Direct Digital Holdings, Inc. 10-K

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk As a “smaller reporting company,” we are not required to provide the information required by this Item 7A. 54 ITEM 8. Consolidated Financial Statements and Supplementary Data DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm (PCAOB ID Number 688) 56 Consolidated Balance Sheets 57 Consolidated Statements of Operations 58 Consolidated Changes in Members’ Equity (Deficit) 59 Consolidated Statements of Cash Flows 60 Notes to the Consolidated Financial Statements 61 55 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors of Direct Digital Holdings, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Direct Digital Holdings, Inc. (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations , changes in equity (deficit) and cash flows for each of the two years in the period ended December 31, 2021, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit s . We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit s in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit s to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit s we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audit s included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit s also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit s provide a reasonable basis for our opinion. /s/ Marcum llp Marcum llp We have served as the Company’s auditor since 2021. Houston, Texas March 31, 2022 56 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2021 AND 2020 December 31, 2021 2020 ASSETS CURRENT ASSETS Cash and cash equivalents $ 4,684,431 $ 1,611,998 Accounts receivable, net 7,871,181 4,679,376 Prepaid expenses and other current assets 1,225,447 223,344 Total current assets 13,781,059 6,514,718 Goodwill 6,519,636 6,519,636 Intangible assets, net (Note 3) 15,591,578 17,545,396 Deferred financing costs, net (Note 2) 96,152 90,607 Other long-term assets 11,508 25,118 Total assets $ 35,999,933 $ 30,695,475 LIABILITIES AND MEMBERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 6,710,015 $ 3,263,326 Accrued liabilities 1,044,907 1,392,520 Notes payable, current portion 550,000 1,206,750 Deferred revenues 1,348,093 308,682 Related party payables (Note 7) 70,801 70,801 Seller notes payable - 315,509 Seller earnout payable - 74,909 Total current liabilities 9,723,816 6,632,497 Notes payable, net of short-term portion and $2,091,732 and $501,796 deferred financing cost, respectively 19,358,268 11,213,697 Mandatorily redeemable non-participating preferred units 6,455,562 9,913,940 Line of credit 400,000 407,051 Paycheck Protection Program loan 287,143 10,000 Economic Injury Disaster Loan 150,000 150,000 Total liabilities 36,374,789 28,327,185 COMMITMENTS AND CONTINGENCIES (Note 8) MEMBERS' EQUITY (DEFICIT) Units, 1,000,000 units authorized at December 31, 2021 and 2020, 34,182 units issued and outstanding as of December 31, 2021 and 2020, respectively 4,294,241 4,294,241 Accumulated deficit (4,669,097 ) (1,925,951 ) Total members' equity (deficit) (374,856 ) 2,368,290 Total liabilities and members' equity (deficit) $ 35,999,933 $ 30,695,475 See accompanying notes to the consolidated financial statements. 57 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS DECEMBER 31, 2021 AND 2020 For the Year Ended December 31, 2021 2020 Revenues Buy-side advertising $ 26,127,787 $ 9,656,165 Sell-side advertising 12,009,075 2,821,354 Total revenues 38,136,862 12,477,519 Cost of revenues Buy-side advertising 9,927,295 4,864,234 Sell-side advertising 9,780,442 2,440,975 Total cost of revenues 19,707,737 7,305,209 Gross profit 18,429,125 5,172,310 Operating expenses Compensation, taxes and benefits 8,519,418 3,334,060 General and administrative 5,525,107 1,848,407 Acquisition transaction costs - 834,407 Total operating expenses 14,044,525 6,016,874 Income (loss) from operations 4,384,600 (844,564 ) Other income (expense) Other income 19,185 134,776 Forgiveness of Paycheck Protection Program loan 10,000 277,100 Gain from revaluation and settlement of seller notes and earnout liability 31,443 401,677 Loss on redemption of non-participating preferred units (41,622 ) - Loss on early extinguishment of debt (2,663,148 ) - Interest expense (3,184,029 ) (865,055 ) Total other expense (5,828,171 ) (51,502 ) Tax expense (63,526 ) (12,124 ) Net loss $ (1,507,097 ) $ (908,190 ) Net loss per common unit: Basic and diluted $ (44.09 ) $ (30.32 ) Weighted-average common units outstanding: Basic and diluted 34,182 29,954 See accompanying notes to the consolidated financial statements. 58 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED CHANGES IN MEMBERS’ EQUITY (DEFICIT) DECEMBER 31, 2021 AND 2020 Common Units Receivable Members' Units Amount from members Accumulated equity (deficit) equity (deficit) Balance, January 1, 2020 28,545 $ 200 $ (370,789 ) $ (900,253 ) $ (1,270,842 ) Receipts from members - - 370,789 - 370,789 Distributions to members - - - (117,508 ) (117,508 ) Shares issued for acquisition of Orange 142, LLC 5,637 4,294,041 - 4,294,041 Net loss - - - (908,190 ) (908,190 ) Balance, December 31, 2020 34,182 4,294,241 - (1,925,951 ) 2,368,290 Distributions to members (1,236,049 ) (1,236,049 ) Net loss (1,507,097 ) (1,507,097 ) Balance, December 31, 2021 34,182 $ 4,294,241 $ - $ (4,669,097 ) $ (374,856 ) See accompanying notes to the consolidated financial statements. 59 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS DECEMBER 31, 2021 AND 2020 For the Year Ended December 31, 2021 2020 Cash Flows Provided By (Used In) Operating Activities: Net loss $ (1,507,097 ) $ (908,190 ) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Amortization of deferred financing costs 356,442 84,629 Amortization of intangible assets 1,953,818 488,454 Loss on early extinguishment of debt 2,663,148 - Forgiveness of Paycheck Protection Program loan (10,000 ) (277,100 ) Paid-in-kind interest 269,260 97,243 Gain from revaluation and settlement of earnout liability (31,443 ) (401,677 ) Loss on redemption of non-participating preferred units 41,622 - Bad debt expense 91,048 8,086 Changes in operating assets and liabilities: Accounts receivable (3,282,853 ) 737,554 Prepaid expenses and other current assets (1,005,159 ) (7,093 ) Accounts payable 3,446,689 (516,690 ) Accrued liabilities (273,735 ) 540,033 Deferred revenues 1,039,411 (490,577 ) Related party payable - 70,801 Net cash provided by (used in) operating activities 3,751,151 (574,527 ) Cash Flows Used In Investing Activities: Cash paid for acquisition of Orange142, net of cash acquired - (10,985,849 ) Net cash used in investing activities - (10,985,849 ) Cash Flows (Used In) Provided By Financing Activities: Proceeds from note payable 22,000,000 12,825,000 Payments of notes payable and extinguishment of debt (15,672,912 ) - Payments of litigation settlement - (210,000 ) Proceeds from lines of credit 400,000 1,083,051 Payments on lines of credit (407,051 ) (1,403,000 ) Payment of deferred financing costs (2,190,874 ) (677,032 ) Proceeds from Paycheck Protection Program loan 287,143 287,100 Proceeds from Economic Injury Disaster Loan - 150,000 Redemption of Preferred Shares (3,500,000 ) 370,789 Payments on seller notes and earnouts payable (358,975 ) (18,318 ) Distributions to members (1,236,049 ) (117,508 ) Net cash (used in) provided by financing activities (678,718 ) 12,290,082 Net increase in cash and cash equivalents 3,072,433 729,706 Cash and cash equivalents, beginning of the period 1,611,998 882,292 Cash and cash equivalents, end of the year $ 4,684,431 $ 1,611,998 Supplemental Disclosure of Cash Flow Information: Cash paid for taxes $ 63,527 $ 12,124 Cash paid for interest $ 2,528,240 $ 620,474 Non-cash Investing and Financing Activities: Issuance of members’ units as purchase consideration (Note 3) $ - $ 14,207,981 See accompanying notes to the consolidated financial statements. 60 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Note 1 — Organization and Description of Business Direct Digital Holdings, Inc. and its subsidiaries, headquartered in Houston, Texas, is an end-to-end, full-service programmatic advertising platform primarily focused on providing advertising technology, data-driven campaign optimization and other solutions to underserved and less efficient markets on both the buy- and sell-side of the digital advertising ecosystem. Direct Digital Holdings, Inc., incorporated as a Delaware corporation on August 23, 2021, is the holding company for Direct Digital Holdings, LLC (“DDH LLC”), which is, in turn, the holding company for the business formed by its founders in 2018 through the acquisition of Huddled Masses, LLC (“Huddled Masses”) and Colossus Media, LLC (“Colossus Media”). Colossus Media operates our proprietary sell-side programmatic platform operating under the trademarked banner of Colossus SSP TM (“Colossus SSP”). In late September 2020, Holdings acquired Orange142, LLC (“Orange142”) to further bolster its overall programmatic buy-side advertising platform and to enhance its offerings across multiple industry verticals such as travel, healthcare, education, financial services, consumer products, etc. with particular emphasis on small and mid-sized businesses transitioning into digital with growing digital media budgets. . In February 2022, Direct Digital Holdings, Inc. completed an initial public offering of its securities and, together with DDH, LLC, effected a series of transactions (together, the “Organizational Transactions”) whereby Direct Digital Holdings, Inc. became the sole managing member of DDH, LLC, the holder of 100% of the voting interests of DDH, LLC and the holder of 19.7% of the economic interests of DDH, LLC. In these financial statements, the “Company,” “Direct Digital,” “Direct Digital Holdings,” “DDH,” “we,” “us” and “our” refer (i) following the completion of the Organizational Transactions, including the initial public offering, to Direct Digital Holdings, Inc., and, unless otherwise stated, all of its subsidiaries, including DDH LLC, and, unless otherwise stated, its subsidiaries, and (ii) on or prior to the completion of the Organizational Transactions, to DDH LLC. All of the subsidiaries are incorporated in the state of Delaware, except for DDH LLC, which was formed under the laws of the State of Texas. The subsidiaries of Direct Digital Holdings, Inc are as follows: Subsidiary Current % Ownership Advertising Solution and Segment Date of Formation Date of Acquisition Direct Digital Holdings, LLC 19.7 % N/A June 21, 2018 August 26, 2021 Huddled Masses, LLC 100 % Buy-side November 13, 2012 June 21, 2018 Colossus Media, LLC 100 % Sell-side September 8, 2017 June 21, 2018 Orange142, LLC 100 % Buy-side March 6, 2013 September 30, 2020 Both buy-side subsidiaries, Huddled Masses and Orange142, offer technology-enabled advertising solutions and consulting services to clients through multiple leading demand side platforms (“DSPs”). Colossus SSP is a stand-alone tech-enabled, data-driven platform that helps deliver targeted advertising to diverse and multicultural audiences, including African Americans, Latin Americans, Asian Americans and LGBTQ+ customers, as well as other specific audiences. Providing both the front-end, buy-side operations coupled with our proprietary sell-side operations, enables us to curate the first through the last mile in the ad tech ecosystem execution process to drive higher results. Note 2 — Basis of Presentation and Summary of Significant Accounting Policies Basis of presentation The Company’s consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and reflect the financial position, results of operations and cash flows for all periods presented. 61 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. The Company has elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that it (i) is no longer an emerging growth company or (ii) it affirmatively and irrevocably opts out of the extended transition period provided in the JOBS Act. As a result, these financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates. The adoption dates discussed below reflect this election. Basis of consolidation The consolidated financial statements include the accounts of Direct Digital Holdings, Inc. and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. Business combinations The Company analyzes acquisitions to determine if the acquisition should be recorded as an asset acquisition or a business combination. The Company accounts for acquired businesses using the acquisition method of accounting under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations , (“ASC 805”), which requires that assets acquired, and liabilities assumed be recorded at the date of acquisition at their respective fair values. The fair value of the consideration paid, including any contingent consideration as applicable, is assigned to the underlying net assets of the acquired business based on their respective fair values based on widely accepted valuation techniques in accordance with ASC Topic 820, Fair Value Measurement , as of the closing date. Any excess of the purchase price over the estimated fair values of the net tangible assets and identifiable intangible assets acquired is recorded as goodwill. Significant judgments are used in determining the estimated fair values assigned to the assets acquired and liabilities assumed and in determining estimates of useful lives of long-lived assets. Fair value determinations and useful life estimates are based on, among other factors, estimates of expected future net cash flows, estimates of appropriate discount rates used to calculate the present value of expected future net cash flows, the assessment of each asset’s life cycle, and the impact of competitive trends on each asset’s life cycle and other factors. These judgments can materially impact the estimates used to allocate acquisition date fair values to assets acquired and liabilities assumed, and the resulting timing and amounts charged to, or recognized in, current and future operating results. For these and other reasons, actual results may vary significantly from estimated results. On September 30, 2020, the Company completed the acquisition of Orange142, which was accounted for under ASC 805. See “Note 3 — Business Acquisition”. Use of estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates include the allocation of purchase price consideration in the business combination and the related valuation of acquired assets and liabilities, intangible assets, and goodwill impairment testing. The Company bases its estimates on past experiences, market conditions, and other assumptions that the Company believes are reasonable under the circumstances, and the Company evaluates these estimates on an ongoing basis. Cash and cash equivalents Cash and cash equivalents consist of funds deposited with financial institutions and highly liquid instruments with original maturities of three months or less. Such deposits may, at times, exceed federally insured limits. As of December 31, 2021, $3,332,303 of the Company’s cash and cash equivalents exceeded the federally insured limits. The Company has not experienced any losses in such amounts and believes it is not exposed to any significant credit risk to cash. 62 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Accounts receivable Accounts receivable primarily consist of billed amounts for products and services rendered to customers under normal trade terms. The Company performs credit evaluations of its customers’ financial condition and generally does not require collateral. Accounts receivables are stated at net realizable value. The Company began insuring its accounts receivable with unrelated third-party insurance companies in an effort to mitigate any future write-offs and establish an allowance for doubtful accounts as deemed necessary for accounts not covered by this insurance. As of December 31, 2021 and 2020, the Company’s allowance for doubtful accounts was $40,856 and $0, respectively. Management periodically reviews outstanding accounts receivable for reasonableness. If warranted, the Company processes a claim with the third-party insurance company to recover uncollected balances, rather than writing the balances off to bad debt expense. The guaranteed recovery for the claim is approximately 90% of the original balance, and if the full amount is collected by the insurance company, the remaining 10% is remitted to the Company. If the insurance company is unable to collect the full amount, the Company records the remaining 10% to bad debt expense. Bad debt expense was $91,048 and $8,086 for the years ended December 31, 2021 and 2020, respectively. Concentrations of credit risk The Company has customers on both the buy-and sell-side of its business. The following table sets forth our consolidated concentration of accounts receivable: December 31, 2021 December 31, 2020 Customer A 62.9 % 7.4 % Customer B 5.2 % 0.3 % Customer C 3.0 % 40.4 % Customer D 1.0 % 18.4 % Property and equipment, net Property and equipment are recognized in the consolidated balance sheets at cost less accumulated depreciation and amortization. The Company capitalizes purchases and depreciates its property and equipment using the straight-line method of depreciation over the estimated useful lives of the respective assets, generally ranging from three to five years. Leasehold improvements are amortized over the shorter of their useful lives or the remaining terms of the related leases. As of and December 31, 2021 and 2020, the Company has fully depreciated all property and equipment. The cost of repairs and maintenance are expensed as incurred. Major renewals or improvements that extend the useful lives of the assets are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation thereon are removed, and any resulting gain or loss is recognized in the consolidated statements of operations. Goodwill Under the purchase method of accounting pursuant to ASC 805, goodwill is calculated as the excess of purchase price over the fair value of the net tangible and identifiable intangible assets acquired. In testing goodwill for impairment, we have the option to begin with a qualitative assessment, commonly referred to as “Step 0”, to determine whether it is more likely than not that the fair value of a reporting unit containing goodwill is less than its carrying value. This qualitative assessment may include, but is not limited to, reviewing factors such as macroeconomic conditions, industry and market considerations, cost factors, entity-specific financial performance and other events, such as changes in our management, strategy and primary user base. If the Company determines that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then a quantitative goodwill impairment analysis is performed, which is referred to as “Step 1”. Depending upon the results of that measurement, the recorded goodwill may be written down, and impairment expense is recorded in the consolidated statements of operations when the carrying amount of the reporting unit exceeds the fair value of the reporting unit. Goodwill is reviewed annually and tested for impairment upon the occurrence of a triggering event. For the years ended December 31, 2021 and 2020, the Company did not recognize any goodwill impairment losses. 63 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 As of December 31, 2021 and 2020, goodwill was $6,519,636, which includes $2,423,936 as a result of the acquisition of Huddled Masses and Colossus Media in 2018 and $4,095,700 of goodwill recognized from the acquisition of Orange142 in September 2020. Intangible assets, net The Company’s intangible assets consist of customer relationships, trademarks and non-compete agreements. The Company’s intangible assets are recorded at fair value at the time of their acquisition and are stated within our consolidated balance sheets net of accumulated amortization. Intangible assets are amortized on a straight-line basis over their estimated useful lives and recorded as amortization expense within general and administrative expenses in our consolidated statements of operations. Impairment of long-lived assets The Company evaluates long-lived assets, including property and equipment, and acquired intangible assets consisting of customer relationships, trademarks and trade names, and non-compete agreements, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability is assessed based on the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the undiscounted cash flows is less than the carrying amount of the asset, an impairment loss is recognized. Any impairment loss, if indicated, is measured as the amount by which the carrying amount of the asset exceeds its estimated fair value and is recognized as a reduction in the carrying amount of the asset. As of December 31, 2021 and 2020, there were no events or changes in circumstances to indicate that the carrying amount of the assets may not be recoverable. Fair value measurements The Company follows ASC 820-10, Fair Value Measurement , (“ASC 820-10”), which defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and requires certain disclosures about fair value measurements. ASC 820-10 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the most advantageous market for the asset or liability in an orderly transaction. Fair value measurement is based on a hierarchy of observable or unobservable inputs. The standard describes three levels of inputs that may be used to measure fair value. Level 1 — Inputs to the valuation methodology are quoted prices available in active markets for identical securities as of the reporting date; Level 2 — Inputs to the valuation methodology are other significant observable inputs, including quoted prices for similar securities, interest rates, credit risk etc. as of the reporting date, and the fair value can be determined through the use of models or other valuation methodologies; and Level 3 — Inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity of the securities and the reporting entity makes estimates and assumptions relating to the pricing of the securities, including assumptions regarding risk. We segregate all financial assets and liabilities that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date. 64 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Deferred financing costs The Company records costs related to its line of credit and the issuance of debt obligations as deferred financing costs. These costs are deferred and amortized to interest expense using the straight-line method over the life of the debt. In December 2021, the Company amended its line of credit with East West Bank (see Note 5 – Long Term Debt) and incurred additional deferred financing costs of $63,689. Unamortized deferred financing costs related to the line of credit was $96,152 and $90,607 as of December 31, 2021 and 2020, respectively, and due to the revolving nature of this debt, was classified as an asset on the consolidated balance sheets. In December 2021, the Company refinanced its note payable with SilverPeak Credit Partners, LP (“SilverPeak”) (see Note 5 — Long-Term Debt) and expensed the remaining unamortized deferred financing costs of $238,951 to loss on early extinguishment of debt. Unamortized deferred financing costs for the note payable to was $501,796 as of December 31, 2020, and netted against the outstanding debt on the consolidated balance sheets. In December 2021, the Company entered into an agreement with Lafayette Square Loan Servicing, LLC (“Lafayette Square”) (see Note 5 – Long Term Debt) and incurred $2,127,185 in deferred financing costs. Unamortized deferred financing costs for the note payable to was $2,091,732 as of December 31, 2021 and netted against the outstanding debt on the consolidated balance sheets. Revenue recognition The Company adopted FASB Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers , (“Topic 606”), as of January 1, 2019, for all contracts not completed as of the date of adoption which had no impact on its financial position or results of operations using the modified retrospective method. The Company recognizes revenue using the following five steps: • Identification of a contract(s) with a customer; • Identification of the performance obligation(s) in the contract; • Determination of the transaction price; • Allocation of the transaction price to the performance obligation(s) in the contract; and • Recognition of revenue when, or as, the performance obligation(s) are satisfied. The Company’s revenues are derived primarily from two sources: buy-side advertising and sell-side advertising. Buy-side advertising The Company purchases media based on the budget established by its customers with a focus on leveraging data services, customer branding, real-time market analysis and micro-location advertising. The Company offers its services on a fully managed and a moderate/self-serve basis, which is recognized over time using the output method when the performance obligation is fulfilled. An “impression” is delivered when an advertisement appears on pages viewed by users. The performance obligation is satisfied over time as the volume of impressions are delivered up to the contractual maximum for fully managed revenue and the delivery of media inventory for self-serve revenue. Many customers run several different campaigns throughout the year to capitalize on different seasons, special events and other happenings at their respective regions and localities. The Company provides digital advertising and media buying capabilities with a focus on generating measurable digital and financial life for its customers. Revenue arrangements are evidenced by a fully executed insertion order (“IO”). Generally, IOs specify the number and type of advertising impressions to be delivered over a specified time at an agreed upon price and performance objectives for an ad campaign. Performance objectives are generally a measure of targeting, as defined by the parties in advance, such as number of ads displayed, consumer clicks on ads or consumer actions (which may include qualified leads, registrations, downloads, inquiries or purchases). These payment models are commonly referred to as CPM (cost per impression), CPC (cost per click) and CPA (cost per action). The majority of the Company’s contracts are flat-rate, fee-based contracts. 65 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 In instances where the Company contracts with third-party advertising agencies on behalf of their advertiser clients, a determination is made to recognize revenue on a gross or net basis based on an assessment of whether the Company is acting as the principal or an agent in the transaction. The Company is acting as the principal in these arrangements and therefore revenue earned and costs incurred are recognized on a gross basis as the Company has control and is responsible for fulfilling the advertisement delivery, establishing the selling prices and delivering the advertisements for fully managed revenue and providing updates and performing all billing and collection activities for the self-serve proprietary platform. Cash payments received prior to the Company’s delivery of its services are recorded to deferred revenue until the performance obligation is satisfied. The Company recorded deferred revenue (contract liabilities) to account for billings in excess of revenue recognized, primarily related to contractual minimums billed in advance and customer prepayment, of $1,348,093 and $308,682 as of December 31, 2021 and 2020, respectively. Sell-side advertising The Company partners with publishers to sell advertising inventory to its existing buy-side clients, as well as its own Colossus Media-curated clients and the open markets (collectively referred to as “buyers”) seeking to access the general market as well as unique multi-cultural audiences. The Company generates revenue from the delivery of targeted digital media solutions, enabling advertisers to connect intelligently with their audiences across online display, video, social and mobile mediums using its proprietary programmatic sell-side platform (“SSP”). The Company refers to its publishers, app developers, and channel partners collectively as its publishers. The Company generates revenue through the monetization of publisher ad impressions on its platform. The Company’s platform allows publishers to sell, in real time, ad impressions to buyers and provides automated inventory management and monetization tools to publishers across various device types and digital ad formats. The Company recognizes revenue when an ad is delivered in response to a winning bid request from ad buyers. The Company is acting as the principal in these arrangements and therefore revenue earned and costs incurred are recognized on a gross basis, as the Company has control and is responsible for fulfilling the advertisement delivery, establishing the selling prices and delivering the advertisements for fully managed revenue and providing updates and performing all billing and collection activities for its self-serve proprietary platform. The Company maintains agreements with each DSP in the form of written service agreements, which set out the terms of the relationship, including payment terms (typically 30 to 90 days) and access to its platform. In an effort to reduce the risk of nonpayment, the Company has insurance with a third-party carrier for its accounts receivable as noted above. The following table sets forth our concentration of revenue sources as a percentage of total net revenues on a consolidated basis. With the acquisition of Orange142 in September 2020, the mix of our concentrations changed year-over-year. December 31, 2021 2020 Customer A 27.9 % 7.1 % Customer E 12.8 % 9.5 % Customer F 11.4 % 2.3 % Customer G 0.0 % 11.2 % Customer D 2.2 % 14.0 % Cost of revenues Buy-side advertising Cost of revenues consists primarily of digital media fees, third-party platform access fees, and other third-party fees associated with providing services to our customers. Sell-side advertising The Company pays publishers a fee, which is typically a percentage of the value of the ad impressions monetized through the Company’s platform. Cost of revenues consists primarily of publisher media fees and data center co-location costs. Media fees include the publishing and real-time bidding costs to secure advertising space. 66 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Advertising costs The Company expenses advertising costs as incurred. Advertising expense incurred during the years ended December 31, 2021 and 2020 was $216,464 and $8,056, respectively. These costs are included in general and administrative expenses in the consolidated statements of operations. Income taxes DDH LLC is a limited liability company and is not required to pay federal income tax. Accordingly, no federal income tax expense has been recorded in the consolidated financial statements for the years ended December 31, 2021 and 2020. Taxable income or losses are reported to the individual members for inclusion in their respective individual federal income tax returns. The Company is subject to state income taxes as applicable. Taxes on the consolidated statements of operations represent franchise taxes for the State of Texas. The Company applies ASC 740-10, Income Taxes (“ASC 740-10”), in establishing standards for accounting for uncertain tax positions. The Company evaluates uncertain tax positions with the presumption of audit detection and applies a “more likely than not” standard to evaluate the recognition of tax benefits or provisions. ASC 740-10 applies a two-step process to determine the amount of tax benefits or provisions to record in the consolidated financial statements. First, the Company determines whether any amount may be recognized and then determines how much of a tax benefit or provision should be recognized. As of December 31, 2021 and 2020, the Company had no uncertain tax positions. Accordingly, the Company has not recognized any penalty, interest or tax impact related to uncertain tax positions. If the Company were to incur an income tax liability in the future, interest on any income tax liability would be reported as interest expense and penalties on any income tax liability would be reported as income taxes. The Company’s conclusions regarding uncertain tax positions may be subject to review and adjustments at a later date based upon ongoing analyses of tax laws, regulations and interpretations thereof as well as other factors. Segment information Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and assessing performance. The Company’s chief operating decision maker is its Chairman and Chief Executive Officer. The Company views its business as two reportable segments, buy-side advertising, which includes the results of Huddled Masses and Orange142, and sell-side advertising, which includes the results of Colossus Media. Accounting pronouncements not yet adopted In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) . Under the new guidance, lessees will be required to put most leases on their balance sheets but to recognize expenses in the income statement in a manner similar to current accounting. The guidance also eliminates the current real estate-specific provisions and changes the guidance on sale-leaseback transactions, initial direct costs, and lease executory costs for all entities. The updated guidance will be effective for the Company beginning January 1, 2022, with early adoption permitted. Upon adoption, entities will be required to use the modified retrospective approach for leases that exist, or are entered into, after the beginning of the earliest comparative period in the financial statements. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements , which allows entities to not apply the new leases standard, including its disclosure requirements, in the comparative periods they present in their financial statements in the year of adoption. The Company is currently evaluating the potential effect that adopting this guidance will have on its consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13 , Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments , as amended, which requires, among other things, the use of a new current expected credit loss (“CECL”) model in order to determine the Company’s allowances for doubtful accounts with respect to accounts receivable. The CECL model requires that the Company estimates its lifetime expected credit loss with respect to its receivables and contract assets and record allowances that, when deducted from the balance of the receivables, represent the net amounts expected to be collected. The Company will also be required to disclose information about how it developed the allowances, including changes in the factors that influenced its estimate of expected credit losses and the reasons for those changes. This ASU is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2022. The Company is currently evaluating the potential effect that adopting this guidance will have on its consolidated financial statements. 67 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Risks and Uncertainties Management is currently evaluating the impact of the COVID-19 pandemic and has concluded that while it is reasonably possible that the virus could have a negative effect on the Company’s financial position and results of its operations, the specific impact is not readily determinable as of the date of these financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Liquidity and capital resources As of December 31, 2021, we had cash and cash equivalents of $4,684,431 and availability under our Revolving Credit Facility (see Note 5 — Long-Term Debt) of $1,798,145. Based on projections of growth in revenue and operating results in the coming year, the available cash held by us and availability under our Revolving Credit Facility, the Company believes that we will have sufficient cash resources to finance our operations and service any maturing debt obligations for at least the next twelve months. Note 3 — Business Acquisition Effective September 30, 2020, the Company acquired 100% of the equity interests of Orange142 from USDM Holdings, LLC (“USDM”), for a purchase price of $26,207,981. The acquisition was funded by a combination of cash, issuance by DDH LLC of member common units, mandatorily redeemable preferred units (see Note 6 — Mandatorily Redeemable Preferred Units), a facility term note, and a revolving credit facility (see Note 5 — Long-Term Debt). The Company paid $12,000,000 in cash and DDH LLC issued (i) 5,637-member common units with a fair value of $4,294,041, (ii) 3,500 non-participating preferred A units (“Class A Preferred Units”) at a redemption value of $3,500,000, and a fair value of $3,458,378, and (iii) 7,046 non-participating preferred B units (“Class B Preferred Units”) at a redemption value of $7,046,251, and a fair value of $6,455,562. The acquisition was accounted for using the acquisition method of accounting and, accordingly, the consolidated statements of operations include the results of operations of Orange142 beginning September 30, 2020. The acquisition of Orange142 was recorded by allocating the total purchase consideration to the fair value of the net tangible assets acquired, including goodwill and intangible assets, in accordance with ASC 805. The purchase consideration exceeded the fair value of the net assets, resulting in goodwill of $4,095,700 and intangible assets of $18,033,850. Intangible assets consist of $13,028,320 of 10-year amortizable customer relationships, $3,501,200 of 10-year amortizable trademarks and tradenames, and $1,504,330 of 5-year amortizable non-compete agreements. The Company records amortization expense on a straight-line basis over the life of the identifiable intangible assets. For the years ended December 31, 2021 and 2020, amortization expense of $1,953,818 and $488,454, respectively, was recognized, and as of December 31, 2021 and 2020, intangible assets net of accumulated amortization was $15,591,578 and $17,545,396, respectively. Intangible assets and the related accumulated amortization and future amortization expense are as follows: Trademarks and Non-compete Customer lists tradenames agreements Total Fair value at acquisition date $ 13,028,320 $ 3,501,200 $ 1,504,330 $ 18,033,850 Accumulated amortization (1,628,540 ) (437,650 ) (376,083 ) (2,442,273 ) Intangibles, net as of December 31, 2021 $ 11,399,780 $ 3,063,550 $ 1,128,248 $ 15,591,578 Estimated life (years) 10 10 5 Weighted-average remaining life (years) at December 31, 2021 8.8 8.8 3.8 68 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Total 2022 $ 1,953,818 2023 1,953,818 2024 1,953,818 2025 1,878,602 2026 1,652,952 Thereafter 6,198,570 Total $ 15,591,578 DDH LLC paid $12,000,000 in cash and acquired cash of $1,014,151 for net cash used in the acquisition of $10,985,849. Total purchase consideration and fair value of the DDH LLC equity units issued is as follows: Cash paid to sellers $ 12,000,000 Member units issued 4,294,041 Mandatorily redeemable units 9,913,940 Total purchase consideration $ 26,207,981 The following table summarizes the allocations of the purchase consideration to the fair value of the net assets: Fair value of assets acquired: Cash and cash equivalents $ 1,014,151 Accounts receivable 4,590,945 Prepaid expenses and other current assets 148,717 Other assets 9,618 Intangible assets 18,033,850 Goodwill 4,095,700 Total assets acquired 27,892,981 Fair values of liabilities assumed: Accounts payable $ 683,521 Accrued liabilities 244,165 Deferred revenue 757,314 Total liabilities assumed 1,685,000 Total fair value of net assets $ 26,207,981 During the year ended December 31, 2020, the Company incurred $834,407 in acquisition transaction costs related to the acquisition of Orange142. These expenses primarily related to referral and legal fees. The Company expects to deduct goodwill for tax purposes in future years. The factors that make up goodwill include entry into new markets not previously accessible and generation of future growth opportunities. The table below presents the unaudited pro forma revenue and net loss of the Company for the year ended December 31, 2020, assuming the acquisition had occurred on January 1, 2019, pursuant to ASC 805. This unaudited pro forma consolidated financial information does not purport to represent what the actual results of operations of the Company would have been had the acquisition occurred on that date, nor does it purport to predict the results of operations for future periods. This pro forma financial information does not give effect to any anticipated synergies, operating efficiencies or cost savings or any integration costs related to the acquisition. The unaudited pro forma consolidated financial information excludes transaction costs recorded as general and administrative expenses of $834,407 during the year ended December 31, 2020. 69 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 For the Year Ended December 31, 2020 Revenue – pro forma combined $ 30,415,600 Net income – pro forma combined $ 3,783,883 For the Year Ended December 31, 2020 Revenue $ 12,477,519 Add: revenue, Orange142 17,938,081 Revenue – pro forma combined $ 30,415,600 Note 4 — Accrued Liabilities Accrued liabilities consisted of the following: December 31, 2021 2020 Accrued compensation and benefits $ 406,510 $ 482,436 Accrued litigation fees 501,078 501,078 Accrued expenses 123,118 317,401 Accrued interest 14,201 91,605 Total accrued liabilities $ 1,044,907 $ 1,392,520 Note 5 — Long-Term Debt Revolving Line of Credit East West Bank On September 30, 2020, the Company entered into a credit agreement that provides for a revolving credit facility with East West Bank in the amount of $4,500,000 with an initial availability of $1,000,000 (the “Revolving Credit Facility”). The loans under the Revolving Credit Facility bear interest at the LIBOR rate plus 3.5% per annum, and at December 31, 2021 and 2020, the rate was 7.0% and 6.75%, respectively, with a 0.50% unused line fee. The maturity date of the Revolving Credit Facility is September 30, 2022. All accrued but unpaid interest under the Revolving Credit Facility is payable in monthly installments on each interest payment date until the maturity date when the outstanding principal balance, together with all accrued but unpaid interest will be due. On December 17, 2021, the Company amended the Revolving Credit Facility, which increased the availability to $5,000,000 with an initial availability of $2,500,000. In connection with the amendment, the Company incurred additional deferred financing fees of $63,689. As of December 31, 2021 and 2020, the Revolving Credit Facility had borrowings outstanding of $400,000 and $407,051 and deferred financing cost of $96,152 and $90,607, respectively, which are classified as an asset on the consolidated balance sheets. The Revolving Credit Facility is secured by the trade accounts receivable of DDH LLC and guaranteed by the Company. The Revolving Credit Facility includes financial covenants, and as of December 31, 2021 and 2020, the Company was in compliance with all of its financial covenants. First Citizens Bank On May 17, 2019, the Company entered into a line of credit agreement with First Citizens Bank in the amount of $750,000, which bears fixed interest of 3.15% and expired on May 17, 2020. The agreement was renewed for one additional year through May 17, 2021. On October 2, 2020, the line of credit was fully repaid. 70 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 The components of interest expense and related fees for the lines of credit are as follows: December 31, 2021 2020 Interest expense – East West Bank $ 37,210 $ 9,391 Interest expense – First Citizens Bank — 19,158 Amortization of deferred financing costs 58,144 12,944 Total interest expense and amortization of deferred financing costs $ 95,354 $ 41,493 Accrued and unpaid interest as of December 31, 2021 and 2020, respectively, for the East West Bank was $5,553 and $5,100 related to the unused line fee. As of December 31, 2020, there was no accrued and unpaid interest for the First Citizens Bank line of credit. 2020 Term Loan Facility and 2021 Credit Facility SilverPeak In conjunction with the acquisition of Orange142 (see Note 3 — Business Acquisition), on September 30, 2020, the Company entered into a loan and security agreement (the “2020 Term Loan Facility”) with SilverPeak in the amount of $12,825,000, maturing on September 15, 2023. Interest in year one was 15%, of which 12% was payable monthly and 3% was paid-in-kind (“PIK”). All accrued but unpaid interest under the 2020 Term Loan Facility is payable in monthly installments on each interest payment date, and the Company was required to repay the outstanding principal balance on January 15 and July 15 of each calendar year in an amount equal to 37.5% of excess cash flow over the preceding six calendar months until the term loan is paid in full. The remaining principal balance, and all accrued but unpaid interest was to be due on the maturity date. The obligations under the 2020 Term Loan Facility were secured by first-priority liens on all or substantially all assets of DDH LLC and its subsidiaries. The 2020 Term Loan Facility contained a number of financial covenants and customary affirmative covenants. In addition, the 2020 Term Loan Facility included a number of negative covenants, including (subject to certain exceptions) limitations on (among other things): indebtedness, liens, investments, acquisitions, dispositions, and restricted payments. Each of Mark Walker (“Walker”), Chairman of the Board and Chief Executive Officer, and Keith Smith (“Smith”), President, provided limited guarantees of the obligations under the 2020 Term Loan Facility. As of December 31, 2020, the Company owed a balance on the 2020 Term Loan Facility of $12,922,243, which included principal and $97,243 of accrued PIK interest. Financing costs incurred in the transaction were $573,481 and unamortized deferred financing costs as of December 31, 2020 were $501,796. Accrued and unpaid interest was $73,542 as of December 31, 2020 and is included in accrued expenses on the consolidated balance sheets. In January 2021, the Company made a repayment of $1.2 million with respect to the period ending December 31, 2020. The maturity date of the 2020 Term Loan Facility was September 15, 2023; however, on December 3, 2021, DDH LLC entered into the 2020 Term Loan and Security Agreement (the “2021 Credit Facility”) with Lafayette Square and used the proceeds to repay and terminate the 2020 Term Loan Facility. The Company recognized a loss on the early extinguishment of debt of $2,663,148 associated with prepayment penalties, exit fee, and the write-off of the unamortized deferred financing fees. Lafayette Square On December 3, 2021, DDH LLC entered into the 2021 Term Loan Facility with Lafayette Square as administrative agent, and the various lenders thereto. The term loan under the 2021 Credit Facility provides for a term loan in the principal amount of up to $32.0 million, consisting of a $22.0 million closing date term loan and an up to $10.0 million delayed draw term loan. The loans under the 2021 Credit Facility bear interest at LIBOR plus the applicable margin minus any applicable impact discount. The applicable margin under the 2021 Credit Facility is determined based on the consolidated total net leverage ratio of the Company and its consolidated subsidiaries, at a rate of 6.50% per annum if the consolidated total net leverage ratio is less than 2.00 to 1.00 and up to 9.00% per annum if the consolidated total net leverage ratio is greater than 4.00 to 1.00. The applicable impact discount under the 2021 Credit Facility is a discount of 0.05% per annum to the extent that DDH LLC adopts certain services intended to improve overall employee satisfaction and retention plus an additional discount of 0.05% per annum to the extent that DDH LLC maintains a B Corp certification by Standards Analysts at the non-profit B Lab (or a successor certification or administrator). The maturity date of the 2021 Credit Facility is December 3, 2026. 71 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 The obligations under the 2021 Credit Facility are secured by senior, first-priority liens on all or substantially all assets of DDH LLC and its subsidiaries and are guaranteed by the subsidiaries of DDH LLC and include a pledge and guarantee by the Company. The 2021 Credit Facility is subject to an intercreditor agreement pursuant to which the Revolving Credit Facility has a priority lien on the trade accounts receivable of DDH LLC and its subsidiaries that constitute eligible accounts under the Revolving Credit Facility and related proceeds, and the 2021 Credit Facility has a priority lien on all other collateral. In connection with the entry into the 2021 Credit Facility, we paid off in full and terminated the 2020 Term Loan Facility. As of December 31, 2021, the Company owed a balance on the 2021 Credit Facility of $22,000,000. Financing costs incurred in the transaction were $2,127,185 and unamortized deferred financing costs as of December 31, 2021 were $2,091,732. Accrued and unpaid interest was $0 as of December 31, 2021. The components of interest expense and related fees for the 2020 Term Loan Facility and the 2021 Term Loan Facility are as follows: December 31, 2021 2020 Interest expense – SilverPeak $ 1,810,372 $ 518,622 Interest expense–- Lafayette Square 151,833 — Amortization of deferred financing costs–- SilverPeak 262,845 71,685 Amortization of deferred financing costs–- Lafayette Square 35,453 — Total interest expense and amortization of deferred financing costs $ 2,260,503 $ 590,307 U.S. Small Business Administration Loans Economic Injury Disaster Loan In 2020, DDH LLC applied and was approved for a loan pursuant to the Economic Injury Disaster Loan (“EIDL”), administered by the U.S. Small Business Administration (“SBA”). DDH LLC received the loan proceeds of $150,000 on June 15, 2020. The loan bears interest at a rate of 3.75% and matures on June 15, 2050. Installment payments, including principal and interest, of $731 will be payable monthly beginning June 15, 2022. Each payment will first be applied to pay accrued interest, then the remaining balance will be used to reduce principal. The loan is secured by substantially all assets of DDH LLC. Accrued and unpaid interest expense as of December 31, 2021 and 2020 was $8,647 and $3,041, respectively, and is included in accrued expenses on the consolidated balance sheets. Paycheck Protection Program In 2020, DDH LLC applied and was approved for a loan pursuant to the Paycheck Protection Program (“PPP”), administered by the SBA (the “PPP-1 Loan”). The PPP was authorized in the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act and was designed to provide a direct financial incentive for qualifying business to keep their workforce employees. The SBA made PPP loans available to qualifying businesses in amounts up to 2.5 times their average monthly payroll expenses, and loans should be forgivable after a “covered period” (eight or twenty-four weeks) as long as the borrower maintains its payroll and utilities. The forgiveness amount will be reduced if the borrower terminates employees or reduces salaries and wages more than 25% during the covered period. Any unforgiven portion is payable over two years if issued before, or five years if issued after, June 5, 2020 at an interest rate of 1.0% with payments deferred until the SBA remits the borrower’s loan forgiveness amount to the lender, or if the borrower does not apply for forgiveness, then six months after the end of the covered period. 72 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 DDH LLC received the PPP-1 Loan proceeds on May 8, 2020. The principal amount of the PPP-1 Loan was $287,100 and there are no collateral or guarantee requirements. Under the terms of the PPP-1 Loan, payments were deferred until December 8, 2020. The loan bears interest at 1% per annum and matures on May 8, 2022. On October 6, 2020, DDH LLC applied for forgiveness of the PPP-1 Loan. On November 30, 2020, $277,100 of the PPP-1 Loan was forgiven. On February 16, 2021, the remaining $10,000 balance of the PPP-1 Loan was forgiven. In March 2021, DDH LLC applied for and received another PPP loan (the “PPP-2 Loan”) for a principal amount of $287,143 and there are no collateral or guarantee requirements. Under the terms of the PPP-2 Loan, monthly payments of $6,440 are due starting June 11, 2022, and the loan bears interest at 1% per annum and matures on March 11, 2026. As of December 31, 2021, future minimum payments related to long-term debt is as follows for the years ended December 31: 2022 $ 1,237,143 2023 1,100,000 2024 1,100,000 2025 1,100,473 2026 1,100,473 Thereafter 17,199,054 Total 22,837,143 Less deferred financing costs (2,091,732 ) Long-term debt, net $ 20,745,411 In addition to the future minimum payments on the 2021 Credit Facility, commencing with the annual compliance certificate for the fiscal year ended December 31, 2022, and annually thereafter, DDH LLC shall make a principal payment in an amount equal to 50% of consolidated excess cash flow, as defined by the agreement. Note 6 — Mandatorily Redeemable Preferred Units ASC 480, Distinguishing Liabilities from Equity, (“ASC 480”), defines mandatorily redeemable financial instruments as any financial instruments issued in the form of shares that have an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur. A mandatorily redeemable financial instrument shall be classified as a liability unless the redemption is required to occur only upon the liquidation or termination of the reporting entity. Under ASC 480, mandatorily redeemable financial instruments shall be measured initially at fair value. In connection with the acquisition of Orange142, DDH LLC issued mandatorily redeemable preferred units which are only redeemable for a fixed amount of cash at a date specific to each class. Due to the mandatory redemption feature, ASC 480 requires that these preferred units be classified as a liability rather than as a component of equity, with preferred annual returns being accrued and recorded as interest expense. Class A Preferred Units In connection with the Orange142 acquisition (see Note 3 — Business Combination), DDH LLC issued 3,500 non-voting Class A Preferred Units at a purchase price of $3,500,000, and a fair value of $3,458,378. Class A Preferred Units are entitled to certain approval rights and are mandatorily redeemable for $3,500,000 on September 30, 2022, with 10% preferred annual returns paid on a quarterly basis. Due to the mandatory redemption feature, ASC 480, requires that the Class A Preferred Units be classified as a liability rather than as a component of equity, with the preferred annual returns being accrued and recorded as interest expense. In December 2021, DDH LLC paid the Class A Preferred Units and recognized a loss on the redemption of $41,622 in connection with the write-off of the fair value associated with the units. For the years ended December 30, 2021 and 2020, the Company recorded interest expense relating to the Class A Preferred Units of $323,151 and $88,219, respectively. 73 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Class B Preferred Units In connection with the Orange142 acquisition (see Note 3 — Business Combination), DDH LLC issued 7,046 non-voting Class B Preferred Units at a purchase price of $7,046,251, and a fair value of $6,455,562. Class B Preferred Units are mandatorily redeemable for $7,046,251 on September 30, 2024, with 7% preferred annual returns paid on a quarterly basis. Due to the mandatory redemption feature, ASC 480 requires that the Class B Preferred Units be classified as a liability rather than as a component of equity, with the preferred annual returns being accrued and recorded as interest expense. For the years ended December 31, 2021 and 2020, the Company recorded interest expense relating to the Class B Preferred Units of $493,238 and $124,323, respectively. Note 7 — Related Party Transactions Related Party Debt Seller Notes In conjunction with the acquisition of Huddled Masses and Colossus Media on June 21, 2018, the Company issued seller notes (“Seller Notes”), to shareholders of Huddled Masses and Colossus Media (together the “Former Shareholders”) in the aggregate principal amount of $500,000. The Seller Notes bore interest of 5% and matured on June 21, 2021. The Company paid $323,715 and $149,628 during the years ended December 31, 2021 and 2020, respectively, for principal and interest on the Seller Notes. Also, in conjunction with the acquisition, the Company entered into a $350,000 seller payable (“Seller Payable”) with a Former Shareholder that was to be due in twelve monthly installments of $29,167. The outstanding balance of the Seller Notes was $0 and $315,509 as of December 31, 2021 and 2020, respectively. During the year ended December 31, 2020, the Company entered into a settlement agreement (“Settlement Agreement”) with the Former Shareholders, and as a result, recorded a net gain of $894 comprised of Seller Note forgiveness of $184,491, Seller Payable forgiveness of $26,403, offset by a $210,000 payment to settle credit card indebtedness. Accrued and unpaid interest was $0 and $9,792 as of December 31, 2021 and 2020, respectively. Interest expense related to the Seller Notes was $5,359 and $17,309 for the years ended December 31, 2021 and 2020, respectively. Seller Earnouts In conjunction with the acquisition of Huddled Masses and Colossus Media on June 21, 2018, the Company entered into an agreement to pay each of the Former Shareholders a seller earnout (“Seller Earnouts”) based on gross revenue generated for each of the three years following the acquisition. The Seller Earnouts were recorded at their estimated fair value at the date of grant and adjusted annually for actual revenues generated as well as estimates of future revenues. The Seller Earnouts were paid on June 21, 2021. As a result of the Settlement Agreement, the Company recognized a gain of $31,443 and $400,783, during the years ended December 31, 2021 and 2020, respectively, for the termination of certain seller payouts and paid $68,729 and $18,318, respectively, to the Former Shareholders. The outstanding balance of the Seller Earnouts was $0 and $74,909 as of December 31, 2021 and 2020, respectively. Related Party Transactions Member Payable As of December 31, 2021 and 2020, the Company had a net payable to members that totaled $70,801 and $70,801, respectively, which is included as a related party payable on the consolidated balance sheets. Board Services and Consulting Agreement On September 30, 2020, the Company entered into board services and consulting agreements with Walker, Smith and Leah Woolford (“Woolford”). Walker, Smith and Woolford were then all members of the Company. Prior to the Organizational Transactions, Walker served as Manager of the Board of DDH LLC, and now serves as Chairman of the Board and Chief Executive Officer of the Company. Prior to the Organizational Transactions, Smith served as Manager of the Board of DDH LLC and now serves as a director on the Board and President of the Company. Woolford previously served as a Manager of the Board of DDH LLC and Senior Advisor of DDH LLC. In exchange, the Company paid Walker and Smith annual fees of $450,000 each and employee benefits for their direct families. The Company paid Woolford $300 per hour for up to 50 hours per month and employee benefits for Woolford and her direct family. For the year end December 31, 2021, total fees paid to Walker, Smith and Woolford were $456,923, $456,923, and $180,000, respectively. For the year end December 31, 2020, total fees paid to Walker, Smith and Woolford were $136,167, $137,942, and $49,670, respectively. 74 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 In February 2021, in conjunction with the Company’s IPO, the consulting agreements were terminated. See Note 13 – Subsequent Events. Note 8 — Commitments and Contingencies Operating Leases The Company leases furniture and office space in Houston, Austin, and Colorado Springs from an unrelated party under non-cancelable operating leases dating through December 2023. Rent expense for the years ended December 31, 2021 and 2020 was $215,008 and $94,806, respectively. As of December 31, 2021, future minimum payments under the operating leases were as follows: 2022 121,651 2023 90,138 $ 211,788 Litigation The Company may from time to time be subject to various legal or administrative claims and proceedings arising in the ordinary course of business. In management’s opinion, the outcome of any such currently pending litigation will not materially affect the Company’s financial condition. Nevertheless, due to uncertainties in the settlement process, it is at least reasonably possible that management’s view of the outcome could change materially in the near term. Huddled Masses was named as a defendant in a lawsuit on July 10, 2019 related to a delinquent balance to a vendor. The matter is currently underway, and the Company has estimated a potential liability of approximately $500,000. Such liability has been recorded and included in accrued liabilities on the consolidated balance sheets as of December 31, 2021 and 2020. The Company entered into mediation discussions beginning April 2021 and expects to resolve the matter during 2022. Note 9 — Members’ Equity (Deficit) The Company is authorized to issue 160,000,000 shares of Class A common stock, par value $0.001 per share, 20,000,000 shares of Class B common stock, par value $0.001 per share and 10,000,000 shares of preferred stock, par value $0.001 per share. Prior to the Organizational Transactions, DDH LLC was authorized to issue common units, Class A Preferred Units and Class B Preferred Units. As further described in Note 3 — Business Acquisition and Note 6 — Mandatorily Redeemable Preferred Units, in connection with the acquisition of Orange142, DDH LLC issued 5,637 common units, 3,500 Class A Preferred Units and 7,046 Class B Preferred Units. The common units were valued at $4,294,041 and Class A and Class B Preferred Units were valued at a total of $9,913,940. In December 2021, DDH LLC redeemed all of the Class A Preferred Units. As of December 31, 2021 and 2020, the total outstanding common units of DDH LLC were 34,182 and 34,182, respectively. The common units have voting rights, as well as certain redemption features at the option of the Company. In accordance with ASC 480, as of December 31, 2021 and 2020, the Company has classified the preferred units as a liability in the consolidated balance sheets. Following the completion of the Organizational Transactions, DDH LLC’s limited liability company agreement was amended and restated to, among other things, appoint the Company as the sole managing member of DDH LLC and effectuate a recapitalization of all outstanding preferred units and common units into (i) economic nonvoting units of DDH LLC held by the Company and, through their indirect ownership of Direct Digital Management, LLC, our Chairman and Chief Executive Officer and our President, and (ii) noneconomic voting units of DDH LLC, 100% of which are held by the Company. 75 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Note 10 — Loss Per Unit Basic income (loss) per unit is calculated by dividing the net loss for the year by the weighted average number of units outstanding during the period. The Company does not have any dilutive units, and therefore the diluted weighted average number of units outstanding are equal to the basic weighted average number of units. December 31, 2021 2020 Net loss per share attributable to members: $ (1,507,097 ) $ (908,190 ) Number of units outstanding at the beginning of the year 34,182 28,545 Weighted average units issued during the year - 1,409 Weighted average units outstanding at the end of the year, basic and diluted 34,182 29,954 Net loss per unit $ (44.09 ) $ (30.32 ) Note 11 — Employee Benefit Plans The Company sponsors a safe harbor, defined contribution 401(k) and profit-sharing plan (the “Plan”) that allows eligible employees to contribute a percentage of their compensation. The Company matches employee contributions up to a maximum of 100% of the participant’s salary deferral, limited to 4% of the employee’s salary. For the years ended December 31, 2021 and 2020, the Company matching contributions were $171,306 and $52,673, respectively. Additionally, the Company may make a discretionary profit- sharing contribution to the Plan. During the years ended December 31, 2021 and 2020, no profit-sharing contributions were made. The Company has an Employee Benefit Plan Trust (the “Trust”) to provide for the payment or reimbursement of all or a portion of covered medical, dental and prescription expenses for the employees of Orange142. The Trust is funded with contributions made by the Company and participating employees at amounts sufficient to keep the Trust on an actuarially sound basis. The self-funded plan has an integrated stop loss insurance policy for the funding of the Trust benefits in excess of the full funding requirements. As of December 31, 2021 and 2020, there were no unpaid claims for the Company’s employees. Note 12 — Segment Information Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker is its Chairman and Chief Executive Officer. The Company views its business as two reportable segments, buy-side advertising, which includes the results of Huddled Masses and Orange142, and sell-side advertising, which includes the results of Colossus Media. All of the Company’s revenues are attributed to the United States. Revenue by business segment is as follows: For the Year Ended December 31, 2021 2020 Buy-side advertising $ 26,127,787 $ 49,656,165 Sell-side advertising 12,009,075 2,821,354 Total revenues $ 38,136,862 $ 12,477,519 76 DIRECT DIGITAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2021 AND 2020 Operating income (loss) by business segment is as follows: For the Year Ended December 31, 2021 2020 Buy-side advertising $ 5,768,953 $ 1,171,324 Sell-side advertising 1,146,648 29,633 Corporate office expenses (2,531,001 ) (2,045,521 ) Consolidated operating income (loss) $ 4,384,600 $ (844,564 ) Total assets by business segment are as follows: At December 31, 2021 2020 Buy-side advertising $ 25,648,105 $ 27,622,180 Sell-side advertising 8,277,575 2,641,325 Corporate office 2,074,2533 431,970 Total Assets $ 35,999,933 $ 30,695,475 Note 13 — Subsequent Events The Company has evaluated events and transactions occurring subsequent to December 31, 2021 through the date of this report and determined there were no events or transactions that would impact the consolidated financial statements for the year ended December 31, 2021. On February 15, 2022, the Company completed its initial public offering of 2,800,000 units (“Units”), each consisting of (i) one share of our Class A common stock and (ii) one warrant entitling the holder to purchase one share of our Class A Common Stock at an exercise price of $5.50 per share. The warrants became immediately exercisable upon issuance and are exercisable for a period of five years after the issuance date. The shares of Class A Common Stock and warrants may be transferred separately immediately upon issuance. The underwriters in our initial public offering were granted a 45-day option to purchase up to an additional 420,000 shares and/or warrants, or any combination thereof, to cover over-allotments, which they initially exercised, in part, electing to purchase warrants to purchase an additional 420,000 shares of Class A Common Stock. In connection with our initial public offering, we issued to the underwriters of the offering a unit purchase option to purchase (i) an additional 140,000 Units at a per Unit exercise price of $6.60, which was equal to 120% of the public offering price per Unit sold in the initial public offering, and (ii) warrants to purchase 21,000 shares of Class A Common Stock at a per warrant exercise price of $0.012, which was equal to 120% of the public offering price per warrant sold in the offering. The Units were sold at a price of $5.50 per Unit, and the net proceeds from the offering were approximately $12.4 million, after deducting underwriting discounts and commissions and offering expenses payable by us. DDH LLC used the proceeds, together with pre-existing cash and cash equivalents, to purchase all of the LLC Units held indirectly by Woolford for an aggregate purchase price of approximately $14.0 million, of which $10.3 million was paid on the closing date of the initial public offering, and we intend to use the remainder for working capital and general corporate purposes, including potential future acquisition of, or investment in, technologies or businesses that complement our business. We intend to pay the remainder of the purchase price to the entity controlled by Woolford during the first half of 2022. We have no present commitments or agreements to enter into any such acquisitions or make any such investments. Pending these uses, we may invest the net proceeds from the initial public offering in short-term, investment-grade, interest-bearing securities such as money market accounts, certificates of deposit, commercial paper and guaranteed obligations of the U.S. government. 77 ITEM 9. Changes in and Disagreement with Accountants on Accounting and Financial Disclosure None.