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Edited Transcript of LFGR earnings conference call or presentation 5-Aug-19 9:00pm GMT

Q2 2019 Leaf Group Ltd Earnings Call

SANTA MONICA Sep 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Leaf Group Ltd earnings conference call or presentation Monday, August 5, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jantoon Reigersman

Leaf Group Ltd. - CFO

* Sean P. Moriarty

Leaf Group Ltd. - CEO & Director

* Shawn Christopher Milne

Leaf Group Ltd. - IR Contact

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Conference Call Participants

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* Jason Michael Kreyer

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Maria Ripps

Canaccord Genuity Corp., Research Division - Analyst

* Thomas Steven Champion

Cowen and Company, LLC, Research Division - VP

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Presentation

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Operator [1]

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Good afternoon. My name is Cavene, and I will be your conference operator today. At this time, I would like to welcome everyone to Leaf Group Second Quarter 2019 Earnings Call.

On the call with me today is Sean Moriarty, CEO; Jantoon Reigersman, CFO; and Shawn Milne, Investor Relations.

Shawn Milne, you may begin the conference.

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Shawn Christopher Milne, Leaf Group Ltd. - IR Contact [2]

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Good afternoon, everyone. On behalf of Leaf Group, welcome to our conference call. I'm pleased to have Sean Moriarty, our Chief Executive Officer; and Jantoon Reigersman, our Chief Financial Officer, on the call with me today.

Any metrics discussed on the call without reference to a specific third-party source are based on our internal data. You'll find the letter to shareholders and a related release along with supplemental materials posted on the Investor Relations section of our corporate website located at ir.leafgroup.com.

Before we get started, we need to make the following safe harbor statement. We would like to remind everyone that during today's conference call, management will make certain forward-looking statements, which are subject to various risks and uncertainties that could cause actual results to differ materially from our current expectations discussed in such forward-looking statements.

In particular, comments about our anticipated future revenue, earnings, operating expenses, operating metrics and growth rates as well as statements regarding our business strategy and objectives, plans, intentions, operating outlook, planned investments and the impact of recent acquisitions are considered forward-looking statements.

Factors that could cause actual results to differ materially from anticipated results are detailed in our letter to shareholders, earnings release and our SEC filings.

I would like to point out that during the call, we will discuss certain non-GAAP financial measures while talking about the company's financial and operating performance, including adjusted EBITDA and free cash flow. Reconciliations of these non-GAAP financial measures to their most directly comparable GAAP measures can be found in the financial tables included at the end of our letter to shareholders and press release.

Lastly, I would like to remind everyone that today's conference call is being recorded and that it is also available via webcast through the Investor Relations section of our corporate website.

A replay will also be available on our website.

With that, I'll now turn the call over to our CEO, Sean Moriarty.

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Sean P. Moriarty, Leaf Group Ltd. - CEO & Director [3]

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Thank you, Shawn. Good afternoon, and welcome to our Q2 2019 earnings call.

Before we jump into the Q&A, I'll provide a brief update. In Q2, we drove improved results with accelerated revenue growth at several of our brands, including Saatchi Art, Well+ Good and Hunker and strong expansion in Media segment operating margin versus the prior quarter.

However, our overall top line growth of 4% is not where we want it to be due to the ongoing Society6 segments.

Media revenue increased 13% year-over-year and 26% in quarter-over-quarter driven by a solid rebound in branded direct sales, including client wins with Walmart, Tide and Vital Proteins among others.

Looking ahead we expect strong median growth rates given continued audience expansion as a -- excuse me, as our reach improved to more than 66 million monthly unique visitors. And Leaf broke through the top 50 rankings in the U.S., reaching #48 in June.

We are especially pleased with strong audience growth at Hunker, which reached 13.9 million monthly unique visitors in June, up 58% year-over-year and remains the largest single domain site in the home category in the United States.

While Society6 remained challenged with a revenue decline of 10% given the shift away from third-party marketplaces and international softness, our focus on reducing promotion levels during the quarter were rewarded with a roughly 3% -- 3 point quarter-over-quarter improvement in gross margin. Also, while still early, we are further encouraged by our recently launched site in Germany, where we see significantly stronger conversion rates and higher AOV as customers benefit from our fully localized offering.

Overall, we continue to push deeper into the home decor category with the launch of high-quality new products, including our new 6-piece outdoor collection.

The Society6 -- excuse me, the Saatchi Art group had another strong quarter in Q2, growing revenue 41% year-over-year.

Our core online platform delivered accelerating GTV growth of 22% in Q2 as we continue to take share in the large fragmented art market, which is rapidly migrating online.

The Other Art Fair posted significant revenue growth as we hosted 3 fairs this quarter in Chicago, London and Melbourne compared with one fair in the same period a year ago.

Looking ahead to the remainder of 2019, we expect strong growth in our Media segment driven by our investments in content renovation, further expansion of branded direct sales as well as mobile.

On the Marketplace front, we expect strong growth to continue for Saatchi Art Group. And for Society6, we are beginning to test new third-party marketplace merchandising, expanding our B2B segment and are excited by the preliminary results in Germany and plan to test localized marketing efforts.

Lastly, I want to remind everyone that the strategic alternative review that we announced on April 15 is still ongoing. And we will not be making further announcements until the Board has approved the course of action in requiring disclosure.

With that brief summary, we're now ready to take your questions. Operator, please open the line.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Jason Kreyer with Craig-Hallum.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

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I just wanted to start off in the Media segment there. So you're a few months into this strategic change where you're having more focus on the larger engagements. Obviously, that appears to have paid off in the quarter. I know previously [you know Athleta] and now you're talking about this engagement with Walmart. Just wondering if you can talk about what the strategy is there as far as small deals versus large deals? What the sales cycles are like? Implementations, things like that. Help us -- help fill us in the gaps as far as what we need to understand and the difference between the large and small engagements.

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Sean P. Moriarty, Leaf Group Ltd. - CEO & Director [3]

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Sure. A great question, Jason. The key when you're talking about the larger Media relationships and winning really big deals, one of the things that we've learned is not only do these deals take time, but you can certainly increase your likelihood of winning it. In fact, you've executed smaller deals with those advertisers and agencies because you not only need a really strong audience and a really strong brand to win deals, you need to prove that you can execute. And one of the things we've been able to do over the course of the past couple of years is when we get our foot in the door, so to speak, to do a great job on the execution side. And so -- you know, well, these big deals really are a testament to what we've been doing over the course of the past couple of years to drive these large audiences with brands that actually matter a lot to people, they're also a consequence of the quality of execution. What we love about the larger deals is these aren't transactions. These are relationships, and if you're a large brand and you find a brand or audience that you know you want to be in front of and when you're working with Leaf Group, you know you're going to get consistent, reliable execution and you are very, very likely to come back and renew with us. So you will continue to see us play it, all parts of the spectrum, small, medium, large with respect to deal size, but we can see in the coming quarters and years is some really strong relationships with top advertisers with the large deals we've been talking about recently.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

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Got it. And sticking with Media there. Just a question on kind of the overall strategy here as it relates to the content. So it seems like some of the newer properties that you've been working on have more timely or trendy editorial content comparing that to some of the stuff that we saw on eHow a couple of years ago, which was a little bit more timeless. And so is that the right way to think about the type of content you're pursuing right now? Or is it just more dependent on which property we're talking about?

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Sean P. Moriarty, Leaf Group Ltd. - CEO & Director [5]

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It depends on the property itself and what the editorial focus is. So for example, on a site that's substantially reference-based, the content is -- some of the content's going to change, but some of the fundamentals, for example, on eHow with the DIY project, like changing out a light switch, that doesn't change too often year-over-year. But if you look at a site like Hunker, there's both the functional content around what does it mean to maintain a home as an owner, and what's on trend from a design perspective. And we want to make sure we're actually a trusted resource for both. And the degree to which one site is focused on one or the other, again, really is a consequence of editorial focus. So if you look at Livestrong. Livestrong exists to provide fact-based, science-backed information that allows everyone to live a healthier life by providing very useful information about workouts and nutrition that the average person can implement in their daily life. So no question, as trends come into the world of diet and exercise, we're going to cover those, but it's on top of a deep base of reference material that users can trust. If you look at Well+ Good, it's really focused on providing the latest in wellness, which is, how do I live in all facets of my life? A life that's rich, meaningful and full.

Something is -- nutrition matters and fitness matters, but decor matters and the way you resolve disputes matter. And so all of those trends in wellness are being covered within that brand. So that's a much more trend-focused brand. And so that's really the way to think about it.

How do we best serve the audience? Is that audience looking for deep reference material on a particular topic? Or is that audience looking for a trusted guide to the latest and greatest in a world or a category that's rapidly changing.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6]

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So can you just dovetail that into this content renewal? I know you had some success there. It seems like in Q2, and you're going to pursue more of that in Q3. What are you seeing there that validates that strategy? And what does that mean in terms of customer returns when you go in? And I guess, what does it mean to just refresh the content?

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Sean P. Moriarty, Leaf Group Ltd. - CEO & Director [7]

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Sure. I think the -- one of the things that's wonderful about the Internet, but also presents the greatest challenge for businesses is the fact that it's an environment of constant change and the bar is constantly being raised. And so if you were really good at somethings a couple of years ago, chances are, unless you have really focused on incremental improvement in that period of time, you're probably not as good as you once were, at least, relative to the competition and what's expected. And so we renovate content -- in some cases, it's because the information has actually changed and evolved, i.e., we know more now than we did a couple of years ago. In some cases, there's been innovation in content formatting. In some cases, we've augmented that article with information that allows it easier for someone to complete a task. In some cases, we've tailored that content for third-party distribution, i.e., social platforms.

So renovation is really an acknowledgment that the world is changing. And the bar is constantly being raised and in order for us to maintain these brands that, in many cases, are built on authoritative deep libraries, we should be evolving even faster than the rate of change that -- in the world we operate in. This is -- and it would be -- I mean one way to think about it, and this is a bit of a narrow analogy, but if you wrote in a [assentive] encyclopedias on reference-based content in 1950s and you wrote it for one year and then you did not advance it, the beauty of the Internet is we can reflect the changes in knowledge and human understanding almost as they occur when we're working with talented editors and writers who are expert in their fields. So as knowledge improves, so too should our sites and very, very quickly.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [8]

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Well that makes a lot of sense. And two other quick questions here on the Marketplace side. I guess part one would be just the drop that you saw in transaction volume this quarter. Wondering if you can call out anything specific because we're a few quarters removed from the third-party changes and a few quarters -- we've had some international pressure for a couple of quarters.

So I don't know if something else changed in this quarter that impacted the transaction number there. And then the second question on Marketplaces, just understanding is there any change in the strategy going forward? I know you have new leadership there. So I don't know if you're pivoting more towards wholesale and international? Or if there's a different focus?

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Sean P. Moriarty, Leaf Group Ltd. - CEO & Director [9]

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Let me take the second part of your question, Jason. I'll have Jantoon take the first. So from a leadership perspective, we've asked, Julie Matrat, who's one of our senior finance executives to step into the GM roll at Society6 several months ago. Julie was a senior finance partner on the business for the past several years. She knows it cold. She's absolutely one of our top leaders, and she's doing a fantastic job leading the business. No real strategic changes to speak of. We're really -- the things we've been talking about in the past, particularly those areas of challenge, whether it's the B2B business, international third-party marketplaces, adapting and overcoming in those areas, a challenge we would -- and making sure that we've got good, healthy margins is absolutely key. We have very strong B2B growth, which is testament to Julie's leadership and focus in the most recent quarter. Keep in mind she's only 3 months in. Really, really strong, discipline with respect to promotion.

(technical difficulty)

tremendous confidence in her and in the success of the plan. Jantoon, would you take the first part for me?

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Jantoon Reigersman, Leaf Group Ltd. - CFO [10]

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So Jason -- so if you look at the Marketplace transactions, so we're about 15% year-over-year. That's primarily international decline and the shift to -- away from the 3P.

Remember that the 1P that has been added this quarter, and so -- basically the sales tax, which has had an impact on transactions overall.

However, also one thing that we want to make sure, we really clarify is the total dollar's been -- a decline in the transaction, there's a huge focus on basically increasing the AOV as well as our margins overall. So if you look at the margins of the [6 for B2B] the last quarter, there's been an improvement of 290 basis points. The AOV is obviously up also slightly because of the taxes so there is some element that [is listed] in taxes, but there's also an element of a mix in the -- of a product mix effectively as we continue to go deeper into the home category.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [11]

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Okay. Just trying to sneak in one more to Jantoon on that topic. Can you just talk about the seasonal cadence in marketplace? Because there's a lot of volatility in that segment. I know you're starting to anniversary some of these changes in last year, so how should we expect that to flow going back into the back half of the year?

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Jantoon Reigersman, Leaf Group Ltd. - CFO [12]

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Sure. So I think there are 2 pieces here that are important. Q3 -- in Q3, we will lap and anniversary the 3P shift away. So as from the end of Q3, we should be able to be relatively clear from that, number one. And then number two is obviously, Marketplaces overall skew second half of the year, right? So overall, first half of the year, we -- our network capital, basically, is more negative. And in the second half, it's obviously positive. So overall, we are a business that skews second half, regardless. Does that answer your question?

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [13]

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That does answer my question.

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Operator [14]

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And our next question comes from Maria Ripps with Canaccord.

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Maria Ripps, Canaccord Genuity Corp., Research Division - Analyst [15]

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I wanted to ask you about the 3P transition. And Shawn, I believe you mentioned testing new 3P merchandising strategy. If I heard that right, could you please maybe share more color on this? And also, can you comment on underlying dynamics in the quarter for Society6? Excluding 3P and international?

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Jantoon Reigersman, Leaf Group Ltd. - CFO [16]

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Sorry. What was -- can you repeat the last question?

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Maria Ripps, Canaccord Genuity Corp., Research Division - Analyst [17]

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Yes, could you just comment on underlying dynamics in the quarter for Society6, if you exclude 3P and international?

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Jantoon Reigersman, Leaf Group Ltd. - CFO [18]

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Purely focus on transactions? Or in general?

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Maria Ripps, Canaccord Genuity Corp., Research Division - Analyst [19]

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Just in terms of trends, including transactions and GMV, I guess.

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Jantoon Reigersman, Leaf Group Ltd. - CFO [20]

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Yes. So I think let me take the latter first. I think it's -- So obviously, remember, because of the decline in international, right? Which is a decline of 27% year-over-year. So that's a big driver for the transaction element. We mentioned that there is a -- there was a decline in the U.S., B2C, [rate of] growth declined 3%. When we do think that the majority of that is attributable to the taxes. And we started -- the sales taxes that we started taking in throughout the quarter this time around. So I think if you add those 2 together, that's probably -- explains most of the difference. The testing on the 3P is really the idea of how you can you be strategic on the 3P area? Obviously, we're going to anniversary that, but it will be very marginal for us. But it is an important element that we've always had. There is an important element in the overall economy for us to be playing, for example, if you think of, how do you play in prime? Or how do you help with those -- how do you utilize some of those platforms to your benefit? And so those are some of the elements we are looking into. It's like how can we think through that in light of our business model while also making sure that we keep driving customers to our own sites.

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Maria Ripps, Canaccord Genuity Corp., Research Division - Analyst [21]

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That makes sense. And another question I wanted to ask you is about free shipping. And we've seen some other e-commerce sort of companies in this space proactively moving towards free shipping. I guess how important do you think it is for your Marketplaces segment? And so any color on this would be helpful.

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Sean P. Moriarty, Leaf Group Ltd. - CEO & Director [22]

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I think certain -- over time, Maria, I think, it's important. We've been much more judicious in our use of free shipping as a promotional driver because we also want to make sure that particularly when you're -- comes to new customer acquisition, we're getting high-quality customers that we think will have a high likelihood of repeating and staying with us for a while.

So we're doing a lot more experimentation around free shipping by type of offer in acquiring those customers. Keep in mind, with our business, we're doing real-time creation of a product someone is looking to buy based on their selection of a design. And we do this across a global network of artists. So there's some, not only [attend] and complexity to that, but the customers know they're getting something unique and one-of-a-kind, right? So -- which means that we probably shouldn't set our sights in the near term on free shipping for every order because all of a sudden, you're competing with someone who's shipping toothpaste and toothbrushes, which are commodities. They can be pushed out from a number of warehouses, if it's an already built product. That said, customer expectations only go up over time. And we're living in a world where if people expect something in a couple of days for the most basic staples in their life then that absolutely causes them to have higher expectations around everything else. And we need to certainly adapt with that and really focus on delivering as quickly and efficiently as possible while still providing people unique, one-of-a-kind stuff. But we also need to be really mindful about how, where and when we deploy free shipping. People talk about it quickly becoming a constant. And I think it's true for certain commodities, but I don't think long term, it will be true of all types of products because the effect that, that would have on many business, and you can see it in other businesses, is it can be a margin killer if it's not very, very thoughtful or already baked into the model that you have. That said, it's important, we'll continue to refine the way we use free shipping as a promotion offer. We're also going to always be looking to ways to not only get products in the hands of consumers in more cost-effective ways, but to get them the products they want at even more competitive prices.

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Operator [23]

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And our final question comes from Tom Champion with Cowen.

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Thomas Steven Champion, Cowen and Company, LLC, Research Division - VP [24]

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I'm just wondering if you can go a little bit deeper on Society6 and maybe help us think through the trends overseas. On the one hand, it seems like the business is under pressure, but you've got a new .de site and potentially some other localizations through the balance of the year. I'm just wondering if you could help us think about the trends overseas and maybe frame up reasonable expectations.

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Jantoon Reigersman, Leaf Group Ltd. - CFO [25]

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Sure. So let me maybe -- let me explain it this way as a -- probably a way to think about. So we've said some quarters ago that historically roughly 20% of our GTV comes from overseas. Remember that, that's a number that we reached without any actual real investments from our side, right? No acquisition marketing spend, nothing. And so that number, that 20% GTV has been in decline, right? And this quarter was in decline of 27%. So that number is shrinking. Our focus has always been on the U.S. number, which is the other 80%. That number obviously, has tremendous opportunities and continues to have that including obviously the growth of B2B. If you think of international with now our localized focus in Germany, it obviously shows really good and healthy signs of effectiveness. [But that has] tremendous opportunities in the long term as we start rolling that out in other countries over time. And so I think we will only focus on the international businesses in areas where we're going to be localized. We're not going to necessarily spend on the -- in the [overall] international places. So as a result, I would argue that one way to think about the business overall is to continue to focus on that 80% of the GTV level and see how that evolves over time. And then we're going to go and focus increasingly on the international side as we further rollout localized sites. Does that help to think about it roughly?

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Thomas Steven Champion, Cowen and Company, LLC, Research Division - VP [26]

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Okay. Yes, that's helpful. Guys, can you update us your expectations for EBITDA performance this year?

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Jantoon Reigersman, Leaf Group Ltd. - CFO [27]

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Sure. So we plan on being adjusted EBITDA profitable for the second half of '19. Obviously, excluding any of these (inaudible) costs with the proxy contest. At the same time, we also want to just reiterate that we continue to invest in these young brands, right? I mean I think in the shareholders letter we [spent] the last paragraph outlining some of the opportunities that we have in the near term to really invest, including further content renovation on the Media side, expand the B2B side in terms of Society6, enhancing artist tools, localization efforts for Saatchi Art, et cetera, et cetera. So there a variety of initiatives that could drive real growth for us in the long term. So we're not necessarily optimizing the EBITDA for the near term at the expense of these [indiscernible] investment opportunities, but we're definitely looking to be adjusted EBITDA profitable for the second half of the year.

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Operator [28]

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And that concludes the Q2 2019 Leaf Group earnings call. Thank you for joining.