Direct Digital Holdings, Inc. (DRCT) Q3 2022 Earnings Report, Transcript and Summary

Thank you for standing by. And welcome to the Direct Digital Holdings’ Third Quarter 2022 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation follow by a question-and-answer session. [Operator Instructions] I will now turn the hand the conference over to Mr. Brett Milotte, please go ahead.

Good afternoon, everyone, and welcome to Direct Digital Holdings third quarter 2022 earnings conference call. My name is Brett Milotte and I'm representing Direct Digital Holdings Investor Relations from ICR. On today's call are Direct Digital Holdings’ Chair and Chief Executive Officer, Mark Walker; and Chief Financial Officer, Susan Echard. The information discussed today is qualified in its entirety by the Form 8-K and accompanying earnings release that’s been filed today by Direct Digital Holdings, which may be accessed through the SEC’s website and DRCT's website. Today's call is also being webcast and a replay will be posted to DRCT's Investor Relations website. Immediately following the speakers' presentation, there will be a question-and-answer session. Please note the statements made during this call, including financial projections or other statements that are not historical in nature, may constitute forward-looking statements. Such statements are made on the basis of DRCT's views and assumptions regarding future events and business performance at the time they are made. And we do not undertake any obligation to update these statements. Forward-looking statements are subject to risks which could cause the DRCT's actual results to differ from its historical results and forecasts, including those risks set forth in DRCT's filings with the SEC. You should refer to and carefully consider those for more information. This cautionary statement applies to all forward-looking statements made during this call. Do not place undue reliance on any forward-looking statements. During this call DRCT will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most recently comparable GAAP measures s available in earnings release DRCT filed with its Form 8-K today. I will now hand over to conference to Mark Walker, Chief Executive Officer. Mark?

Thanks, Brett. And good afternoon everyone. This is our third earnings call as a public company and I'm incredibly proud to report strong financial performance for the quarter and continued growth for the year. Before I go into specific details, I want to provide a brief overview for those of you joining us for the first time. Direct Digital Holdings is a company that leverages technology to assist clients in driving ROI through the buying and selling of media. Our technology platform meets the demands of the underserved middle market and provides access to general and multicultural market publishers through our proprietary sell-side platform. Our company's business was founded in 2018 through the initial acquisition of Huddled Masses and Colossus SSP, which was the genesis of our end-to-end programmatic platform. Colossus SSP is our sell-side proprietary technology that enables publishers to sell media to buyers while Huddled Masses, along with Orange 142 is our buy-side platform, which enables middle market businesses across the United States to purchase media to drive ROI. In 2020, we acquired Orange 142 to further develop and grow our buy-side platform and to expand our industry offering into education, travel and tourism, financial services and other verticals. I will begin the call by providing a brief business overview and the main financial highlights for the quarter, and we'll then turn it over to Susan Echard, our CFO, who will share detailed financial results and revise guidance for the remainder of 2022. We will then be happy to answer your questions. As you will see from our third quarter results Direct Digital Holdings is continuing to experience strong organic growth driven by our business model. By focusing on expanding both our buy and sell-side business segments, with the focus on the middle market and multicultural publishers, we have been able to deliver increased top line revenue, net income, and consequently overall growth in our adjusted EBITDA. For the third quarter of 2022, we generated $26 million of revenue and increase of 211% over the same period in 2021. Our net income was $810,000, up 458% over the same period in 2021, and we achieved an adjusted EBITDA of $2.4 million, up 128% over the same period in 2021. Our sell-side platform business segment saw significant growth through a combination of enhanced publisher partner engagement and monetization strategies, increasing our impression count, and growing our advertising publisher base. In Q3 at 2022, our sell-side advertising platform processed approximately 125 billion monthly impressions, an increase of over 247% over the same period of 2021 with over 1.3 trillion bid requests for the quarter. This segment received over 11 billion bid responses, an increase of over 1624% over the same period in 2021 through 129,000 advertisers for the quarter, which is 135% year-over-year increase. We are also continuing to see growth in our buy-side platform, which for Q3 2022 served over 200 customers, an increase of 2% compared to the same period in 2021. We had strong engagement in our current customer base and we firmly believe that the growth in our overall customer count for our buy-side platform will continue to fuel our organic growth strategy for the foreseeable future. As we mentioned last quarter, and as evidence from recent earnings reports, the industry continues to see clients' experience, diminishing returns and higher cost and traditional wall gardens, such as Twitter, Meta and Google. Consequently Direct Digital Holdings and other open market digital participants have been the beneficiary providing advertisers cost efficient digital solutions, and more efficient ROI measurement capabilities. The trend, coupled with our business model and compounded by our company's comprehensive client mix, which is focused on underserved middle market companies and multicultural and general market publishers, has resulted incredible growth across both our sell- and buy-side advertising segments. Our sell-side platform consisting of the Colossus SSP business grew to $18.9 million in revenue, up 710% over the 2.3 million in the same period of 2021. Our buy-side platform consisting of the Huddled Masses and Orange 142 businesses grew to $7.1 million in revenue, up 18% over the $6 million in the same period of 2021. As it relates to overall macroeconomic trends, we view the market uncertainty and volatility as an unmatched opportunity to aggressively capture clients and market share as other companies choose to take a less aggressive approach in the marketplace. Historically, in market downturns, brands and middle market businesses have searched for efficient media and therefore moved dollars from less efficient traditional advertising outlets towards digital media, and we believe we will continue to see that acceleration adoption throughout the year and into 2023. Furthermore, Q4 has historically been our strongest quarter and combined with the stated factors above, we are pleased to announce that we are raising our full year 2022 revenue guidance to $85 million to $90 million. I will now hand things over to Susan Echard, who is going to walk you through some of the financial highlights for the quarter and a further update on guidance.

Thank you, Mark. Moving right into our financial results, as Mark stated, our revenue increased to $26 million in the third quarter of 2022, an increase of $17.6 million or 211% over the $8.4 million in the same period of 2021. Our sell-side advertising segment drove this increase and grew to $18.9 million for Q3, and contributed $16.5 million of this increase, or 477% over the $2.3 million in the same period of 2021. This was driven, as Mark said, by our continued increase in enhanced publisher partner engagements in the monetization strategies as well as increases in our impression inventory. Our buy-side advertising segment grew to $7.1 million and contributed $1.1 million of the increase, or 18% over the $6 million in the same period of 2021. This increase was primarily driven by higher spending by our existing customer base as well as new middle market customer spending. Gross profit dollars increased $3.2 million as a result of higher revenue. Gross margins for the third quarter of 2022 were approximately 29% compared to 49% in the same period of 2021. These margin results are in line with our margin expectations given the rate of accelerated growth in our sell-side advertising segment. Our sell-side segment whose revenues grew as a percentage of our overall revenue, has a lower gross margin than our buy-side segment The buy-side advertising segment, gross margins were 65% for the third quarter of 2022 compared to 64% in the third quarter of 2021. The sell-side advertising segment, gross margins were 15% for the third quarter of 2022 compared to 16% in the third quarter of 2021. As this business segment continues to grow, the slight reduction in the margins are due to the continued investment in our technology and our overall mix of publishers. Due to the operating leverage of this programmatic business, the higher revenue results in higher dollar EBITDA contribution by the sell-side segment. Operating expenses increased to $5.6 million in the third quarter of 2022, or an increase of $1.9 million over the $3.7 million of expense in the third quarter of 2021. Included in the third quarter expenses is a one-time severance charge of approximately $502,000, an increased costs resulting from headcount additions, higher commissions, and bonus expense, as well as approximately $700,000 of public company costs. This increase is due to our strategic edition of revenue generating headcount added to our operating businesses since Q3 of 2021, as well as cost of being a public company. Since our IPO in February of 2022, we have continued to invest in our infrastructure and public company requirements and we estimate that these costs incurred were approximately $700,000 in the quarter related to higher insurance and professional fees. We anticipate operating margins will expand as revenue growth outpaces the added expense of public company costs. Even with these additional costs, operating income increased to $1.8 million for the third quarter of 2022 compared to operating income of $0.6 million in the same period of 2021. Net income for the third quarter was $0.8 million compared to a loss of $0.2 million loss in the same period of 2021. In the third quarter of 2022, adjusted EBITDA increased 128% to $2.4 million or 9.2% margin compared to $1.1 million or 12.6% margin in the third quarter of 2021. As mentioned above, we incurred approximately $502,000 related to severance costs as well as increased costs resulting from headcount additions, higher commission and bonus expenses, and approximately $700,000 of public company-related costs, which impacted the EBITDA margin by around five basis points. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $7 million. As we reported in August, our debt partner Lafayette Square Loan Servicing worked with us to amend our debt agreement and provide proceeds from our delayed draw term loan of approximately $4.3 million. This allowed us to pay off the remaining $4 million owed in connection with the redemption of our common units and to cover the cost of the transaction. In connection with this transaction, the company terminated its line of credit with EastWest Bank and repaid the outstanding principal balance of $400,000. We are currently working on a new line of credit agreement and expect this to be finalized by the end of November. These actions, along with our new line of credit, will improve our working capital ratio and liquidity position, as well as reduce future cash interest costs. Now to touch on our guidance, if you recall in our initial call of the year, we indicated that we expected our full year 2022 revenue to be in the range of $48 million to $52 million or 31% growth year-over-year at the midpoint. After a strong Q2, we raised our annual guidance to be in the range of $70 million to $75 million or up 113% year-over-year at the midpoint. Now, after yet another strong quarter, we are increasing our full year 2022 revenue to be in the range of $85 million to $90 million or up 130% year-over-year growth at the midpoint, while continuing to target our double-digit adjusted EBITDA margins for the year As we continue to transition to being a publicly listed company, we look forward to executing our growth plan with a keen focus on enhancing shareholder value. Additionally, we anticipate continuing to invest in our core business in infrastructure to further support both our rapid organic growth and our inorganic growth strategies. We continue to focus on our top line growth and we remain disciplined in our goal of increasing adjusted EBITDA and positive cash flow. Now I would like to turn it back over to Mark for some closing comments.

Thank you, Susan. And thank you to everyone for joining. We sincerely appreciate your interest in Direct Digital Holdings and the exciting and fast growing business where continuing to build. We are now going to open the line for some questions.

Thank you. [Operator Instructions] Your first question comes from Dan Kurnos from The Benchmark Company. Please go ahead.

Great, thanks. Good afternoon. Susan actually read out the data point that I actually went back just to double check the initial guide for the year of about $50 million. If you, let's just assume you guys do buy-side revenue, modest growth in Q4 your sell-side platform could beat that number by $10 million. I'm not telling you something you guys don't already know, but 710% growth in Q3, an implied guide of what, 250% growth or so in Q4 on those numbers, and there is some variance in there. You talked about being aggressive, Mark in this environment. Nobody else is raising numbers like this. Like what exactly are you doing differently that's causing you to win business, when we continue to hear from others that the advertising environment is generally softening?

Yes, Dan. Yes, first off, it's good to hear from you. Our formula has been consistent and simple. We continue to add new DSPs into our ecosystem which we were able to accomplish through Q2 and Q3. And then in addition to that, as we said in our announcement, we also have added new publishers into our ecosystem as well. The recent addition of Mediavine into CafeMedia, into our ecosystem has actually benefited us very favorably and we're going to continue with that exact same push throughout the rest of the year. So our formula has worked. We continue to increase the amount of buyers that we have coming in. As you saw, we had over 120 advertisers who are buying directly from us, and then we're also continuing to grow the level of impressions that we're actually continuing to serve. And that formula and the buyers and the advertisers that are working with us, keep rewarding us by continuing to do business with us and we're very thankful for that.

I mean, is there a particular vertical that's outperforming and I would love to also hear, because it did actually catch some good press mark about the CafeMedia announcement in like a pretty meaningful partnership stuff forward here.

Yes, the CafeMedia definitely was a strong partnership and we're thankful to have it. The segment that we are seeing continued growth in is our formula of having multicultural publishers actually connected into our ecosystem. You're starting to see more and more brands interested in actually targeting those audiences and the fact that roughly about 15% to 20% of our entire offering is geared towards that, has played favorably towards us and therefore we're going to keep putting a push on adding more and more impressions from those different communities, the African-American, Hispanic-American, LGBTQ, as well as Asian-American, we're going to continue to invest in those. And then we're also going to continue to invest in adding more DSPs when we start the beginning of the year in 2023.

Got it. And just last one for me, margins have been very healthy, you've got some good momentum. Just how do we think about the balance of your willingness to continue investing at this point? I mean, you've got clear momentum, but as we look at Q4, some seasonal uptick to be expected, but just generally speaking, your willingness to reinvest or redeploy cash for future growth in the life of the strong top line you're putting up.

Yes, Dan, we're going to keep seeing this compression of the margin, which we're happy to tradeoff for more EBITDA dollars and we're happy to invest in a technology that has proven time and again on this growth. And so we really want to protect that and invest in lowering our IVT, making publishers comfortable with our inventory, as well as investing in the technology. We also have a mix of publishers that have a different take rate profile. So as you see some of that along with the mix of revenue between the buy-side and sell-side, you're going to see these lower margins, but like we keep saying those dollars are going to keep dropping to the bottom line.

Perfect. That's really helpful color. Thank you Susan. And thank you Mark, and congratulations obviously to stellar numbers.

Absolutely. Thank you.

Thank you. The next question comes from Darren Aftahi from ROTH Capital Partners. Please go ahead.

Hey guys, good afternoon. Thanks for taking my questions. I have my congratulations as well. Mark you kind touched on dollars moving around. I'm just kind of curious, I mean, you're coming off a small base and the rest of the macro sounds pretty dire. Where do you think the ad budgets are shifting from and going to your platform? That’s my first question. I saw you hired a Chief Growth Officer, I think, late August, so I'm kind of curious about general thoughts as we go into 2023, kind of what are your top three priorities in that year? And then it seems like the business is humming along. I'm just kind of curious, are there any things that kind of keep you up at night in terms of risks where things could maybe get unraveled on the platform? Thanks.

Yes, no, absolutely. Yes, I'll tackle that one at a time. In regards to the overall the Chief Growth Officer, we're making continual investments on our growth strategy finishing off this year, of course, for the last month and a half, and then also going into 2023. So the investments that we're making is really in putting in infrastructure that's revenue generating and revenue producing for our overall organization, while we build out and continue to grow our shared services structure, which we feel is going to allow us to manage overall margins and reduce costs in the long run. In regards to risk we always are – you ask what keeps us up at night, we're up at night thinking about everything. We make sure that we're managing and hedging our business on multiple fronts. And so we try to de-risk our platform from a margin perspective, we try to de-risk it from infrastructure perspective. So we are always coming up with plans and also contingency plans so that we can make sure that we can keep the business humming along smoothly as we continue to grow our overall business. And then, what we also are focused in on specifically I would say in the near term and in the short term, is to continue to invest in infrastructure so that we can continue to maintain our growth plan and our growth strategy for the foreseeable future.

That's helpful. Thanks. Congrats.

Thank you. The next question comes from Michael Kupinski from Noble Capital Markets. Please go ahead.

Thank you for taking my questions and congratulations for me as well. So some businesses are feeling the effect of inflation and macroeconomic trends and some advertisers are – some companies are actually giving discounts to certain categories and certain verticals in trying just to have them kind of weather through some tough times, so to speak. I was just wondering what verticals are you seeing in terms of the strength and where you might be seeing, and this follows up on Dan's question a little bit where you might be seeing maybe a little bit of softness.

Yes. I would say in the overall business, there's two things that we look at. One, the fact that on the buy-side of our business, we're focused in on the middle market. Because we're in the performance marketing business and we're continually trying to drive ROI, we try to align ourselves as close to revenue as possible for the clients and partners that we work with so that they can always see some level of return or value in the media that they're spending. What we have found and what is the approach that we've taken, the closer you are to sales, the closer you are to revenue and hard metric KPIs tend to be the last dollars that companies want to not spend in a up or downturn market in order to ensure that they are maintaining their customer base by making sure they are investing those dollars into revenue driving activities. And so we try to align ourselves as close as possible to revenue driving activities and media in order to deliver ROI for our clients. Therefore, the dollars that we are seeing shifting are really focused in on, that are shifting away from some of our competitors and towards us are really those brand dollars where we might see some level of softening into more performance marketing. And then I would also say the wall gardens are we have heard anecdotally from some of our clients that they're seeing higher CPMs and getting less of a return, and therefore they're looking for open CPM marketplaces to actually invest those dollars. And we appreciate that those customers for working directly with us as they reconstitute those dollars into different digital channels. That's been the major impact that we've seen, and we think we are properly positioned with the buy-side as well as the sell-side of our business to capitalize on that shift.

Got you. And thanks for that color. Obviously the investor community is always looking at to say, okay, great, now what beyond looking beyond Q, which is another extraordinary quarter, how the company is investing in tech, obviously the ability to scale their – which you have done the addition in publishers, all these types things, all of these things support another strong year in 2023. And I was just wondering if you can give us your thoughts about the type of revenue growth opportunity, given all the investments in infrastructure, and publishers, and so forth. If you could give us your thoughts of what you might like to see in 2023 in terms of growth.

Yes, right now we are continuing and planning on pretty much maintaining our formula of seeing double digit growth year-over-year from 2022 to 2023. And we're planning on supporting that with double double-digit EBITDA margin going into next year. And we believe that having that, I would say, organizational discipline allows investors and gives them comfort to invest with us because that's how we're aligning the business, and that's how we're modeling the business and that's how we're running it.

There is always a thought that there might be some M&A activity at some point. Have you guys identified anything on that front?

Yes. We're not in a position to talk about inorganic growth opportunities, but the one thing that I will say the management team here has a significant amount of experience in dealing with and also targeting and rolling in inorganic growth opportunities. And we always have a line of sight or eye on those activities. And it's something that we have thought about and actually are looking at for future opportunities. And once that happens we will definitely provide a notice for you guys to know about those activities. But as of right now, it's something that we always keep our eye on and it is in the realm of possibility for us.

Great. That's all I have. Thank you very much. Congratulations.

Thank you.

Thank you. There are no further questions at this time. I'll now hand back to Mark for closing remarks.

All right. Well thank you. We are very pleased with the performance of Direct Digital Holdings and we're looking forward to speaking with you next quarter. Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.