Earnings Call: Q3 2019

Nov 6, 2019

Good day, and welcome to the Rubicon Third Quarter Earnings Conference Call and Webcast. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Mr. Nick McCormick. Please go ahead. Thank you, operator, and good afternoon, everyone. Welcome to Rubicon Project's 3rd quarter 2019 earnings conference call. As a reminder, this conference call is being recorded. Joining me on the call today are Michael Barrett, President and CEO and David Day, our CFO. I would like to point out that we have posted financial highlights slides to our Investor Relations website to accompany today's presentation. Before we get started, I'd like to remind you that our prepared remarks and answers to questions will include information that might be considered to be forward looking statements, including but not limited to statements concerning our anticipated financial performance and strategic objectives. These statements are not guarantees of future performance. They reflect our current views with respect to future events and are based on assumptions and estimates and subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from expectations or results projected or implied by forward looking statements. A discussion of these and other risks, uncertainties and assumptions is set forth in the company's periodic reports filed with the SEC, including our 2018 annual report on Form 10 ks and subsequent filings. We undertake no obligation to update forward looking statements or relevant risks. Our commentary today will include non GAAP financial measures. Reconciliations between GAAP and non GAAP metrics for our reported results can be found in our earnings press release and in the financial highlights deck that is posted on our Investor Relations website. We define cash flow as adjusted EBITDA less capital expenditures, which excludes changes in working capital. At times, in response to your questions, we may offer incremental metrics to provide greater insights into the dynamics of our business. Please be advised that this additional detail may be one time in nature and we may or may not provide an update on the future of these metrics. I encourage you to visit our Investor Relations website to access our press release, financial highlights deck, periodic SEC reports and webcast replay of today's call to learn more about Rubicon Project. I will now turn the call over to Michael. Please go ahead. Thank you, Nick. We are pleased to post another solid quarter with revenue of $37,600,000 reflecting year over year revenue growth of 27%. Importantly, our bottom line came in very strong, showing the leverage we have in our business model. We delivered $6,100,000 of adjusted EBITDA carrying a 16% margin. We continue to perform very well during a time of industry consolidation and feel very good about our position with buyers and sellers, especially as we realize the first, albeit small, revenue from Demand Manager in the 4th quarter. Stepping back from Q3 specific performance, I wanted to give some context and perspective on industry trends that have influenced several of our strategic moves. Our first strategic objective when I started at Rubicon was to build our position in header bidding and regain our independent market leading position. Header bidding caused an explosion in ad requests over the past few years and we focus on ingesting as many impressions as possible to really understand the new market dynamics of header. This large volume of add requests required a significant amount of CapEx and cloud investment for both us and our DSP partners. Our first move to optimize this inventory at scale was buying nToggle for their traffic shaping technologies and industry leadership demand side. We have now reached the stage that allows us to refine unit economics and to focus to a greater degree on profitability along with our focus on revenue growth. This takes the form of filtering, prioritizing, removing and eliminating various impressions and creating further efficiencies in the large volumes of internal data flows. The results of our efforts in this phase have more significantly manifested themselves in our financial performance this quarter. This also completely aligns with buyers and sellers priorities of getting the most streamlined and efficient supply of hospital and have more ad dollars flow to working media. This allows us to sharpen our focus on mobile, audio, video and demand manager. Back to current revenue trends, as was the case in Q2, in Q3 we saw some monthly revenue variability during the quarter. Q3 started strong, followed by some volatility, which included: 1st, Google's move to a 1st price unified auction structure that included Google's removal of Last Look Advantage, which had historically hurt win rates of others. From what we've observed thus far, after initial period of volatility, the net results have been neutral to slightly positive. 2nd, our implementation of app ads. Txt and seller. Json later in the quarter, which are industry initiatives that highlight transparency in the supply chain. The impact of these has slightly reduced top line revenue. And lastly, implementation of efficiency and profitability initiatives in network optimization through expanded traffic shaping, filtering and low value inventory scrubbing was slightly negative to revenue, but improved bottom line flow through. I would like to focus on network benefits we realized in Q3 that resulted from a number of initiatives and allowed us to operate with a more efficient cost base even as our ad requests doubled on a year over year basis. 2 key efficiency drivers came together this quarter. 1st was greater benefit from deploying our traffic shaping and filtering technology into the software layer of our tech stack. Previously, we had deployed filtering and traffic shaping with a more costly hardware based solution. The software layer development allowed for removal of servers in our exchange, a reduction in related data center costs and allowed us to remove non monetizing impressions and reduce network load. A second network optimization move made in Q3 was removing inventory that either did not monetize or monetize very low CPMs or fill rates that were not profitable. On all fronts, the nToggle acquisition has greatly exceeded expectations from the financial benefits of lowering our annual CapEx spending from $40,000,000 back in 2017 to $20,000,000 each the last 2 years to lowering our network operating expenses to the leadership who are the foundation of our buyer sales team, we've benefited across the board. Given the strong financial performance we had in Q3, we believe we are on track to deliver our long term targeted adjusted EBITDA margins of 25% or higher. Let's turn to our growth drivers. Our long term growth drivers remain unchanged. Supply Path Optimization, Video and Demand Manager. We continue to see supply path optimization or SPO attention with agencies, brands and DSPs with a typical seasonal pause related to annual code freeze in Q4. Video continues to be a driver of our revenue growth. The rate of growth in Q2, Q3 was in line with industry growth rates and the opportunity for CTV remains very promising for the long term. We are very pleased with the high customer interest and our continued customer pipeline progression for Demand Manager, which has now begun initial revenue generation. We are also excited to have announced the purchase of RTK. Io, a leader in the emerging space of pre bid tools. RTK provides pre bid tools and services that brings simplicity and control to header bidding for publishers and the acquisition adds some of the world's experts and developers to our already great team. The RTK customer base is highly complementary to our existing pipeline and will add to our early revenue generation. We are thrilled to double down on this growth opportunity for the future. Our plan is to merge both products in the coming months in a best of breed combination that further distances us from any competitive offerings. We are very pleased with our demand manager customer engagement with the additions of Business Insider, LA Times and Everyday Health among others to those previously announced back in May. Revenue from our prebid tools business will be more predictable than our auction business since it's based on a much larger ad spend base from our publishers as opposed to just the portion of their ad spend that runs through our exchange. It will also be stickier and we anticipate will build steadily similar to a service based software model. It will also carry strong incremental margins continuing to add to the financial leverage in our business. We are very pleased to be adding this service revenue to our overall revenue base for the long term. As you are aware, our demand manager solution is built on Prebid, the open source standard that's used by hundreds of the world's largest sellers and respected across the ecosystem for its transparency and flexibility. Prebid continues to gain greater publisher support with each passing month and the number of publishers adding code now numbers in the 100 and has critical mass. We will share more customer and financial details about Demand Manager and the addition of RTK on our Q4 call as previously indicated. Our journey to recovery started with growing ad spend and amounts paid to sellers back in 2017 2018. We then moved to growing revenue in 2018 2019 crossing over to positive adjusted EBITDA late last year and this year. For the full year 2019, inclusive of our Q4 guidance, which David will discuss shortly, we expect to post year over year revenue growth of approximately 25% with adjusted EBITDA margins in the mid teens and positive cash flow for the full year. While we still have much work to do, we are pleased with top line growth and even more so with the bottom line performance this past quarter. Our market position and growth drivers combined with the powerful leverage we have in our business model puts us in a great position to grow, invest in the business and delivered improved profitability going forward. With that, I will hand things over to David, who will go into greater detail regarding our Q3 financial performance. Thanks, Michael. We are happy with our solid results for Q3. We generated $37,600,000 in revenue, a 27% increase year over year, meaningfully controlled operating expenses and as a result generated adjusted EBITDA of $6,100,000 The year over year increase in revenue was once again driven by solid growth in both take rate and ad spend. Revenue came in slightly lower than our guidance due to the factors as noted by Michael. Our mobile revenue grew 26%, our desktop revenue grew 28% and video and audio revenue continued to be growth drivers in the quarter. Operating expenses, which in our case includes cost of revenue for the Q3 of 2019 were $44,000,000 flat as compared to the same period a year ago. On an adjusted EBITDA basis, operating expenses, including cost of revenue, for the 3rd quarter were down to $31,500,000 from $33,500,000 in Q2 2019 and roughly flat versus $31,200,000 in Q3 twenty eighteen. This is 10% lower than the total adjusted EBITDA operating expenses of $35,000,000 we expected as noted on our last call. This improvement was primarily driven by lower than expected network costs related to the traffic shaping and filtering efficiency gains, which Michael mentioned. The efficiency gains outpaced even our estimates as we realized network capacity savings in cloud and connectivity costs. As a result, our gross margin for the Q3 was 63%, up from 51% in the same period a year ago. Net loss was $6,200,000 in the Q3 of 2019 as compared to a net loss of $13,800,000 in the Q3 of 2018. As I mentioned earlier, adjusted EBITDA was $6,100,000 which represents a 16% margin compared to an adjusted EBITDA loss of $1,400,000 reported in the same period 1 year ago. The improvements in net loss and adjusted EBITDA were driven primarily by higher revenues as costs remained relatively flat. GAAP loss per share was $0.12 for the Q3 of 2019 compared to GAAP loss per share of $0.27 in the same period in 2018. Non GAAP loss per share in the Q3 of 2019 was $0.02 compared to non GAAP loss per share of $0.18 reported for the same period in 2018. Capital expenditures, including purchases of property and equipment as well as capitalized internally software development costs were $7,100,000 for the Q3 of 2019. We closed the Q3 with $85,000,000 in cash, roughly flat versus the $86,000,000 balance at the end of Q2. As a reminder, our cash and marketable security balances can swing disproportionately both up and down compared to the run rate of our business since we collect and pay the gross amount of flow through to our sellers while we record revenue on a net basis. Please also keep in mind that after the close of the quarter, we used $11,000,000 in cash for the purchase of RTK. For the quarter, we had roughly $1,000,000 of negative cash flow, excluding changes in working capital, which we calculate as adjusted EBITDA less CapEx. I will now share some indications for our 4th quarter expectations. These expectations include the impact of RTK in the quarter since the date of acquisition. We expect revenue for the Q4 to be in the range of 40 $7,000,000 to $48,500,000 We expect that adjusted EBITDA operating expenses in Q4, including cost of revenue, will be approximately $33,000,000 This represents the continued benefit from our network efficiency initiatives. As a result, we expect an adjusted EBITDA margin approaching 30%. We continue to expect the CapEx for the full year 2019 will be in line with prior guidance at the $20,000,000 level similar to 2018. I'd like to provide some additional context for our revenue growth expectations for Q4 compared to Q3. 1st and foremost, and as we've discussed in the past, Q4 will structurally no longer have the favorable year over year take rate comparisons. 2nd, we focused on greater network efficiency, has filtered out lower CPM and low margin inventory, resulting in some drag to revenue growth, but adding profitability benefits. 3rd, we are seeing a normalization in video growth rates, partially attributable to app ads. Txt and seller. Json implementation. It's been quite a journey the last several years as we've turned from negative revenue growth to solid double digit revenue growth. As Michael noted, we are also entering in a phase of significant unit economic focus. We are beginning to see the significant upside from the financial leverage in our model and expect adjusted EBITDA margins of 15% or more for the full year 2019 and expect to be cash flow positive for the full year 2019, 1 year ahead of expectations. With that, let's open the line for Q and A. Thank you. We will now begin the question and answer Your first question comes from Jason Kreyer with Craig Hallum. Please go ahead. Guys, good afternoon. Just wanted to touch on, Michael, your commentary on just the app ads. Txt and sellers. Json. If you can provide a little bit more explanation on how those had kind of a little bit of a hiccup towards the end of the quarter there? And then then I'm not sure I'm connecting the right dots, but we saw mobile growth slow down a little bit in the quarter. Was that related to the kind of the app app. Txt implementation or is there something else embedded in that? Yes. Hey, Jason, I'll jump on some of this and let David chime in. Yes, so the we've often talked about new developments that occur in our marketplace, the exchange that sometimes favor one side versus the other, imbalances of CPMs, bid jamming by publishers in the beginning of header. And we all kind of feel as though despite the fact that we have to do this on 90 day sprints, it tends to reach an equilibrium at a certain point. I think our feeling is that, although we implemented app ads. Txt and seller. Json per the rules of the industry that some of it was unfairly hurt our publishers and I think they feel the same way that there are some legitimate resellers out there, some legitimate avenues to acquire their inventory that was profitable for them. It felt very strongly that it provided value add, but buyers kind of approach it with just a one size fits all and that if it's not from the direct source, we're going to pause it and review it as it comes across on a case by case basis. So I don't think we've seen the full extent of either initiative, but I also feel as though we've seen the bulk of it and that over time, I think we're going to see a balanced return to more equilibrium that would help the publisher. And I would say to answer your question about mobile and video, app ads. Txt disproportionately affected video on mobile in international markets. So you saw a kind of a triple a trifecta there from the application of app ads. Txt. And, again, I our gut tells us, it swung a little bit out of balance and it will come back. But that said, listen, it's really good for the industry. And if we got dinged by it slightly, I can't imagine what other exchanges are as well curated, well lit, well polished as ours is. So I think it's good. Anytime you can create greater efficiencies for buyers to reach sellers with less fees along the way, that's good. It puts more dollars to working media. So we're totally leaning into it. We just think that like any initiative, be it GDPR, be it Google's move to 1st price, there's always going to be this period of uncertainty, maybe overreaction on one side versus the other. But over time, I think it's good for the industry. We aggressively enforced it and I think it will shake out as the quarters go on. It. Extra color there, Michael. And maybe David, kind of related, is there any way we can kind of quantify these two developments and look at what kind of a headwind that created? Or is that is it kind of complicatedly tied to several categories? I think, like Michael said, there's some impact. I think we talked about a couple of factors that impacted our revenue for the quarter and have impact going forward. And we think our actually unrelated cleanup, not cleanup, but our focus on unit economics probably was a little bit greater of a driver in that impact. So I guess it had some impact, but it's not not a huge impact. Okay. Switching gears a little bit, there's been a lot more talk that I've heard from people just on accessing log level data. And I think that you've been participating in that with brands and agencies and whatnot. And just wondering if you can give some perspective on how broad based that is and if that creates an opportunity for you to get a little bit closer to the sources with brands and agencies? Yes, another good question, Jason. We've been very favorably disposed to helping buyers understand exactly how much dollars are going to working media. And a lot of that disclosure at the bid level is helpful to them in that respect. And we think it's helpful to us because we made decisions to lower our take rates to below industry average. And so we feel as though we'll be the net beneficiary of it. As far as the momentum of it, it certainly started at the marketer level, not necessarily at the agency level. And I haven't seen it spread like wildfire, but then there's this other concept of Direct Connect. And now all of a sudden, you're kind of merging 2 concepts into 1. So I think the broader bucket would be direct connect, which would give you not just the Direct Connection as the name implies, but it will also give you log level data in many cases. And so that I think you've seen initiatives that we've done in it, you've seen press releases, you've seen people talking about in the industry. And although some folks have said, well, there goes the depth of the exchange, we kind of feel opposite. We think that's the evolution of the exchange and where it should go. So we're really leaning into that too and think we're kind of leading the industry as it relates to initiatives there. And that I think has a lot more momentum than one off. I want to make sure the buy I did for $600,000 I want to see every bid, what price it cleared at, etcetera. Okay. Last one and I'll cede the floor. We talked before that pre bid was going to be adding support for video. I think that was expected to occur at some point in Q3. I was never able to track down whether or not that happened. So just wanted to see if you could confirm if that's there yet and if you think that that could be a driver for a little bit of a rebound in video growth? Yes. So, I'm not trying to be vague. I just don't have the information at my fingertips as to what developed in Q3 on a pre bid roadmap. There's no question that video is going to be a big role, probably more impactful as it moves to the server, but be that as it may, yes. So as we've talked about Prebid and its aspirations as a dotorg, there is no question that it wants to be kind of a complete operating system for publishers monetization and video is a very important piece of it. So there are assets, video assets that we're developing, we're putting Prebid. I've heard that AppNexus is putting tools into Prebid. So yes, there's no Prebid is not just for desktop, it's for mobile, it's for video, it's for everything and that's the natural evolution of the vision we have for it. All right. Thanks for taking the question, guys. Thanks, Steve. Your next question comes from Lee Crowell with B. Riley FBR. Please go ahead. Great. Thanks for taking my question, guys. Real quick, just on audio, kind of wanted to maybe connect the dots. Spotify on their call highlighted that a migration within Google impacted the quarterly results on the ad supported side. Did you guys feel that impact as well just given your relationship there? No, we really didn't. So it's we have such a distributed inventory base and their overall growth was still very healthy. So their issues didn't really impact us. Got it. And then these developments with filtering and driving some margin through efficiencies in the quarter, It seems like you guys had a fairly notable jump across the board realizing these efficiencies. Do you guys kind of anticipate that now that everything is fully implemented that you've kind of level set or is there incremental improvement in Q4 expected as well in terms of the filtering and efficiency initiatives? Well, from a cost basis with our guide of the $33,000,000 in adjusted EBITDA OpEx, which includes cost of revenues, there's a slight uptick in those cost of revenue costs. But if you think about it, we're absorbing with the 4th quarter heavy season a much greater increase in ad requests. And so we're still we see significant efficiency gains continuing forward. We haven't given 2020 guidance, but we could see some additional leverage of the cloud, which could result in some incremental OpEx costs there and cost of revenue. But we think we'll continue on this path of more efficiency gains. Got it. And then just last one on Demand Manager and the integration of RTK. Does the timeline in terms of revenue growth kind of get a little bit delayed as you integrate the 2 product portfolios or product suites into 1? Or do you anticipate that prior expectations in terms of initial rev rec but a more notable kind of uptick in 2020 timeline is still on track? Yes. We don't feel I mean, not that we've shared in any great detail the timeline, but it hasn't altered our internal timeline at all. In fact, it's accelerated it. We'll operate as 2 separate platforms. But as we mentioned before, they're both on pre bid. So we're not talking about like a 2 year integration process between 2 software companies. So I think they have some unbelievable tools that we were envious of that adding to our dashboard, once we get we'll get to a unified dashboard in a relatively quick period of time, which won't have any impact or drag on revenue from the either product. Yes. And to clarify, we'll operate as 2 separate platforms in this Q4 busy season and then have, we think, a fairly rapid integration in 2020. Got it. That makes sense. Thanks for taking my questions guys. Thanks, Lee. Your next question comes from Matthew Thornton with SunTrust. Please go ahead. Hey, good afternoon, everybody. This is Anthony on for Matt. Thanks for taking the question. Just a couple, I mean most of mine were taken already. But without quantifying precisely, are there are we still within the take rate range that you talked about at the start of the year? And then, if you already addressed this, apologies again, but could you quantify the RTK impact for 4Q, in terms of revenue expenses, what the actual impact would be? Thanks. Yes, sure. Yes, I mean, we're not updating our take rate guidance, but at the beginning of the year, we talked about take rate being in the mid-13s. And so we'll stick with that. And the we're not breaking out the RTK expenses separately. We acquired them on the 21st October, so you've got a partial quarter in Q4 with those expenses. And with 20 give or take employees and contractors, you can kind of work out a run rate. And that's included in our $33,000,000 guide on adjusted EBITDA operating expenses for Q4. Understood. Thanks. Yes. Thank you. Thanks, Anthony. Your next question comes from Kyle Evans from Stephens. Please go ahead. Hi, good afternoon. Thanks for taking my questions. You guys talked about the focus on unit economics and maybe taking some of the lower effective CPM units out of the equation. Can you talk about where you are in that process and maybe how that process affected different ad units across the ecosystem like video, desktop, etcetera? Yes. I think we have more to come there. Not that it will have huge impacts on revenue, but it's a continual process of optimization as we figure out how to squeeze the most out of the inventory that we have. I think there was probably some disproportionate impact similar to some of the transparency initiatives on video, on mobile and in the international realm. Got you. Can you kind of step back and look at the competitive landscape? Was there anything meaningful that changed in the Q3? Or is there anything that we should be thinking about going into 2020 on that front? We obviously cited Google's auction changes, which they're kind of a one time only thing. So anything that arose from those changes, we'll be living with. And as we kind of said, it's neutral. There was a period of volatility that led to more of a kind of steady state. We've seen areas of our business that we do with Google slightly down, areas that we do without Google slightly up. So maybe that fell into that bucket. So but I don't see that occurring. And now that everyone's at first price, I don't see another shoe falling with any of our competitors on the privacy initiatives privacy initiatives and the idea that recently I think it was floated as early as yesterday, the idea of a federal privacy initiative, which frankly we welcome, although we haven't seen any details, so I should be careful. But it sure beats having to do 50 different ones for the states. And so those will always be a real macro reality for us. And then lastly, we talk often about supply path optimization or SPO. And although we haven't seen any dramatic changes in SPO, and we've talked about it to we're kind of blue in the face for the last 2 years because people keep alluding to it on the buy side. I've got to imagine that 2020 will come to an end with the same number of players or the same, should I say, the size of the players. We've been clear about supply path optimization has kind of looked like 100 exchanges going to 60 going to 20. And although that's probably provided us with some tailwind, the big changes for us will be when you go 20 to 10, 10 to 5. We think we're very well positioned to benefit from those reductions in supply partners. However, it really hasn't manifested itself yet. And so we just continue to do what we think we need to do to convince buyers and sellers that we're a vital partner in their monetization scheme and hope for the best in terms of SPO. What inning do you think we're in, Michael, for SPO? I think if you talk to someone that was exchange number 100, the game is over, right? So for us, again, for those meaningful things to occur, I think you're into you're batting in the bottom of the 4th. Yes, so I think we still but then it can accelerate fast. We always we often talk about how tens of thousands of buyers buy from us every day and you might be like, well, boy, how is that ever going to get rationalized? But behind those buyers are 5 to 6 global AMF agencies and that can pretty much take care of a big chunk of the spend if they decide to work with just a handful of partners. So that's what we spend a lot of our time and energy in FRN and that's what we talked about when buying Entagl. Obviously, we get the technology benefits. But when we talked about the leadership of intagl in the demand space, essentially our team's leadership on the buy side is from the intagl coupled with some of the very talented people we had on board prior to their arrival. And we feel really, really good about the talent we have on that side and the kind of conversations we're having. Great. I can demand manager. I know it's still very early days there. Could you frame up demand manager. I know it's still very early days there. Could you frame up the competitive set there, talk about what you think a more mature revenue model there looks like? And then maybe if you want to put brackets around the long term opportunity, go for it, but if you don't, I understand. Yes. No, we it's hard to tamp down the excitement with demand manager. We really fundamentally think it will change our business. Of course, like any software initiative, it will take time and we'll probably be able to lay out a little bit more of a roadmap at Q4 earnings. But yes, I mean the simplicity of it is great. Instead of winning a small portion of a publisher's inventory in our auction, we're able to monetize 100% of their inventory, albeit at much lower take rates. So we're very excited about it. The traction has been terrific. Who's our biggest competitor in market? Prebid itself, by far and away. There are big enterprise publishers who are like, hey, guys, I've already switched to Prebid. I've hired folks that can help me with Prebid. Yes, your tools are really cool, but I'm not so sure. Right now, I want to flip out what I have got going. I think I got this home built thing on pre bid that's working just fine. And I think our feeling is, especially if you look at the economics of the digital publishing business, the idea of being able to save hard costs, even if you have to pay to use a product, I think it's going to be in the end too enticing to pass up. In addition, we have seen from our publishers that adopted, they make more money. So you get a double whammy there. So yes, so Prebid would be the biggest competitor we're faced with. The other folks that were header bidder pioneers, credit to them for changing the industry in terms of the way publishers monetize and way buyers buy. But the day of this proprietary kind of black box solution is dwindling fast. So we don't really go up against proprietary solutions. It's just it's pre bidding us essentially. Great. Thank you. Thank you. This concludes our question and answer session. I would now like to turn the conference back over to Mr. Michael Barrett for any closing remarks. We're very happy to deliver strong financial results again this quarter. We're well positioned for the future growth of SPO, Video and Demand Manager. We look forward to seeing many of you in the next couple of weeks at the Craig Hallum, Stevens and Ideas conferences. I want to thank you for joining us for our Q3 results call and have a good evening.