Direct Digital Holdings, Inc.

Hello, everyone, and welcome to Direct Digital Holdings second quarter 2023 earnings call. At this time, I would like to hand the call over to Mr. Brett Malott. Please go ahead, sir.

Good afternoon, everyone, and welcome to Direct Digital Holdings second quarter 2023 earnings conference call. My name is Brett Malott, and I'm representing Direct Digital Holdings from ICR. On today's call are Direct Digital Holdings Chairman and Chief Executive Officer Mark Walker and Chief Financial Officer Diana Diaz. Information assessed today is qualified in its entirety with the form 8K and accompanying earnings release, which has been filed today by Direct Digital Holdings, which may be accessed at the SEC's website and GRCT's website. Today's call is also being webcast and a replay will be posted to GRCT's Investor Relations website. Immediately following the speaker's presentation, there will be a question and answer session. Please note that the statements made during the call, including financial projections or other statements that are not historical in nature, may constitute forward-looking statements. These 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 risk, which would cause DRCT's actual results to differ from its historical results and forecasts, including those risks set forth in DRCT's filings at the FCC, and you should refer to 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. Reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the earnings release that DRCT filed in its Form 8K today. I will now hand over the conference to Mark Walker, Chief Executive Officer. Mark?

Thanks, Brett, and thank you to everyone joining our second quarter 2023 earnings call. I'm proud to report strong financial results and operational performance for the first half of 2023. Similar to Q1, Q2 is one of our typically seasonally slow quarters, and we expect to see advertising demand increase as the year progresses. This quarter, we saw strong top line growth across both our sell side and buy side businesses. as well as considerable increases in market share. Our open marketplace CPM platform continues to benefit as middle market businesses look for less expensive, less restrictive, more accessible, and more representative advertising solutions. In Q2 of 2023, our revenue increased to $35.4 million, an increase of $14.1 million, or 67% over $21.3 million in the same period of 2022. Adjusted EBITDA for the quarter was $3.1 million compared to $3.6 million in the same period of 2022. As Diana will explain in more detail shortly, this quarter we did see some margin impact driven by our buy-side and sell-side businesses mix and some higher operating expenses. Our revenue this quarter was driven by strong performance by both our buy-side and sell-side advertising segments, which saw substantial growth. We are pleased to report increases in revenue growth by segment of 27% and 98%, respectively, over the same period of 2022. In the second quarter, our sell-side advertising segment processed approximately 300 billion monthly impressions, an increase of 205% over the same period of 2022. In addition, this quarter, the company's sell-side advertising platform received over 11.2 billion monthly bid responses. an increase of 70% over the same period in 2022 through 119,000 advertisers for the quarter, which is a 34% increase over the same period last year. On the buy side, our businesses served approximately 227 customers, a slight decrease year over year. However, revenue per customer increased 36% compared to the same period last year. Turning to the remainder of 2023, we believe the current market dynamics are favorable for direct digital holdings as we see an increase in media spend being targeted to reach growth and multicultural audiences while simultaneously middle market companies are moving dollars away from traditional media spend to digital. In addition, with our portfolio of customers, we're seeing deepened investments in digital marketing. As we have mentioned in previous quarters, we have been making investments in our infrastructure and servers. which we are starting to see the benefits of which will carry us through the remainder of the year and through 2024. This quarter, we continue to make considerable progress with our server transitions, as well as our overall re-platforming strategy, all the while maintaining business growth and capturing incremental market share. As our company reaches a certain size and scope, we're able to pull certain levers, realizing efficiencies across many aspects of our platform. In combination, we also believe that the U.S. economy will continue to move forward and our market segment will continue to outperform in the second half of the year. Consequently, we're revising our full year 2023 revenue guidance upwards to $125 million to $130 million. I will now hand things over to our CFO, Diana Diaz, who will walk through some of the financial highlights in further detail.

Thank you. As Mark stated, our revenue increased to $35.4 million in the second quarter of 2023, an increase of $14.1 million or 67% over $21.3 million in the same period of last year. Our sell-side advertising segment had a strong quarter and drove the majority of the increase. Colossus grew to $23.6 million for Q2, and contributed $11.7 million of the increase, or 98% over the $11.9 million in revenue in the same period of last year. Our SSP, our sell-side platform, continues to increase publisher partner engagements in addition to increasing our impression monetization. Our buy-side businesses, Orange 142 and Huddle Masses, grew 27% year-over-year, and contributed $2.5 million of our increase, finishing the quarter with $11.8 million in revenue compared to $9.3 million in the same period of 2022. The increase in revenue was primarily a result of upsell opportunities from current customers and a continued effort to capture market share through our drive for new customers within our core industry segments. Related to gross profit, For the second quarter of 2023, gross profit dollars were $10.1 million compared to $8.3 million for the second quarter of last year, an increase of $1.7 million as a result of higher overall revenue. Primarily as a result of our revenue mix, gross margins for the second quarter of 2023 were approximately 28% compared to 39% in the same period of last year. As we discussed last quarter, these margin results are in line with our margin expectations given the rate of accelerated growth in our sell side advertising segment and the resulting mix of our revenue profile. In Q2 2023, the revenue mix was approximately 33% buy side and 67% sell side. While in quarter two of last year, the mix was around 44% on the buy side and 56% on the sell side. Our sell side segment, his revenues grew as a percentage of our overall revenue, has a lower gross margin than our buy side segment. Gross margin in 2023 was also negatively impacted by an increase in fixed costs of approximately $600,000 incurred in the three months ended June 30, 2023. related to an increase in server capacity to support growth in our sell-side advertising segment. Approximately half of these incremental costs are expected to continue each quarter through March of 2024. The buy-side advertising segment gross margins were 61% for the second quarter of 2023 compared to 66% in the prior year period. This range for the buy side margins is in line with our strategy as the mix and timing of customer campaigns can impact the result. Buy side gross margin decreased in 2023 to a level that we believe is sustainable, reflecting our strategic focus on customer retention and increasing customer lifetime value. The sell side advertising segment gross margins were 12% for the second quarter of 2023, compared to 18% in the second quarter of last year. As this business segment continues to grow, the slight reduction in margins are due to the continued investment in our technology and our overall mix of publishers. With respect to the operating leverage of the SSP programmatic business, the higher revenue results in higher dollar EBITDA contribution by the sell-side segment. As stated previously, the increase in fixed costs we saw in the second quarter of 2023 should reduce by half over the next three quarters and then should resort back to historical margin targets of 14 to 15% by the end of Q2 2024. Now I'll talk about operating expenses. Operating expenses increased to $7.8 million in the second quarter of 2023 or an increase of $2.5 million over the $5.3 million of expenses in the second quarter of last year. A $2.5 million increase in operating expenses reflects a million dollar increase in compensation tax and benefit expenses and a $1.5 million increase in general and administrative expenses. Increases in compensation tax and benefits expense was primarily driven by headcount additions mainly in shared services to support our public company infrastructure, as well as a one-time $300,000 employee severance expense this quarter. The increase in general and administrative costs was due to expenses associated with supporting our growth and ongoing marketing initiatives. We expect to continue to invest in and incur additional expenses associated with our transition to operating as a public company including increased professional fees, investment and automation, and compliance costs associated with developing the requisite infrastructure required for internal controls. Net income was $1.2 million in the second quarter of 2023 compared to net income of $2.6 million in the same period of last year. Our organic growth year over year is measured by our buy side and sell side operating income results. The operating income of our business segments for the second quarter of 2023 was $6.1 million compared to the operating income of our business segments of $4.8 million in the same period of 2022. That's an increase of 28% year over year. For the second quarter, adjusted EBITDA was $3.1 million compared to $3.6 million in the second quarter of last year. This was impacted by the items we described before, including increase in operating expenses, partially offset by the increase in gross profit. Turning to the balance sheet. We ended the quarter with cash and cash equivalents of $5.7 million, an increase of $1.7 million from the $4 million that we had as of December 31st, 2022. Additionally, in the second quarter, 2023, we entered into a $5 million revolving credit facility with East West Bank, which includes an additional $5 million uncommitted incremental revolving facility that may increase the aggregate principal amount of the credit facility to $10 million. This provides us with a new source of non-dilutive capital for us to continue to invest and grow the business. And now I'd like to turn it back over to Mark for some closing comments.

Thank you, Diana, and thank you to everyone for joining. We sincerely appreciate your interest in Direct Digital Holdings and are looking forward to your questions. Operator, please open the line.

Thank you, sir. And everyone, if you would like to ask a question, please press star 1 on your telephone keypad. Once again, that is star 1 if you have a question today. We'll take our first question from Darren Aftahi, Roth MKM.

Hi, this is Dylan. I'm for Darren. Thanks for taking my questions. First, I wanted to see, could you sort of talk about the strength you're seeing on the sell side? I mean, any extra color as to where you think that's coming from? Is it, is it growth in the market? Is it that you're, you're working with larger advertisers now? Um, something with demand, um, just, are you more efficient with return on ad spend? Um, just anything you could provide to sort of help what you think is really driving the strength there.

Yeah, Dylan. Hey, Hey, good to hear from you. And thanks for the question. Um, two things. One, We're definitely seeing an impact from the increase in new publishers that we're actually bringing into our programmatic ecosystem. I think you can see that the impression count year-over-year growth has definitely increased and that actually helps fuel our overall growth strategy. In addition to that, the level of investments that we're actually putting in our marketing sales and in our marketing efforts is definitely starting to pay off. We're much more known in the advertising community and we're starting to see benefits of that coming into the Q2, Q3, and then subsequently for the rest of the year. So we think that the level of effort that we've actually put in the investments that we've put in the marketing and then that publisher mix is definitely starting to pay off and we're going to continue to see that growth for the remainder of the year. In addition to that, we're getting a little bit more efficient, and we're actually getting more efficient with our overall infrastructure and our architecture, and that's part of the investment that we're making in servers, and we're starting to see that benefit come to light as well.

Got it. Thank you. And as a follow-up, when you sort of make the comment about, you know, expecting increase in ad demand as the year progresses, If you look at the midpoint of your new guidance, it sort of implies, I mean, if you take the standard seasonality where your revenue typically gets better in the second half of the year, it almost sort of implies that 3Q and 4Q are at the same level in dollars as 2Q. I mean, is there anything that sticks out there, or am I looking at this wrong?

No, I think what we see is we do feel bullish about the remainder of the year, and that's why we were able to raise our guidance to the 125-130 range. And as of right now, we feel very confident in us being able to achieve that goal.

Okay, thank you. Appreciate the help. Thank you.

We'll take the next question from Dan Kernos, the benchmark company.

Yeah, thanks. Good afternoon. All right, Mark, let me ask Dylan's question a different way. Given your commentary around sort of expected improvement in spend, I know there's been a lot of unevenness in the broader market right now, especially from a category perspective. If you want to provide some color on what you're seeing, we know DMOs are pretty strong, but there's been clearly some uneven categorical performance just in broader advertising. Are we looking for standard seasonality this year? We didn't have it last year, obviously, in Q4, so there are kind of some easier video prompts, I guess. It's not a strength of yours, but just trying to get a sense of how you think the year unfolds. Does it get progressively better? Do we see the typical step up in Q4? Just help us understand what you're seeing maybe from a category perspective.

Yeah. Yeah, we're expecting to see some level of step in the typical seasonality that we have seen historically. As you said, you know, last year Q4 was a little bit different than what has historically happened. But we are anticipating and some of the feedback that we're hearing from some of our demand partners is that we're anticipating to see the same level of seasonality that we have seen historically in the past where Q3 and Q4 are strong or stronger than Q1 and Q2. So as of right now, one of the reasons why we've stepped up guidance is because we expect that seasonality to present itself, and that's why we went to the 125-130 in raising our guidance for the remainder of the year.

And just in terms of categories or categorical strength or weakness, Mark, I know it's kind of a very uneven environment, I keep saying that word, but just any kind of help or thoughts on what you're seeing from that perspective?

Yeah, you know, I'll refer more to kind of what we're seeing on the buy side of the business because, as you saw, the performance on our buy side was strong. We do believe that the spaces that we're actually sitting in as it relates to the buy side business and the DMO space, we believe that travel in this economy and this market actually lends itself favorably to the markets that we actually service where people are tending to drive. to local and regional vacation destinations. That's one of the benefits that we've seen and why we're positioned in the way we are. Also, we've seen good performance from the educational space, which we have a good swath of customers that actually lend itself there, and then also in the energy sector. Those three industries for us have tended to be somewhat recession-proof. As it relates to how the economy has performed over the last year and then subsequently in the first half of this year, we think we were positioned ourselves favorably for the go forward for the remainder of the year. And then in addition to that, one of the last points that we would call out is that for our middle market region, we have not seen a slowdown in marketing and advertising spend. So that's one of the reasons why we're still, we feel pretty optimistic about how Q3 and Q4 are going to play itself out.

That's super helpful. And I guess just kind of to wrap it up on that sort of point, I don't know if you care to weigh in on sort of the topic du jour, given what's gone on with some of the larger competitors, but obviously the evolving narrative around SSPs versus DSPs and who wins, you guys have obviously taken a platform approach and your sell-side business in particular has outperformed every quarter. I know that you guys are adding new publishers, so it's not necessarily an apples-to-apples comparison, but I am just kind of curious about where you think the balance of power lies and how you think the platform approach and or which side of the equation, if one or the other, will outperform over time. That's kind of in your thoughts or you're still early stages.

Yeah, I would say for us, since 2018, we've taken the platform approach of having a buy side and a sell side. We believed in that economic thesis back in 2018 and we think you've seen more and more of the market actually move into that domain. We think we were ahead of it, but we also think another competitive advantage that we have is that we're focused on the middle market for the buy side, but on the sell side, we believe that our strategy of going for the long tail and going for what I would call the niche or micro niche or multicultural publishers actually works to our advantage. With 40% of the United States being in the multicultural domain, we think adding those publishers into our ecosystem has given us a favorable advantage for the large advertisers that like to advertise and sell. So I'm trying to reach those audiences. So we like our platform strategy of having a buy side and a sell side. And I think that what you're going to start seeing and what you're actually seeing unfold is the market is catching up with the strategy that we implemented back in 2018.

Got it. Super helpful, Mark. Congrats on another solid quarter. Thank you.

Hey, thanks, Dan.

And up next, we'll hear from Pat McCann in Noble Capital Markets.

Hey, good afternoon. This is Pat on for Mike Kapinski. My first question has to do with the transition to the new servers. I guess it's a two-fold question. On the one hand, what are you seeing as far as the positive impacts on processing and so forth with the new servers? And then on the other hand, with regard to the cost redundancies, what's your expectations for those sort of trailing off dramatically here?

Yeah, yeah. I expect in order for us to maintain the level of growth that we had as well as being able to make sure that the company performed the way that it has, it was required for us to have some level of redundancy in place. We felt like that that was the prudent approach to managing the business to maintain profitability and also to maintain the market momentum that we've been able to experience over the last year and a half, two years while we've been public. So we expect the way that we designed those relationships and the way we structured the business was for those to tail off so that we can bring our margin back to the point that we've been, which has been in the 14, 15% range. So we believe that we wanted to give some level of guidance and expectation to the street on what they have seen as what the impact was to our margin on the sell side business, and when they can expect to see it, of course, correct itself in the immediate future. Hopefully we'll be able to figure out how to grab some of that margin back in Q3 and Q4, but we want to make sure that we manage expectations on the go forward.

Gotcha. And then also, you know, on the sell side, related to the margins, you know, when you talk about the margins sort of being impacted by the investments on the technology side, but also on the publisher mix, Could you characterize which maybe is a greater impact to margins between those two factors?

It's the level of redundancy that we've actually put in place to ensure that our growth and sustainability of the company existed specifically on the sell side of the business. So we see it as more of a redundancy play. So that's why we're still bullish about our business and we don't feel like there's a margin impact there. Gotcha.

Okay, and then, yeah, I just have one final question. You know, you recently began processing audio advertising, and I was just wondering, you know, what are the early returns there? How has that gone since you added that medium?

Yeah, we're still testing that out. We're not at the point of scale, but once we do, we will definitely let you guys know.

Excellent. That's all I got. Thanks so much.

Thank you.

At this time, there are no further questions. I'll hand the call back to our speakers for any additional or closing remarks.

Nothing from us, so thank you.

And ladies and gentlemen, that does conclude the direct digital holdings call. We would like to thank you all for your participation today.