Neighborhood social network Nextdoor (NYSE:KIND) announced better-than-expected results in Q2 FY2023, with revenue up 4.31% year on year to $56.9 million. Nextdoor made a GAAP loss of $35.4 million, improving from its loss of $36.8 million in the same quarter last year.
Nextdoor (KIND) Q2 FY2023 Highlights:
- Revenue: $56.9 million vs analyst estimates of $53.4 million (6.51% beat)
- EPS: -$0.09 vs analyst estimates of -$0.10 (10% beat)
- Free Cash Flow was -$12.4 million compared to -$13.8 million in the previous quarter
- Gross Margin (GAAP): 81.7%, in line with the same quarter last year
- Weekly Active Users (WAU): 41.6 million, up 4.7 million year on year
Helping residents figure out what's happening on their block in real time, Nextdoor (NYSE:KIND) is a social network that connects neighbors with each other and with local businesses.
Nextdoor Holdings was founded in 2008 in San Francisco and went public in 2021. The company aims to connect neighbors and local organizations (restaurants, local government entities) with each other so they can exchange information, goods, and services.
Nextdoor's primary product is a private social network for neighborhoods, and the company generates most of its revenue from advertising (as opposed to from users). The platform allows neighborhood residents to create private groups where they can post updates, events, and classifieds, and connect with neighbors. It also offers a directory of local businesses and services, allowing residents to find trusted recommendations from their neighbors. Additionally, Nextdoor has features such as crime and safety updates, lost and found pets, and emergency preparedness resources, which make it a valuable tool for residents to stay informed and connected with their community.
In the aftermath of natural disasters like hurricanes, wildfires, and earthquakes, for example, Nextdoor was used by residents to connect and support each other. During the COVID-19 pandemic, the platform has been used to organize food drives, mask donations, and other mutual aid efforts.
Businesses must meet their customers where they are, which over the past decade has come to mean on social networks. In 2020, users spent over 2.5 hours a day on social networks, a figure that has increased every year since measurement began. As a result, businesses continue to shift their advertising and marketing dollars online.
Competitors offering localized social networking include Meta (NASDAQ:META), Alphabet (NASDAQ:GOOGL) because of its Maps app, and Yelp (NYSE:YELP).Sales Growth
Nextdoor's revenue growth over the last three years has been strong, averaging 28.6% annually. This quarter, Nextdoor beat analysts' estimates but reported lacklustre 4.31% year-on-year revenue growth.
Ahead of the earnings results, analysts covering the company were projecting sales to grow 17% over the next 12 months.
Usage Growth
As a social network, Nextdoor generates revenue growth by increasing its user base and charging advertisers more for the ads each user is shown.
Over the last two years, Nextdoor's daily active users, a key performance metric for the company, grew 13.1% annually to 41.6 million. This is solid growth for a consumer internet company.
In Q2, Nextdoor added 4.7 million daily active users, translating into 12.7% year-on-year growth.
Revenue Per User
Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like Nextdoor because it measures how much the company earns from the ads shown to its users. ARPU can also be a proxy for how valuable advertisers find Nextdoor's audience and its ad-targeting capabilities. 
Nextdoor's ARPU has declined over the last two years, averaging 14.1%. Although the company's users have continued to grow, it's lost its pricing power and will have to make improvements soon. This quarter, ARPU declined 7.48% year on year to $1.37 per user.
Pricing Power
A company's gross profit margin has a major impact on its ability to extert pricing power, develop new products, and invest in marketing. These factors may ultimately determine the winner in a competitive market, making it a critical metric to track for the long-term investor. Nextdoor's gross profit margin, which tells us how much money the company gets to keep after covering the base cost of its products and services, came in at 81.7% this quarter, up 0.3 percentage points year on year.
For social network businesses like Nextdoor, these aforementioned costs typically include customer service, data center, and other infrastructure expenses. After paying for these expenses, Nextdoor had $0.82 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.
Gross margins have been trending down over the last year, averaging 81.2%. However, Nextdoor's margins are some of the highest in the consumer internet sector, enabling it to fund large investments in product and marketing during periods of rapid growth to stay one step ahead of the competition.
User Acquisition Efficiency
Unlike enterprise software that's typically sold by dedicated sales teams, consumer internet businesses like Nextdoor grow from a combination of product virality, paid advertisement, and incentives.
It's very expensive for Nextdoor to acquire new users as the company has spent 69.2% of its gross profit on sales and marketing expenses over the last year. This inefficiency indicates a highly competitive environment with little differentiation between Nextdoor and its peers.
Profitability & Free Cash Flow
Investors frequently analyze operating income to understand a business's core profitability. Similar to operating income, adjusted EBITDA is the most common profitability metric for consumer internet companies because it removes various one-time or non-cash expenses, offering a more normalized view of a company's profit potential.
Nextdoor reported negative EBITDA of $18.6 million this quarter, resulting in a -32.7% margin. It pains us to say that this company is one of the least profitable consumer internet businesses, averaging -35.6% EBITDA margins over the last four quarters.
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Nextdoor burned through $12.4 million in Q2,
Nextdoor has burned through $60.4 million of cash over the last 12 months, resulting in an uninspiring negative 28.4% free cash flow margin. This low FCF margin stems from Nextdoor's capital intensive business model and desire to stay competitive.
Key Takeaways from Nextdoor's Q2 Results
Although Nextdoor, which has a market capitalization of $1.11 billion, has been burning cash over the last 12 months, its more than $551.6 million in cash on hand gives it the flexibility to continue prioritizing growth over profitability.
We enjoyed seeing Nextdoor exceed analysts' revenue and adjusted EBITDA expectations this quarter despite a miss on total weekly active users (WAUs). We were also glad that it expanded its user base. On the other hand, its weak revenue growth was a negative. The company will give guidance on its earnings call. Overall, this quarter's results seemed mixed but overall positive and shareholders should feel optimistic. The stock is up 1.72% after reporting and currently trades at $2.95 per share.
Is Now The Time?
When considering an investment in Nextdoor, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter. We cheer for everyone who's making the lives of others easier through technology but in the case of Nextdoor, we'll be cheering from the sidelines. Its revenue growth has been good, though we don't expect it to maintain historical growth rates. But while its impressive gross margins are a wonderful starting point for the overall profitability of the business, the downside is that its ARPU has been declining and its cash burn raises the question of whether or not it can sustainably maintain its growth.
Nextdoor's price/gross profit ratio based on the next 12 months is 5.4x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
To get the best start with StockStory check out our most recent Stock picks, and then sign up to our earnings alerts by adding companies to your watchlist here. We typically have the quarterly earnings results analyzed within seconds of the data being released, and especially for the companies reporting pre-market, this often gives investors the chance to react to the results before the market has fully absorbed the information.