Direct Digital Holdings, Inc. (NASDAQ:DRCT) Q3 2023 Earnings Call Transcript

Direct Digital Holdings, Inc. (NASDAQ:DRCT) Q3 2023 Earnings Call Transcript November 11, 2023

Operator: Good afternoon. My name is Abbie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Direct Digital Holdings Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Thank you. Mr. Brett Milotte, you may begin your conference.

Brett Milotte: Good afternoon, everyone and welcome to Direct Digital Holdings third quarter 2023 earnings conference call. My name is Brett Milotte. I’m representing Direct Digital Holdings from ICR. On today’s call, we have Direct Digital Holdings’ Chairman and Chief Executive Officer, Mark Walker; and Chief Financial Officer, Diana Diaz. Information discussed today is qualified in its entirety with the Form 8-K and company earnings release, which has been filed today by Direct Digital Holdings, which may be accessed at the SEC’s website and DRCT’s website. Today’s call is also being webcast, and a replay we posted to the company’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 risks, which could cause 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 those for more information. This cautionary statement applies to all forward-looking statements made during the call. During this call, DRCT will be referring to non-GAAP financial measures.

These non-GAAP measures are not prepared in accordance to generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures are available in the earnings release that DRCT filed in its Form 8-K today. I will now hand over the conference call to Mark Walker, Chief Executive Officer. Mark?

Mark Walker: Thanks, Brett, and thank you to everyone joining our third quarter 2023 earnings call. Proud to report incredibly strong financial results and operational performance for this quarter. As we’ve discussed during recent earnings calls, we made significant investments in Direct Digital Holdings technology stack, advertising platform and operational structure. We initially expected to see the impact of these investments in 2024. However, we are pleased to report these benefits and associated growth are coming to fruition within 2023. Our technology partnerships and our overarching business strategy have enabled us to meet a growing number of customers’ demand and further the capabilities of our technology platforms.

As a result, our open marketplace CPM platform continues to benefit as middle market businesses seek our differentiating thoughtful approach to our advertiser technology and our tech-enabled solutions. Furthermore, our recently announced strategic partnerships have also helped drive our business to new highs. Our new collaboration between Amazon Publisher Services and our Colossus SSP division, integrates Amazon’s transparent ad marketplace. This integration has allowed Colossus SSP’s roster of publishers, which include both minority-owned and multicultural outlets and general market properties to tap into the benefits of Amazon server-side header bidding solutions that offer a direct auction approach. Most recently, we announced the selection of HPE GreenLake Edge-to-Cloud platform to build a highly reliable, scalable and secure production environment.

Our Colossus SSP division will now incorporate the HPE GreenLake platform with its on-premise infrastructure and cloud services across its entire marketplace to support Direct Digital Holding sell side platform. Our partnership with Beeswax, a FreeWheel-owned programmatic buying platform, has expanded our access to as well as simplify the path for buying multicultural alongside general market connected TV ad inventory, helping drive growth within Colossus SSP, Huddled Masses and Orange142. We will continue to explore opportunities with our strategic partnerships as we continue to execute on our growth strategy. As a result of all these initiatives, DRCT saw significant growth across both the sell and buy side. In Q3 2023, our top line revenue increased to $59.5 million, an increase of $33.5 million or 129% over $26 million in the same period of 2022.

Adjusted EBITDA for the quarter was $5.4 million compared to $2.4 million in the same period in 2022, an increase of 123% year-over-year. Our revenue this quarter was driven by strong performance by both our sell side and buy side advertising segments. Our sell side platform saw substantial growth as a result of our technology investments, increased operational efficiencies and partnership expansion. We are pleased to report increases in sell side revenue growth of 174% and buy side revenue growth of 10% over the same period of 2022. In the third quarter, our sell side advertising segment processed approximately 400 billion monthly impressions, an increase of 220% year-over-year. We also saw an expansion of partners increasing their investment as well as the share of wallet with both our segments.

In addition, this quarter, the company’s sell side advertising platform received over 34 billion monthly bid responses, an increase of 210% over the same period in 2022. Sell side revenue per advertiser also increased 241%. On the buy side, our businesses served approximately 228 customers and buy side revenue per customer increased 14% over the same period in 2022. Another significant milestone for the company was the announcement that we would be purchasing all of our outstanding publicly traded warrants in an effort to protect against shareholder dilution and combat warrant overhang of the stock. We are pleased to report the completion of this redemption initiative, and as a result, an unencumbered stock as Direct Digital Holdings turns its attention to performing for the remainder of 2023 and beyond.

On that topic, for the remainder of 2023, we believe our technology strategy, infrastructure and operational investments will continue to bear fruit as we make considerable progress with our server transitions as well as our overall re-platforming. Historically, Q4 has been our strongest quarter, and we expect to see favorable market dynamics with an increase in media spend being targeted to reach both general and multicultural audiences. Consequently, we’re revising our full year 2023 revenue guidance upwards to a range of $170 million to $190 million. By removing the aforementioned warrant overhang, executing on our re-platforming strategy and continuing our operational excellence, we believe we will pave a way for growth in our stock, valuing Direct Digital Holdings at a similar level to our peers.

I will now hand things over to our CFO, Diana Diaz, who will walk through some of the financial highlights in further detail.

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Diana Diaz: Thank you. As Mark stated, our revenue increased to $59.5 million in the third quarter of 2023, an increase of $33.5 million or 129% over the $26 million in the same period of last year. The exceptional performance of our sell side advertising segment drove the majority of the increase. Sell side advertising segment revenue grew to $51.6 million for the third quarter and contributed $32.8 million of the increase or 174% growth over the $18.9 million in revenue in the same period last year. As Mark stated, our sell side platform has heavily benefited this quarter from continued investments in the technology stack, operational structure and increasing publisher partner engagements. Our buy side advertising segment also saw strong performance, growing 10% year-over-year and contributing about $700,000 to our overall revenue growth, finishing the quarter with $7.9 million in revenue compared to $7.1 million in the same period of last year.

The increase in revenue was primarily a result of increased spend and upsell opportunities from our current customers. Growth in revenue or the sell side and buy side of our business resulted in a direct positive impact on both net income and EBITDA. Now let’s talk about gross profit. Gross profit for the third quarter of 2023 was $11.8 million compared to $7.5 million for the third quarter of last year, an increase of $4.3 million, primarily as a result of our revenue mix, gross margins for the third quarter were approximately 20% compared to 29% 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 the third quarter of 2023, the revenue mix was approximately 87% on the sell side and 13% on the buy side compared to 73% on the sell side and 27% on the buy side over the same period in 2022. The sell side advertising segment gross margins were 14% for the third quarter of 2023 compared to 15% in the third quarter of last year. Sell side revenues, which grew as a percentage of our overall revenue, have a lower gross margin than our buy side segment. Additionally, incremental costs associated with investments in our sell side technology stack, which were about $500,000 in the third quarter of 2023 impacted gross margin. We anticipate that around half of these costs will continue until approximately March of 2024. We then expect sell side gross margin to resort back to historical margin targets of 14% to 15% by the end of Q2 of 2024.

The buy side advertising segment gross margins were 60% for the third quarter of 2023 compared to 65% in the prior year period. This range for the buy side margin is in line with our strategy as the mix and timing of customer campaigns can impact the results. 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. Now I’ll talk about operating expenses. Operating expenses increased to $7.3 million in the third quarter of 2023 or an increase of $1.7 million over the $5.6 million level of expenses in the third quarter of last year. The $1.7 million increase in operating expenses reflects a $900,000 increase in compensation, tax and benefit expense and an $800,000 increase in general and administrative expenses.

The increase in compensation tax and benefits expense was primarily driven by headcount additions, mainly in shared services to support our public company infrastructure. The increase in G&A cost was due to expenses associated with supporting our growth and ongoing market 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 $3.4 million in the third quarter of 2023 compared to net income of $800,000 in the same period of last year, a growth rate of 313% year-over-year.

Our organic growth year-over-year can be measured by our sell side and buy side operating income results. The operating income of our business segments for the third quarter of 2023 was $7.8 million compared to the operating income of our business segments of $3.7 million in the same period of last year, an increase of 108% year-over-year. For the third quarter, adjusted EBITDA was $5.4 million compared to $2.4 million in the third quarter of last year. That’s a 123% increase which was driven by the increase in gross profit, partially offset by the increase in operating expenses that I talked about previously. And as Mark previously mentioned, we believe that currently, our stock is significantly undervalued based on the substantial growth in both revenue and EBITDA.

Turning to the balance sheet. We ended the third quarter with cash and cash equivalents of $5.5 million, an increase of $1.5 million from the $4 million that we had at the end of December 2022. And now I’d like to turn it over to Mark for some closing comments.

Mark Walker: 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.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Darren Aftahi from ROTH MKM. Your line is open.

Dillon Heslin: Hey, thanks for taking the question. This is Dillon on for Darren. First I want to extend my congratulations on the quarter and the guidance. I guess on that note, could you sort of talk about the impact that you’re seeing of those investments that were supposed to — or you’re sort of on track for it to happen in 2024, but are now happening in the second half of this year? Like was that your ability to get certain technology platforms up faster? Or was it publishers or something different that you didn’t think would be on the platform until next year that are now obviously quite big in generating sizable revenue.

Mark Walker: Yes. Hey, Dillon, first off, it’s good to hear from you and thanks for the question. I’d really say it’s a three-pronged approach. I mean, number one, we talked about the technology replatforming that we’ve been going through. I have to give — tip my hat off to our CTO and our technology team they were able to accelerate and streamline our tech stack a little bit faster than what we initially anticipated. That gave us the type of scale that we need as we communicated to grow to that 400 billion impressions on a monthly basis, which gave us more capacity for sale. The second piece of it is, and if you dig into the numbers a little bit, we’ve been able to increase and go deeper with some of our buying partners and agency groups that we work with.

I mean that is starting to yield fruit and come to fruition. So we’ve seen a doubling of the amount of investments at some of our buying groups that we have relationships with. Increase, we had the increase in capacity with the level of impressions that we’ve been able to deliver. And really, some of the benefits that you’ve seen where we are today and what we are anticipating from now until the end of the year is really all three of those components coming together in the culmination of that operational execution that our team has been able to execute against.

Dillon Heslin: Great. Thank you. As a second question, just given where 3Q came in, in terms of revenue mix, and I know you’re talking about getting back to the 14% to 15% sell side gross margins by Q2 of next year. But is there anything that would get in the way of that happening in terms of the revenue within sell side skewing more towards larger publishers that could potentially hit that sort of gross profit number?

Mark Walker: No. Where we are right now, we are anticipating us, specifically on the sell side business, living in that 14%, 15% range. And we are pretty confident that that’s going to hold for us through the 2024 year.

Dillon Heslin: Got it. Last one for me. Could you just sort of touch on where you see yourself in terms of competition, like now that 3Q and 4Q are implying just much bigger numbers. Do you think that invites some of your peers to sort of begin to explore the middle market and other niche markets you play in more?

Mark Walker: Yes. Well, what we think is the processes that we’ve been able to set up will lend ourselves to have a competitive advantage towards the middle market. I think if you look at our revenue per employee, it’s significantly higher than many of our competitors. The processes we put in place, the way that we’ve structured our organization and the way that we are able to operate, we think that gives us the actual competitive advantage against many of our publicly traded competitors that are out there in the marketplace in some of the privately held ones that are held by other PE firms. So we feel pretty good and pretty confident about our position in the marketplace, and we are anticipating growth from now Q4 as well as in 2024.

Dillon Heslin: Great. Thank you. That’s it for me. I will pass it on and congrats on the results.

Mark Walker: Thank you.

Operator: Your next question comes from the line of Dan Kurnos from The Benchmark Company. Your line is open.

Mark Walker: Hey, Dan.

Daniel Kurnos: Thank you. How are you doing, Mark?

Mark Walker: Good.