Yelp Beats Expectations by Embracing More Flexible Ad Contracts

Yelp Inc. (NYSE: YELP announced stronger-than-expected first-quarter 2018 results on Thursday after the market closed, highlighting healthy increases in traffic to its sites, impressive growth in advertising revenue, and narrowing GAAP losses.

But the market wasn't sure what to think of the source of Yelp's relative strength -- specifically, its transition to more flexible, non-term advertising contracts.

With shares down nearly 8% on Friday in response, let's dig deeper to see how Yelp kicked off the new year.

Yelp results: The raw numbers

What happened with Yelp this quarter?

• Revenue arrived above the guidance provided last quarter, which called for a range of $218 million to $221 million.
• Adjusted EBITDA increased 10% year over year to $33 million, also well above guidance for a range of $29 million to $32 million.
• By comparison -- though we don't usually pay close attention to Wall Street's demands -- consensus estimates predicted a wider loss of $0.04 per share on lower revenue of $220.1 million.
• By segment: Advertising revenue grew 20% year over year to $214 million, thanks to a 29% increase in the size of Yelp's local sales force and "strong" sales productivity. Transactions revenue declined to $4 million from $18 million in last year's first quarter, primarily driven by the sale of Eat24 to GrubHub, which closed last October. The majority of transactions revenue this quarter was derived from Yelp's new partnership with GrubHub, through which Yelp is paid a fee for food orders originating on its platform. Other services revenue jumped 250% to $5 million, driven by a combination of Yelp Reservations and the acquisitions of Nowait in February 2017 and Turnstyle in April 2017.
• Advertising revenue grew 20% year over year to $214 million, thanks to a 29% increase in the size of Yelp's local sales force and "strong" sales productivity.
• Transactions revenue declined to $4 million from $18 million in last year's first quarter, primarily driven by the sale of Eat24 to GrubHub, which closed last October. The majority of transactions revenue this quarter was derived from Yelp's new partnership with GrubHub, through which Yelp is paid a fee for food orders originating on its platform.
• Other services revenue jumped 250% to $5 million, driven by a combination of Yelp Reservations and the acquisitions of Nowait in February 2017 and Turnstyle in April 2017.
• Cumulative reviews increased 22% year over year to 155 million.
• App unique devices climbed 17% to 30 million on a monthly average basis.
• Paying advertising accounts grew 27% to approximately 177,000. The increase in advertisers was largely driven by a positive response to Yelp's transition to offering non-term contracts.

What management had to say

"We had a great start to 2018, accelerating advertising revenue growth and attracting a record number of new advertisers in the first quarter," said Yelp co-founder and CEO Jeremy Stoppelman. "The expansion of our non-term advertising product is showing promising results and we are raising our full-year revenue and adjusted EBITDA outlook."

Stoppelman also noted that, starting this quarter, Yelp will communicate its results by publishing a more comprehensive shareholder letter, through which it hopes to "share more informative insights about the business and our strategy."

In that letter, management elaborated that they made a "considered transition away from offering fixed-term contracts in favor of more flexible, open-ended contracts."

Yelp wrote:

If that wasn't enough, Yelp also says it continued to attract longer-duration advertisers, similar to when it was focusing more on fixed-term contracts. But when it embraced more flexible non-term contracts, a significantly higher number of first-time advertisers flocked to Yelp to try the platform.

Looking forward

Based on its first-quarter performance, Yelp now expects full-year revenue in the range of $943 million to $967 million -- the midpoint of which stands slightly above consensus models for $953.5 million -- with adjusted EBITDA of $179 million to $188 million. Both ranges represent modest increases from the previous guidance provided in February, which called for revenue of $935 million to $965 million, and adjusted EBITDA of $175 million to $187 million.

So why today's decline? In short, the market is uneasy about whether Yelp's momentum is sustainable, and particularly about whether its newest advertisers will stick around after trying Yelp with a non-term contract for the first time.

Stoppelman summed up that concern well during the subsequent conference call. He said of the new approach:

In the end, then, it's not terribly surprising to see Yelp shares pulling back as the market digests the risks associated with the company's newfound popularity. But if Yelp can prove that its popular non-term contracts can result in sustained, profitable growth, I suspect this pullback won't last long.

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Steve Symington has no position in any of the stocks mentioned. The Motley Fool recommends GRUB and Yelp. The Motley Fool has a disclosure policy.