusted EBITDA was up 61% versus last year. We have previously commented on the challenges we faced on The Streamable and do not see that resolving until the broader economy recovers, but the positive EBITDA growth in the rest of our business gives us confidence in our balance sheet and ability to grow VerticalScope as a whole.

Lastly, through our disciplined financial management, we were able to achieve 44% adjusted EBITDA margin within the third quarter. As previously mentioned, we believe 40%-plus margins are sustainable through the back half of 2023 before we enter the seasonally low Q1.

We are continuing to cautiously ramp up investment in our Fora platform and mobile app while making strides in reinventing our commerce business. The commerce business will become less of a headwind in 2024, and we believe we're putting the right pieces in place as we reimagine how this business looks in a post-pandemic world.

With that, I'll turn it over to Chris and Vince to go into more detail on the financial results.

[Christopher Goodridge, executive]

Thanks, Rob, and good morning, everyone. Our business continued to show a sequential improvement in Q3, with revenue up 6% from Q2 to $15.5 million. Advertising revenue in Q3 was 6% better than Q2, and e-commerce was 4% better. Gains in advertising were driven by ad-layered improvements and the introduction of video advertising more so than improving macro conditions.

On a year-over-year basis, total revenue was 21% lower than prior year, largely as a result of lower e-commerce revenue, primarily from The Streamable. Year-over-year trends continue to improve in Q3, and we expect the year-over-year gap to continue to narrow in the fourth quarter.

Turning more specifically to advertising. Advertising revenue was $12.8 million in Q3, which was 4% lower than prior year, an improvement compared to the 15% year-over-year decline experienced in Q2.

Programmatic revenue made up 64% of total ad revenue and was down 4%, primarily as a result of lower display CPMs and lower MAUs compared to prior year, which were partially offset by the addition of video impressions and the improved ad layouts. Programmatic trends improved throughout the quarter, and we expect this part of the business to show organic growth in Q4.

Direct advertising continued to be resilient in the face of macro weakness and was down 5% in Q3 compared to prior year. We've seen relative stability with power sports OEMs, Canadian financial services, outdoors and tourism advertisers. But lower spending from U.S. auto insurers and online marketplaces continue to impact our direct results as they have throughout 2023.

Turning to e-commerce revenue. E-commerce continues to weigh on our results with total revenue of $2.7 million, a slight improvement compared to the $2.6 million generated in Q2 but was [ 57% ] lower than prior year. Revenue from The Streamable continues to be the main source of weakness for commerce as a result of lower traffic and lower commissions from streaming partners compared to the strong results recorded in Q3 last year.

The Streamable accounted for 2.5 million of the 3.5 million year-over-year decline in commerce revenue. The site has shown slight gains recently in traffic and commission rates, but it will take time to show material improvement.

E-commerce results continue to be challenging beyond The Streamable in Q3. The impact of shifting in consumer spending from goods to services has had a more concentrated impact on the categories served by our platform and resulted in lower year-over-year transaction volume that has impacted this part of our business since the post-pandemic reopening began.

Despite these challenges, we continue to have strong conviction in the long-term potential for commerce on our platform that will be realized as we continue to [ retool ] this business.

Our recurring revenue subscription business, including the -- from the Fora platform, contributed 59% of total e-commerce revenue in Q3 and continues to provide a partial hedge against the more transactional elements of our commerce revenue.

Turning to our outlook. We expect continued sequential improvement in both advertising and e-commerce revenue as we enter the seasonally strong Q4 season. Improving MAU trends alongside strengthening programmatic CPMs around the holidays and the availability of video advertising are expected to drive organic growth year-over-year in advertising revenue, while e-commerce is likely a few quarters of away from returning to organic growth.

Our outlook for M&A has not changed. M&A activity continues to be subdued across our industry, and we don't expect that to change in the near term.

Our focus will be continuing to drive organic revenue and EBITDA improvement and to use our free cash flow to reduce debt. Our leverage is already relatively low, but we believe our shareholders will be best served at this time by continuing to strengthen our balance sheet to give us greater flexibility for future investments.

With that, I'll now turn it over to Vince to walk you through the rest of our financial results.

[Vincenzo Bellissimo, executive]

Thanks, Chris, and good morning, everyone, and thank you for taking the time to join our call.

The strategic decisions made in the first half of the year have helped us successfully manage costs while continuing to invest in engagement and monetization initiatives that will drive organic growth. This operational leverage has led to improved results, including expanded margins and increased free cash flow, positioning us well to maximize profitability in Q4.

As a management team, our primary focus is on building a strong financial foundation, supported by profitability, and strengthen our resilience in future market challenges.

As mentioned by Rob, our adjusted EBITDA margin in Q3 expanded to 44%, an improvement from the 37% margin achieved in Q2 and the 36% margin generated in the prior year. This is a noteworthy achievement as it marks the first time we have seen margins at this level since the 3 months ending December 31, 2021, during which we recognized the then record $21.4 million in revenue.

Looking ahead, we anticipate sustaining a margin of 40% plus in Q4, leveraging our optimized cost base to maximize our profitability against seasonal highs in revenue.

In the quarter, we generated $6.8 million in EBITDA, down only 3% or $207,000 compared to the prior year, despite a $4.1 million decline in revenue, and is a notable 24% improvement to the $5.5 million adjusted EBITDA generated in Q2, driven by our ongoing discipline towards cost management and contributions from monetization initiatives.

In addition to improved margin and adjusted EBITDA performance in the quarter, we generated strong free cash flow, as defined in our MD&A, of $6 million and achieved an all-time high free cash flow conversion of 88%.

This compares to $4.6 million or 66% conversion generated in the prior year, with year-over-year increase driven by a reduction in both cash taxes and capital expenditures. These results are a testament to our ongoing commitment to driving financial efficiency and strengthening our financial position.

Year-to-date, we generated cash from operations, less net additions to capital expenditures and net lease payments of [ $8.7 million ] and made $9 million in prepayments towards our credit facility, highlighting our commitment to using all available free cash flow to pay down our debt and strengthen our balance sheet.

As of Q3, we had $54.9 million in net debt and a net leverage ratio of 2.21x, based on LTM pro forma adjusted EBITDA, as defined by our credit agreement. As of Q3, we maintain a total liquidity of $64.4 million, comprised of $6.4 million unrestricted cash and an additional $58 million available draw on our revolver.

Our financial performance continues to improve over the prior year and exceed market expectations. In Q3, we generated $566,000 in operating income, an improvement of $6.8 million when compared to $6.2 million operating loss in the prior year.

Improvement year-over-year is driven by a reduction in operating expenses, including savings realized from cost optimization and a low rate of amortization related to acquired intangibles. This improved operating performance has driven a more favorable net loss of [ $516,000 ] in Q3 compared to a net loss of $6 million in the prior year.

Looking ahead, we are excited by recent MAU trends across our [ Fora ] communities and the positive long-term impact this will have on user engagement and community health. It is important to note that from a financial performance perspective, these gains are muted by softness in CPMs, driven by continued weakness in overall advertiser demand, which we believe will still take a few more quarters to recover.

We remain optimistic that as an advertiser -- as advertiser demand recovers, we will see a corresponding improvement in CPMs and a stronger financial impact from the growing user base across our [ Fora ] communities. The team is encouraged by these trends and remain committed to delivering on our organic growth objectives and driving long-term value for both our employees and shareholders.

And now I'll pass it back to Rob to wrap things up. Rob?

[Robert Laidlaw, executive]

Great. Thanks, Vince. We will now open it up for questions.

[Operator]

[Operator Instructions] We have first question on the phone line from [indiscernible] of Cormark Securities.

[Unknown Analyst]

Nice to see -- just first one for, I guess, Rob. Nice to see ad avenue decline soft during the [ quarter ] and advertising ARPU growth churn. Just wanted to get your thoughts on the overall ad market recovery and some of the conversations you're having with advertising. Maybe if you could provide some color in terms of which verticals are coming back sooner than others for advertising?

[Robert Laidlaw, executive]

Look, I think as we mentioned, the advertising market, the macro today is still not great. I think there's advertisers -- whether it be due to high interest rates, kind of the media cycle around potential recession or just overall kind of consumer spending in some of our categories, it's definitely still keeping advertisers on the sidelines or at least being very cautious.

So the conversations we have are certainly a little more muted than they have been in past years. And I think our core advertisers continue to be consistent with us, especially around categories like power sports, outdoors, tourism. But some of those categories, like auto insurance, continue to be really weak and in some cases, have taken a pretty substantial step back.

Automotive advertising, I would say, is still, overall, kind of yet to significantly recover from some of the supply chain challenges and pullback we saw. So I think there's still opportunities there as we move forward and as kind of dealer supplies increase.

So I think what I would say is a lot of the improvement in our advertising numbers and our ad results really comes from kind of self-inflicted changes that we've made, things like improving our ad layouts, introducing video advertising.

And all of this really bodes well for -- as that ad market starts to recover, we're going to have not only more inventory available with our positive MAU trends but also higher-value inventory with respect to video advertising and some of our improved ad layouts.

So we're really looking forward to the ad market getting better. I don't think that's going to be in Q4 just yet. I think we're definitely still a few quarters away from that. But I think the changes that we made earlier in the year have really benefited us, and we see advertising moving to the positive in Q4.

[Unknown Analyst]

Okay. Great. And then on your Q4 call, you highlighted a few priorities for the year, specifically around the app rollout and the product discovery engine. And you touched on some of these in your prepared remarks today as well. So I would appreciate any updates if you can provide on that front.

Last I checked, I think there were about a dozen of communities on the app. So I was just wondering if you can provide some more color on those few priorities that you mentioned earlier?

[Robert Laidlaw, executive]

Sure. Absolutely. On the app rollout, we are now rolled out to over 1,000 communities. So it's pretty broadly rolled out. And we're just kind of in the early days now and starting to ramp up marketing and push and encourage more of our users to download that up.

So I think we went through a bit of a period there where it was like a quiet rollout, make sure everything kind of working and functioning as we would expect. And now we're able to start ramping up, and we're getting pretty excited about it.

One, it did allow us to remove that third-party access to our data and to our communities from those third-party mobile apps, so that's actually a very significant and important milestone for us. And it was done with great fanfare.

I think we've seen competitors in the space have real challenges in kind of turning some of those third-party mobile apps off. And from our perspective, we were able to do it. And a lot of our community members have been quite grateful and praising the switchover of it being pretty smooth. So that was very important for us.

And I think overall, just seeing the user retention, monetization, engagement metrics, all trending quite positively for us has been great to see. So still early days there, but we're pretty optimistic about the app and certainly think it kind of cemented its place as a part of our platform's future.

With respect to product discovery, we did pull back on spending a little bit there to really focus on some of the core revenue initiatives, but we've got that back on track and continuing to experiment and develop around product discovery.

We think products and the product discovery process are kind of an important part of our long-term future and our long-term growth, so you'll see more coming from that stream over the next couple of quarters.

[Unknown Analyst]

Got it. And then any update that you can provide on Streamable? Has outlook improved at all for some of your streaming partners?

[Robert Laidlaw, executive]

Yes. It's -- streaming market is still very challenging. I don't see a significant recovery coming until the broader economy recovers. I think we went from an environment there, where low interest rates, high-growth tech market streaming companies were significantly valued, and the real focus from investors was on subscriber add, how many subscribers did they add in the quarter and the months, in the year.

That's really shifted towards managing costs and focusing really on their own bottom line. So that's kind of changed the narrative in streaming a fair bit.

At the same time, we've got new leadership in place, an exciting road map. We're reinventing that business for a post-pandemic world. So again, this one is going to take a longer time. But we think that The Streamable is still a very exciting property for us. It's just going through -- I'm going to call it kind of more like it's going through its '07, '08 moment, referring to the financial crisis and what businesses went through during that time.

So The Streamable is, I think, very close geared to being at its bottom or its trough. And I think we're getting close to kind of flipping that switch, where the streaming companies are starting to ask a little bit more about "Hey, how can we get more subscribers and partner on some profitable initiatives?" So very, very small green shoots but something that we think we can build upon.

[Unknown Analyst]

Okay. Great. And then just one last one for me before I pass the line for Vince maybe. Just looking at your free flow for the quarter, obviously, solid conversion here. Your CapEx was down significantly versus last year. I know last quarter, you were still in the midst of onboarding [ software ] communities, launch on the mobile app, and you also talked about adding video capabilities through communities.

So I would have expected CapEx to be stable or slightly up. Just wondering if you can provide some color on that, and how we should think about CapEx, going forward?

[Vincenzo Bellissimo, executive]

Yes, thanks for the question. Yes, so sort of reiterating on Rob's point, the fact that we were focusing on fewer products and the shift towards sort of an experiment stream style of product generation, that basically means a lot of the upfront at work that we would have normally capitalized is no longer eligible under IFRS.

So I would expect to see our run rate, going forward, from a CapEx perspective, to stay in and around these levels, what you are seeing in the quarter. There's still some contributions with regards to the work we've done on ad tech and whatnot. But as that's [ subsides ], I think $0.5 million a quarter is a good run rate if you're estimating CapEx on the business.

[Operator]

We another question on the line from [indiscernible] from CIBC World Markets.

[Unknown Analyst]

And also for the added insight on how the app rollout is going. I did have a few follow-up questions. And first, I was wondering if you're starting to see that app replace a bit as the online traffic you usually receive from search engines? And is that something you expect to continue to improve over the next couple of quarters?

[Robert Laidlaw, executive]

I can take that one. Absolutely, we are seeing certainly some of our users starting to shift their behavior from mobile web over to mobile app. And one of the kind of promising signals we're seeing is that when they do that, they're actually using our communities more often and posting more often.

So that content contribution is really part of the flywheel of growth for [ forums ]. So we're, overall, pretty excited about that. I think that's just one of the many metrics that kind of give us confidence that this is a big part of our future.

[Unknown Analyst]

Wonderful. That's great to hear. And just on those metrics that you mentioned, are there any KPIs that we should be looking to over the next few quarters that you expect to be providing us with?

[Robert Laidlaw, executive]

Yes. I think we're still early days on the app, and we'll kind of work through a bit of the marketing phase as we ramp up, kind of bring some of those KPIs forward on future calls, but nothing to report just yet as it's still kind of early days smaller numbers.

But certainly, I think just around those 3 kind of key pieces: Engagement, retention, monetization; we're going to look for being able to provide the market over the next couple of quarters with some additional transparency there.

[Operator]

[Operator Instructions] Confirming we have had no questions registered, so I would like to hand it back to Rob Laidlaw for any closing remarks.

I apologize. We do have a question from Towaki Dojima of TD Cowen.

[Towaki Dojima, analyst]

Subbing in for Vince Valentini here. Great numbers on the margin. And I think in the press release, you talked about focusing on lowering the cost on the e-comm operation as one of the [ margins ] is so good. Just wondering -- I know you talked about e-comm recovery, is still going to be a couple of quarters out.

But how much [ OpEx ] or how much more do you need to invest once that e-comm market starts up? Like are we -- is this run rate sustainable to support e-comm growth in, call it, 1 year, 1.5 years? Or are there going to have to be more investments down the line?

[Robert Laidlaw, executive]

Thank for the question, Towaki. Yes. So e-commerce, we've actually already kind of, within the third quarter, made some of those investments. So from a run rate perspective, we feel pretty comfortable here that any additional investment will be supported by additional revenue. And from the perspective of kind of do we need to layer on a lot of costs to ramp that business back up, we don't think so.

We think from a margin perspective that we're able to kind of sustain here and that overall, like we said, e-commerce is going to take a few more quarters, for sure. But we do have a lot of confidence in that business. We're starting to see a couple of green shoots, and we've got some new leadership in place there that we think is very scrappy and going to help us with that business for the long term and kind of reinvent it post-pandemic.

So I think we've -- like I mentioned earlier, I think we're either very close to or near the bottom. And certainly, it provides much smaller headwinds in 2024. So I don't think we'll see commerce kind of weigh on VerticalScope's overall results the way it has in 2023. And as we look to 2024, it's going to be a year of kind of rebuilding, but not necessarily from a -- do we need to put a lot more money into the commerce business.

[Towaki Dojima, analyst]

That's perfect. And as a follow-up on that, I think you mentioned last quarter that you've now lapped all of Streamable. And so Q4, the headwinds from Streamable is going to be much less on a year-over-year basis than the last few quarters. But just wanted to make sure that there isn't anything left over in Q4 '22 that might be a headwind for this year?

[Robert Laidlaw, executive]

Yes. Chris and Vince, do you want to take the last...

[Christopher Goodridge, executive]

I can take that. Yes, it's Chris here. So really the lapping is happening within Q4. So in October, we still had a fairly tough comparable there, and we start to see that roll over as we work through November.

[Operator]

Thank you. I would now like to turn it back to Rob Laidlaw for any closing remarks.

[Robert Laidlaw, executive]

Great. Thank you. Thanks, everybody, for joining us today. As always, we appreciate your engagement, the trust and support that you're showing us, and we look forward to closing out Q4 and 2023 on a very strong note. Thank you.

[Operator]

Thank you all for joining. This does conclude today's call. Please have a lovely rest of your day, and you may now disconnect your lines.