Digital Turbine, Inc. (APPS) Q2 2018 Earnings Report, Transcript and Summary

Good day and welcome to the Digital Turbine reports Fiscal Q2 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Brian Bartholomew, Senior Vice President of Capital Markets and Strategy. Please go ahead.

Thank you. Good afternoon and welcome to the Digital Turbine Fiscal Second Quarter 2018 Earnings Conference Call. Joining me on the call today to discuss our results are Bill Stone, CEO; and Barrett Garrison, our CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. These forward-looking statements are based on our current assumptions, expectations and beliefs, including projected operating metrics, future products and services, anticipated market demand and other forward-looking topics. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. Except as required by law, we undertake no obligation to update any forward-looking statements. For a discussion of the risk factors that could cause our actual results to differ materially from those contemplated by our forward-looking statements, please refer to the documents we file with the Securities and Exchange Commission. Also during this call, we will discuss certain non-GAAP measures of our performance. Non-GAAP measures are not substitutes for GAAP measures. Please refer to today’s press release for important information about the limitations of using non-GAAP measures as well as reconciliations of these non-GAAP financial results to the most comparable GAAP measures. Now, it is my pleasure to turn the call over to Mr. Bill Stone.

Thanks, Brian, and thanks to all for joining us today. I want to start my prepared remarks with our progress against our stated goal. Our goal has been to build a sustainable and profitable business while demonstrating solid execution against our strategy. I'm pleased to report that we continued our momentum in the September quarter, which was more profitable than the June quarter. We expect the December quarter to continue this favorable trend. I’ll break out my remarks into an operational review of the September quarter; some customer and partner updates; and finally, some strategic comments about the future direction of our business. First on the operational performance. Our overall revenues were $27.9 million, which compared to $26.1 million in the June quarter and $22.8 million in September a year ago. In particular, our Operator and OEM for O&O business finished at $15.9 million for the quarter, which was up 61% from the September quarter last year. This was primarily driven by success with our North American operators and a successful launch of the Samsung Galaxy Note 8. We have very good momentum with our O&O business and expect that momentum to continue in the current quarter. Our Advertiser and Publisher, or A&P, business finished at $2.2 million. As I have said on prior calls, there has been an intentional refocusing of our resources away from A&P to the higher-margin O&O business combined with structural issues that we need to address. Despite the revenue declines, margins have grown from 15% last September to 26% this past quarter. Our content business was up 23% sequentially. This represents our third consecutive quarter of double-digit sequential growth. Our Australian merchants continue to have success driving new revenues. We do expect some modest negative revenue impacts in 2018 as the Australian mobile operators transition away from subscription services for traditional content types, such as games, videos and music, and migrate those services to event-based charging. This change has already been in effect at Vodafone for most of 2017 and will go into effect in the December quarter for Telstra and we expect the March quarter for SingTel’s Australian subsidiary Optus. We expect to see new types of content such as parking, tolls, magazine, newspapers and so on become the future driver of pay growth in Australia. And while still smaller percentage of total revenues when compared to Australia, we continue to expand new connections in the broader Asia Pacific region and our revenues sequentially more than doubled outside of Australia. Next let me shift to customer updates. First I want to receptor advertiser. I've been pleased with the diversification of our advertisers. Our advertisers are comprised of four main groups: social brands such as Starbucks, Bank of America and McDonald's; secondly, our ecommerce players such as Amazon, eBay, NEO; and third, our gaming providers such as EA, Zingo, King, Machine Zone; and the final category, our utilities, like weather, stocks, flashlight and so on. And while O&O advertising growth increased by more than 60%, our gaming providers’ contribution actually declined from 69% of revenue the year ago to 39% today. In other words, gaming revenues were approximately the same last year and this year, thus one can attribute 100% of O&O advertising increase to non-gaming revenues. This was highlighted in the most recent AppsFlyer Performance Index. Digital Turbine was ranked in the top five in North America for the largest distributors of Android non-gaming applications, just behind companies such as Facebook and Twitter. Our revenue per slot, or RPS, on high-end devices continues positive momentum as we continue to have strong demand for those devices. The RPS for the Note 8 in the first month in North America was $0.44. This compares to the first months of the Galaxy S8 launch at $0.42 and the first months of the Galaxy S7 launch being in $0.35. We still have work to do to improve our RPS performance both outside the U.S. and in some lower-end devices, but I'm optimistic of its combination of regional sales people additional third-party relationships and improved global campaigns will drive results. Next I want to make some comments about our operator and OEM partners. I continue to be pleased at the overall advertising revenue growth of our largest North American operator, which grew revenues over 30% annually, but it was also encouraging is that operator percentage of our overall O&O gross profit is declining. Last year it was more than half of our gross profit, this year it was less than 40% as higher-margin partners have begun to ramp. We've seen a major ramp of our other large North American partner revenues and expect that to continue. As many longer-term investors know, this relationship took many years to bear fruit, but is now a material part of our O&O story. I feel the same about T-Mobile and TracFone, and both accounts have taken longer expected to get to market, but I'm enthusiastic about our future prospects with them. Our Indian footprint continues to expand. We continue to do expand our advertising relationships with Jio, Micromax and Indus. Jio's device volumes has slowed from prior quarters as they are focused on the lower-end feature phones. We expect to see additional smartphones from them in 2018. Also in the Asia Pacific region, we also anticipate Ignite with Telenor in Thailand later this quarter as our first market to launch with them. Telenor is one of the top 10 largest global mobile operators with over 175 million subscribers in 12 markets, including approximately 25 million in Thailand. Our Latin America revenues have nearly doubled annually. The pipeline in the region is very strong and we expect to add scale in that region in 2018 with both new relationships and the launch of our APK with American Mobile. We've also seen some increased pipeline traction in Europe as our platform story is resonating well with many potential partners. And finally, our OEM growth continues. And while still a small percentage of our overall O&O revenues, our OEM revenues more than tripled annually, driven by improved performance with companies such as Motorola, Acer, BLU and Archos. We are making a major business development push to improve our OEM footprint to take advantage of the broader trend towards open market or unlock devices. And this leads to the final section in my prepared remarks. The platform story has really generated traction in the marketplace. We’re now at scale with over 110 million devices with Ignite and are growing that number each quarter in a material way. This is the key to get the flywheel going and in our view a key metric for investors to look at our future business into 2018 and beyond. When investors ask me how big can Digital Turbine be in a few years, our response is that we are here to build a meaningful business that is much, much larger than today's results. And to accomplish this, building scale with devices and adding new revenue streams off the platform are the catalyst for that potential step function growth. The key is not just having a single revenue stream from a product but how do we get multiple revenue streams from the same platform, and not just the 100 million devices but on hundreds of millions of devices. We’re seeing a few major macro trends that were extremely well positioned for to capture these. First as a trend of overall smartphone growth of 1.5 billion smartphones to be sold this year, and growing from there, and secondly is application growth as the application market is now at $88 billion, growing at 22% compound annual growth rate. Delivery of those applications on our Ignite platform via our DT Media business today is one avenue of growth, but a much larger opportunity is through our delivers product that can provide one-click access to consumers from any advertising platform, whether that is Facebook, Snap, Twitter, Oath or any advertising company. We’ve trialed this earlier this year, and while not at scale, the results were encouraging. We've been working with one of our large North American partners and another large advertising partner to trial this capability with them exclusively. We need the reminder of the fiscal year on the tech side to get the tech launched at scale across all of our partners, but this is a major internal priority of the business and an opportunity we're excited about as part of the growth story into the future. Next is a trend of open market. Today, many operators don't have the ability to get their applications to the device as customers just buy SIM cards from the operator versus the device itself. We think Ignite on the device from the OEM, this solves that problem. It’s is why we are now changing our open-market focus to embrace the operator versus dealing as an independent approach. We believe this is a better longer-term approach as the operators pay off the license fees for open market devices to deliver their experience to these customers that are hard to reach today. So for illustrative purposes, we envision the future were devices could have $0.50 to gross profit today to be able to accrete the most of those above that current run rate. In multiplying all of these different revenue streams off the platform by multiples more of the device yield some very large potential numbers. And this is why we are very excited about the future and our strategy. We anticipate having an Investor and Analyst Day in early 2018, where we can spend some dedicated and focused time on how we will build this additional shareholder value. I want to conclude my remarks by saying that September was another solid, profitable quarter that beat our internal expectations. So the short-terms are in good shape but the long-term is what I'm really enthusiastic and optimistic about. And with that I'll turn it over to Barrett to take you through the numbers.

Thanks, Bill, and good afternoon everyone. I'm pleased with the solid performance in Q2. We delivered the Company's second consecutive profitable adjusted EBITDA quarter and experienced an accelerating rate of revenue growth. We continue to make progress toward our objectives in delivering sustainable profitability and generating positive free cash flow. Turning now to the financials. All of our comparisons are on a year-on-year basis unless otherwise noted. Total Q2 revenue of $27.9 million was up 22%. Advertising revenue of $18.1 million grew 19%; and within advertising, our O&O revenue of $15.9 million was up 61%. O&O growth in the quarter stem from continued revenue attraction from recently launched partners ramping on the platform. Combined with the successful launch of the new Samsung Note 8, inside our advertising, our E&P revenue was $22.2 million on the quarter down 59%, and now represents less than 8% of total revenue mix. Content revenue of $9.8 million in the quarter grew 28%. Q2 marks the third consecutive sequential revenue growth period from this business. In the quarter, our adjusted EBITDA was positive $0.4 million as compared to a loss of $3 million in the second fiscal quarter of 2017. This improvement of $3.4 million year-on-year in the quarter and additional 5 million in revenue during the same time period is the testament to the embedded operating leverage of our business. Non-GAAP gross margins expanded to 29% in the second fiscal quarter of 2018 as compared to 22% for the same quarter in the prior year. This year-on-year margin expansion is largely driven by a continued mix shift towards our higher margin O&O business, combined with improving gross margins across all of our business units versus prior year. Expanded margins enabled non-GAAP gross profit dollars to increase by $3 million year-on-year to $8 million in the quarter. Let me lead the discussion on gross margin by noting that why we are pleased with our continued improvement in this area an encouraged about our opportunity to expand margins overall. Our gross margin rates can be sensitive to changes in partner mix and revenue type between advertising licensing and our content and these fluctuations can be extenuated during seasonally higher periods and may vary from quarter-to-quarter. Now turning to expenses, total operating expenses for the second quarter were $8.6 million down, down 10% year-over-year. Expenses excluding stock compensation and depreciation or our cash operating expenses in the quarter totaled $7.6 million, down $100,000 from the same quarter prior year. Overall, the reduction in cash expenses is driven largely from realizing continued efficiencies in hosing technology costs and lower G&A expenses. These reductions are partially offset by an accrued expense for the company's annual employee bonus plan, tied to the company's financial performance through the first half year - through the first half of the year. It's important to point out, this type of expense was not earned or recorded in the prior fiscal year. We continue to experience impressive expense scale on the platform, delivering 60% growth in the quarter in gross profit dollars, while holding cash expenses constant during the same time. Non-GAAP adjusted net loss was $0.6 million or $0.01 per share this quarter as compared to a net loss of $0.9 million or $0.01 share loss in the first quarter of 2018. Our GAAP net loss for the first quarter was $6.5 million or $0.10 per share, based on 66.8 million weighted shares outstanding compared to a net loss of $7.3 million or $0.11 per share for the fiscal second quarter of 2017. Including in our GAAP net loss for the quarter, is a recorded loss of $4.5 million from the impact of the change in fair value of derivative liabilities resulting from our convertible note, which is highly sensitive to the company's stock price which increased almost 50% from a $1.03 at the end of June to $1.51 at the end of the September quarter. As a reminder, the derivative liability on our balance sheet will fluctuate as our stock price moves and may have a material impact on our reported GAAP financials. Moving on to the balance sheet. We finished the quarter with $5.9 million in cash, a decrease of $400,000 from the first quarter. Cash from operations generated modest positive cash during the quarter, inclusive of a semiannual $700,000 interest payment, which was offset by capital expenditures of $400,000 in the quarter. $6 million of convertible notes were converted by note holders at the end of the quarter, resulting in a reduction in the gross principal amount of these notes from $16 million at June 30 down to $10 million as of September 30, associated with these conversions approximately 5 million shares of common stock were issued to these note holders. Within our short-term debt, at quarter end, our balance drawn was $2.5 million of the total $5 million revolving facility. Now let me turn to our outlook on fiscal 2018. We currently expect Q3 revenues of approximately $31 million, representing a projected year-on-year growth of 39%. We expect continued sequential improvement in adjusted EBITDA and we reaffirm our expectations to generate positive full-year adjusted EBITDA in fiscal year 2018. In summary, Q2 was a strong quarter. We delivered another quarter of profitable EBITDA growth and continue to strengthen our financial profile. With that let me hand it back to the operator to open up the call for questions. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brian Alger with ROTH Capital Partners. Please go ahead.

I want to get some clarity on what's going on within the content business in Australia. I mean it sound as though we should we expecting a bit of a pause there after the past couple of quarters of growth?

Yes. So Brian, we've seen a nice ramp-up of growth over the past few quarters and we really are in transition as the Australian operators and us are working with the new content merchant. So that touch on these like parking, toll, small businesses, magazine, newspapers et cetera. So I really see that being something that we are going to be focus more on 2018 and some of the traditional subscription activities, we get migrate over to events. So we anticipate this that we have a modest impact in 2018, but nothing that this grade is it want to be materially in fact our guidance and direction to you guys.

Well, obviously in the O&O businesses has become a bigger percentage of revenues and that's masking obviously the content fluctuations as well as E&P. Just curious within the 9.8 reported for content how much does this tide to Australia?

The vast majority of that tide Australia.

Just making sure. Great. And then as we look forward, and we're looking at that delivers, it sounded though you have some trials but were not quite ready to go at Scalia. Can you maybe walk you through the next maybe milestones steps that you need to do before we are ready to go at [Australia]?

Yes, so we are basically eluted a share of trials that had some nice inclusion results, albeit not in scale. We've just recently been working with one advertising partner and one of our large North American partners to trial it and so again the results are encouraging, but the key here is to be able to do across all of our partners all over the world and with any advertising partner we’ve still have a little bit of work on the text side to do. I anticipates at the end of December quarter and kind of early into the March quarter to have some material progress against that. But I think in terms of moving a needle this fiscal year from our results perspective, I wouldn’t anticipate anything and expect to do much more of the story for a next fiscal year. But there is some technical just time of material things that we guys do to operate distinct scale.

Okay, and is that something that's going to be tide business into your focus on the open market? You talked about working with the carriers more from the aspect of licensing from a open device, is that tide into the same thing or are they separate?

Yes, so they are separate, but they are -- I would think of them as different revenue streams. So one revenue stream would be from an advertising partners. So you can think of a Facebook and Snap, Twitter and Oath or whole long tail of advertising partners that really wanted to over one click access to their customers. So we will go out of and work with those advertising partners to deliver that capabilities through Ignite and I would view that as one revenue stream. The second revenue stream is really a pain point we hear from every operator all over the globe, which is, hey, we got all of these phones coming on our networks. The sim cards don’t have the capability to get our experience through these customers. How can we get our experience to our customers? So if you have an AT&T phone that comes on to Verizon or vice versa or goes in the same analogy to other geographies and how can we operate and deliver the experience out to these customers to get a better sticky relationship. And we view having Ignite on those open-market devices as s licensing opportunity back to those that would want to pay us to be able to do that, and it’s solving a big pain point in the marketplace. So something we're really excited about.

Yeah. So it's one of the original pain points that going back several years that we’ve been involved, but you guys were looking at targeting way back. So it’s great to see that moving along. And you mentioned it was a 116 million devices with Ignite in the marketplace today, I would assume that most of those are domestically here in the United States, do you have a rough geographic breakdown in terms of where those might be located?

Yeah, so we didn’t break them out by geography. I think as we go forward in time. When we get to our investment analyst day, we will provide a lot more context and texture around it. We will do that going into the future, but for today I wouldn't conclude that they’re all in North America. I mean, we’ve made a lot of progress in Latin America and India and a lot of other geographies, but yes, we're not breaking it out that today. But it's something we want to really plan to see investors to think about this as a metric of our business because once we can get the platform on the device, then it’s the opportunity to get multiple revenue streams off that device. So you're looking at a device metric on a go-forward basis will be something we think is important. So yes, stay tuned for more on that.

So it sounds like we should be thinking about delivers not so much as - just going on new phones when it's ready to go scale that off, so at that -- potentially at that installed base?

That’s right.

Our next question comes from Mike Malouf with Craig-Hallum Capital Group. Please go ahead.

Great. Thanks for taking my questions guys. If we could just focus a little bit more on Latin America, can you just talk a little bit about the timing with the APK? And as you look out to calendar 2018, we always thought that America Mobile was going to be a big contributor and a big impact and because of the software we had a little bit of a play in that. I’m wondering if you can talk about the traction that you expect there as we go into next year?

Yes, let me talk about Latin America more broadly versus just one partner, and I'll talk about a little bit on that Mike in a second. We've got a pretty, prettiest pipeline in Latin America right now, and so a lot of good things happening there around our footprint and I'm excited about that because that will help us in terms of scaling some of the advertiser demand as well. So you stay tuned for that as well. So a lot of the OEM traction that we’re seeing right now in Latin America, that's one of the fastest growing smartphone markets in the world. So there's some of the OEM yields I referenced in my prepared remarks I think will be another nice catalyst in Latin America. Regarding American Mobile specifically, yes, you’re correct, we merged them with the SDK solution that have some limitations with it. We’re anticipating 2018 migrating them over to an APK solution. But that will be on their new devices. It won't be out to the embedded base. So that’s important distinction there. But that APK solution will deliver much better install rates, much better performance, much better data and that will all yield improved results. So we're extremely bullish in Latin American and our relationship with American Mobile and that APK, I would expect to -- can’t see in the marketplace in the first half of next calendar year.

Do you think it will be out before the S8 or the S9 or what the new Samsung is?

Yeah. No, no comment on that.

Okay. And then and just a follow-up on your comment with regards to T-Mobile and TracFone, can you talk a little bit about when do you expect that to start around?

Yeah, sure. So I said in my prepared remarks, some of these relationships for those investors who have been following this story for a long time, we’ve taken a long time to bear fruit, and we’re bearing some fruit which is rewarding, and that’s why I'm so excited about the TracFone and T-Mobile relationships because I think it's just the opportunity that can bring to the business. But both relationships have taken longer than we've liked with it. As we said in earlier prepared remarks, we expect to see some attraction on that this fiscal year with both of them, but they've taken longer -- for different reasons but they've taken longer than we've didn’t liked to get go on.

Other than that -- you sort of moving that to our next….

No, I think --- yes, they are also affecting.

Our next question comes from Sameet Sinha with B. Riley. Please go ahead.

This is actually Lee Krowl filling in for Sameet. Could I just give some more commentary on RPS? It seems like you guys are making great progress with new product launches in the U.S., but just want to dig in to kind of the GM profile differences between domestic and international and kind of maybe the margin opportunities there and in terms of growing international and kind of the steps you guys are taking?

Yes, sure. So I think when I think about growing international, I think about it not just in the context of RPS, I think about in the context of all the revenue streams we talked about. So we talked about RPSs one but licensing business, for example, with your international with operator partner such as Millicom and then Reliance Jio today as additional one delivers from Brian's earlier question would be another example of pattern and there is some life cycle services, things are on notifications and folders now that things that we think will be added here to that. So when you think about the revenue streams on international devices I think about it and little bit broader than just RPS, but it just double cart in our RPS specifically. Yes, there is the key challenge there is as we've got to get scale in this markets and so as I said in my prepared remarks we're going do that to three primary avenues. Number one is we're hiring additional local sales people on the ground to bring those local popular campaigns and we've done that in Latin America, India and Europe specifically. That's number one. Number two is really helping to drive RPS through third party relationships so those can be local advertising agencies or on other local third-party majors distributors of applications in those markets. And then third is just to improve global demand as we get scale, I talked about a lot of companies that we're driving RPS here in North America as we get global scale than we would be able to bring some of that global scale to some of these international market so those are really the three areas to focus for us to improve RPS internationally but I don’t want to lead with international RPS is the only way to drive value on those devices as we see additional revenue streams coming off of them.

And then just second. Last quarter you guys spoke about a large banking institution kind of increasing spend. More broadly on that sense, can you just talk about how you are reaching kind of beyond these or gaming social and consumer opportunities? Is that through agency relationships or is better direct sales effort?

Yes, it's a combination of both. So our direct sales team has done a fantastic job bringing new brands and I'm not just continuing in the gaming days or gaming activities but also the non-gaming. So they've done nice job ramping. But we've brought in a lot of different agency relationships and those are starting to bear some fruit with us.

And then just kind of -- I know you again mentioned that you guys were able to have grow revenue on those fairly fixed expense base. What kind of leverage can you continue to drive on the top line in regards to that as a fixed cost basis? Because I would have to assume as you guys grow you are going to have to invest a little bit just kind of curious what kind of leverage you can drive with this sales growth?

Yes. So we've been - as we would have concluded from our remarks, we have been very impressive with the scale from the business. We have been making investments in the technology teams and our sales force both domestically and globally. But we expect to continue to have large amount of scale than operating leverage here. I think about where our expense increases will be. We do have some variable cost related to the host the environment. Those will increase and we will continue to make investments in our technology as we deploy some of the things like delivers, but overall we're optimistic about the scale will continue to achieve.

[Operator Instructions] Our next question comes from Ilya Grozovsky with National Securities. Please go ahead.

So I just had a couple of questions. I think, Bill, you had mentioned in your prepared remarks about September, did you mean October where you get some additional color on the month, or was that supposed to be September?

Yeah, it was September. We didn't really provide any color on the current quarter.

Okay. And then given the sequential growth in Ignite of 25 million devices in the quarter. Can you just kind of give me a little bit of color on the sequential growth in the O&O business, kind of how that correlates?

Yeah. So you would think about our growth coming in Ignite from a number of different regions, all right, and at different stages in each of those regions. But as Bill alluded, our device growth, while we're not breaking it out, I came across all regions and in all areas in both in our legacy partners as well as new partners we've launched over the last several quarters. But we're seeing growth fortunately in our large North American partners as well as Latin America and India and other rest of the world. So I'd say we've seen sequential growth across most all areas.

My question refers to the sequential revenue growth. Because if I look at what you did in in June quarter, you were about 15 million in O&O, and now you’re 15.9 million. I just would have thought it would have been a larger sequential growth given that your unit growth was probably 20% sequential growth. I'm just trying to how that - how that translates to revenue growth? Thanks.

Yeah. One thing to recall, we had the S8 launch in the June quarter, which contribute kind of a unusually high lift in our Ignite revenues, and then the Note 8 launched in the September quarter, which gave some lift, but just as a reminder that was late in the September quarter. But I don't want the fact that the O&O revenue grew over 60% year-on-year to be messed here, so while the sequential was modest growth year-on-year is substantial, obviously

This concludes our question-and-answer session. I would like to turn the conference back over to Bill Stone for any closing remarks.

Great. Thank you. Thanks for everyone for joining the call today. We look forward to reporting on our progress against all the points made on today's call and we'll talk to you again on our fiscal third quarter call. Thanks and have a great night.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.