Outbrain Inc. (NASDAQ:OB) Q3 2023 Earnings Call Transcript

Outbrain Inc. (NASDAQ:OB) Q3 2023 Earnings Call Transcript November 7, 2023

Outbrain Inc. beats earnings expectations. Reported EPS is $0.01, expectations were $-0.03.

Operator: Good day, and welcome to Outbrain Incorporated Third Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. Question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I'd like to turn the call over to Outbrain's Investor Relations. Please go ahead.

Unidentified Company Representative: Good morning, and thank you for joining us on today's conference call to discuss Outbrain's third quarter 2023 results. Joining me on the call today, we have Outbrain's Co-Founder and Co-CEO, Yaron Galai; Co-CEO, David Kostman; and CFO, Jason Kiviat. During this conference call, management will make forward-looking statements based on current expectations and assumptions. These statements are subject to risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. These risk factors are discussed in detail in our Form 10-K filed for the year ended December 31, 2022, as updated in our Form 10-Q and in subsequent reports filed with the Securities and Exchange Commission.

Forward-looking statements speak only as of the call's original date and we do not undertake any duty to update any such statement. Today's presentation also includes references to non-GAAP financial measures. You should refer to the information contained in the company's third quarter earnings release for definitional information and reconciliations of non-GAAP measures to the comparable GAAP financial measures. Our earnings release can be found on our investor relations website, investors.outbrain.com, under News and Events. With that, let me turn the call over to David.

David Kostman: Thank you, [Randi] (ph). First, I want to touch on the situation in the Middle East. At Outbrain, we stand with the people of Israel who have been affected by the recent events. Our hearts go to all the people that are impacted by the horrific situation. We all know people that have suffered and we pray and hope for better, peaceful days in the region. I want to take this opportunity to thank so many of you, first and foremost, our employees in Israel and around the globe, for your unwavering commitment, our business partners and our investors and analysts for the outpouring expressions of support. This means a lot to us. From an operational perspective, we have approximately 380 employees in Israel. About 30 have been called to reserve duty.

Our offices are located in Netanya, north of Tel Aviv in the center of Israel. The safety and well-being of our employees and their families is our top priority. Since October 7, we have continued to execute on our business priorities and deliver on our commitments to our customers. We do have business continuity plans in place should the situation further escalate. Now, I will turn to our financial results and business trends. We are pleased with the resumption of year-over-year growth in Q3. We grew ex-TAC gross profit by 8% to $56.8 million, within the range of our guidance. Our adjusted EBITDA of $10.3 million exceeded significantly the high-end of our guidance and can be attributed to the top-end growth and to our cost discipline. We also saw improvements in our ex-TAC margin.

In terms of current trends, the macro environment, which remains volatile, combined with the ongoing situation in the Middle East, leads us to a more cautious outlook for revenues and ex-TAC gross profit in Q4, as you will hear from Jason. Since early October, we've seen a spike in war-related news pages, which are generally more difficult to monetize, as certain brands have brand safety concerns around these types of pages. We have also experienced some brand budget cuts and delays in launching campaigns, resulting in slower-than-normal seasonal Q4 uptick. Despite these near-term headwinds, going into 2024, we're excited with our differentiated position in the market, which focuses on the premium side of publishers and advertisers. Our platform offers full-funnel results for advertisers at scale on the open web and enables total publisher revenue and audience growth, all leveraging our AI-driven prediction engine.

We believe this provides us with a strong foundation for further growth in 2024 and beyond. Let me turn to the advertiser side of our business. Outbrain has traditionally been and continues to be a cost-per-click native advertising customer acquisition platform that uses AI to deliver strong performance on CPA goals across the open web. Yaron will touch on Q3 notable investments in AI and automation capabilities in our core buying platforms, such as the growth in our Codeless Conversion features for our self-serve advertiser base. We continue to innovate to drive return on ad spend and scale for diverse sets of performance advertisers. We are seeing growing adoption of our performance DSP Zemanta with traditional Amplify clients moving budgets to buy more effectively across open web SSPs and not only in the Outbrain marketplace.

As a reminder, Zemanta operates on a percent of spend through the platform, and we have seen record levels of spend growth on Zemanta in 2023. On the branding and awareness front, at the start of Q3, we launched Onyx, our new brand building platform that runs video, high-impact display, and niche media ads, leveraging Outbrain's AI to maximize user attention. Since the launch, we have worked with more than 100 brand advertisers. These advertisers include Sephora, Paramount, L'Oréal, Lancôme, Nestlé, and many others. For many of these advertisers, we are demonstrating that we can outperform incumbent vendors through a unique combination of better creatives, running on high attention placement and utilizing smarter technology to drive attention.

We continue to consistently deliver above-benchmark results in terms of attention. For example, with our High-Impact Display ads on mobile, we see an average 58% higher attention rate versus the Adelaide benchmark. Also, in our video business, which is a core component of our Onyx offering, we switched our focus from out-stream video to in-stream, pre-roll, leveraging our video intelligence acquisitions. This shift is starting to pay off with higher margins for the video segment. We expect video to be even more strategic for our future growth. Another differentiated element of our offering is the ability to drive both performance and awareness for brands. This makes us one of the very few companies beyond the [indiscernible] that can deliver advertiser objectives across the full-funnel consumer journey.

As an example, for many years, AARP has been leveraging our Amplify performance platform to drive objectives like audience development. Now, we have expanded the relationship to encompass branding objectives where Onyx will help them build brand awareness with potential new members. These types of engagements with advertisers get us excited about our strategy to address a larger segment of advertising budget from both new and existing clients. Despite some of the slowdown in brand advertiser business that I referred to, we still expect to close the year as we said before with $10 million to $20 million of Onyx business. Moving to the publisher side. We continue to focus on improving the performance of our premium publisher wins over the last 12 to 18 months.

Among our renewals of long-term partnerships in Q3, I want to highlight L'Équipe in France, [indiscernible] in Germany, as well as [Box] (ph) in the U.S., the partner we have been working with exclusively for close to a decade. We are currently engaged in several discussions with large publishers globally, and feel strong momentum driven by several elements of differentiation. One, our focus on having a balanced portfolio of premium global publishers with no single publishers taking up outside demand. Second, the Onyx premium demand. And third, Keystone capabilities and product vision. To sum it up, considering the current macro environment and the situation in the Middle East, we are more cautious about our short-term revenue outlook, but we continue to leverage our cost discipline to drive profitability and cash flow generation.

We are pleased with the resumption of year-over-year growth in Q3 and expect further acceleration in 2024, leveraging our strategic investments. With that, I will turn it over to Yaron.

A digital publisher using the company's predictive analytics to create relevant content on a webpage.

Yaron Galai: Thanks, David. I want to join David's comments and clearly say we stand with the people of Israel and together with our colleagues there, we are committed to overcoming and to continuing the great level of service and product that all Outbrain customers and partners have come to expect. Since our last call, we've added several new Keystone partners, New York Post, The New Republic, Entrepreneur magazine, Publisher Desk, and others. During this last quarter, we started experimenting with an added business model for Keystone where its cost is covered through revenue sharing on publishers' ad slots. We believe that this addition will help us further accelerate Keystone with more publishers. Two updates on the AI front; one algorithmic AI and one generative AI.

First, one of our core AI algorithms has been conversion bid strategy, or CBS, which automates for advertisers the optimization of their ad campaigns. When using Outbrain CBS, an advertiser can automatically maximize their conversion or their return on ad spend, which is also known as ROAS. And CBS is based on our homegrown AI algorithm, and a majority of our current advertiser campaigns are running on CBS technology. This last quarter, we've deployed a new technology that upgrades CBS with codeless capability. Using this codeless layer, marketers on Outbrain can now significantly accelerate the pace of deploying new conversion events and further improve their ROAS. This technology marks a significant stride in our dedication to marketing automation combined with self-serve functionality and it will be a foundational layer for more automation capabilities we're planning to build upon this new layer in the coming months.

Second, on generative AI. One of the most exciting frontiers for us with generative AI is the automation of ad variety. Ad variety is like algorithm, and the more variety we have in our ad index, the better our algorithms can match each individual ad to each individual person. So, ad variety results in better ad matching, which ultimately leads to higher click-through rate, also known as CTR, and higher RPM. One of the earliest AI capabilities we built almost 10 years ago was for automated image cropping in our ad. So, for example, our technology will auto crop an image to better focus on faces or the areas of interest of an image. This has been a CTR driver for us for many years. Now, we're experimenting in the lab with generative AI capabilities that will also enable the reverse, upscaling images and growing them while filling the new image spaces with automatically-generated content.

Another generative AI capability we're experimenting with in the R&D lab is the automatic creation of face variation. An Outbrain advertiser might upload an ad with a photo of one model, and then our technology can automatically offer the identical product image with a variety of, say, 20 different AI-generated model faces. Most of these capabilities are still in R&D lab mode with early testers. We expect these types of capabilities to significantly boost our ad variety, which will improve the appeal of Outbrain ads to more people and ultimately help continue driving our click-through rates. Anecdotally, following all of our recent investments in algorithmic and generative AI, our advertising CTRs in the past couple of months has been among three-year record high.

This is especially encouraging in light of the weaker demand environment. As a reminder, our yield is a result of ad pricing times click-through rates. And with that, I'll hand it over to Jason for our financial results.

Jason Kiviat: Thanks, Yaron. As David mentioned, based on our growth and cost discipline, we exceeded our Q3 guidance for adjusted EBITDA and achieved our ex-TAC gross profit guidance. From a demand perspective, the quarter started off relatively strong in July with year-over-year growth, followed by weakening demand trends in August before a partial recovery in the last weeks of the quarter. The early portion of Q4 has shown a flatter pattern than the seasonal lifts we historically see this time of year, which is driven largely by softer demand to start the quarter, as macro and geopolitical uncertainties weigh on ad budgets, as well as the impact of the news cycle on certain advertisers' budget usage, as David mentioned. Revenue in Q3 was approximately $230 million, reflecting a slight increase year-on-year.

New media partners in the quarter contributed 5 percentage points or approximately $11 million of revenue growth year-over-year. Net revenue retention of our publishers was 95%, which, while up meaningfully from the last several quarters, reflects a continued headwind and the impact of the demand environment on pricing and yields, which is the primary factor driving retention to be below 100%. As noted in the last few quarters, churn has remained low by our standards, with logo retention of 96% for all partners that generated at least $10,000, and our five largest churns amounted to only 3 combined points of year-over-year headwind in Q3. Ex-TAC gross profit was $56.8 million, an increase of 8% year-over-year, outpacing revenue growth, driven primarily by improved deal performance on certain media partners and the net impact of revenue mix.

As noted, our ongoing focus will continue to be on optimizing deal performance. Moving to expenses. Operating expenses decreased approximately 11% year-over-year to $43.8 million in the quarter as we continue to exercise discipline around spending. The largest component of this is compensation-related expenses, which were down approximately $5 million or 14% year-over-year as we have focused on driving efficiencies in our operations. Non-comp expenses were down slightly year-over-year as we continue to exercise prudence. Notably, bad debt expense, though down from H1, remains at elevated levels as compared with our history as the higher number of customers are facing cash flow pressures in this environment. As a result of our cost management and growth of ex-TAC gross profit, displaying the leverage in our model, adjusted EBITDA was approximately $10.3 million in Q3, growing meaningfully year-over-year and exceeding the high-end of the guidance range.

We believe there continues to be meaningful room for operating leverage in the future, particularly as we drive more and higher yielding demand through new products like Onyx and our expansion of video, and assuming a return to more favorable macro environment in the future. Moving to liquidity. Free cash flow, which as a reminder, we define as cash from operating activities less CapEx and capitalized software costs, was approximately $2 million in the quarter. While we are pleased to return to positive free cash flow in the quarter, we still see pressures on working capital, particularly around collections with elevated DSO levels remaining from Q2 into Q3. As a result, we ended the quarter with $214 million of cash, cash equivalent, and investments in marketable securities on the balance sheet, and $118 million of long-term convertible debt.

In December, the company's Board of Directors authorized a $30 million share repurchase program, incremental to the $30 million program fully executed in 2022. Year-to-date through September 30, we have purchased approximately 2.5 million shares for $12.7 million. We continue to believe it is an attractive way to enhance shareholder value under current market conditions. Now, turning to our outlook. Uncertainty from macro and geopolitical events and the typical back-half-weighted nature of Q4 seasonal uplift are considerations in our decision to present a wider than typical range of guidance for the quarter. In our guidance, we assume the continuation of the softer demand trends we have seen in the first weeks of Q4 and assume that seasonal increases in ad spend will occur at levels below what we've seen historically.

With that context, we have provided the following guidance for Q4. We expect ex-TAC gross profit of $59 million to $64 million, and we expect adjusted EBITDA of $13 million to $17 million. Now, I'll turn it back to the operator for Q&A.

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