Item 2. Management’s Discussion and Analysis
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion together with our unaudited consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the section titled “ Risk Factors ” in our Annual Report on Form 10-K or in other parts of this Quarterly Report on Form 10-Q. See “ – Cautionary Note Regarding Forward-Looking Statements ” below. Our historical results are not necessarily indicative of the results that may be expected for any period in the future.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws and which are subject to certain risks, trends and uncertainties. We use words such as “could,” “would,” “may,” “might,” “will,” “expect,” “likely,” “believe,” “continue,” “anticipate,” “estimate,” “intend,” “plan,” “project” and other similar expressions to identify forward-looking statements, but not all forward-looking statements include these words. All of our forward-looking statements involve estimates and uncertainties that could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. Accordingly, any such statements are qualified in their entirety by reference to the information described under the caption “ Risk Factors ” in our Annual Report on Form 10-K and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.
The forward-looking statements contained in this Quarterly Report on Form 10-Q are based on assumptions that we have made in light of our industry experience and our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. As you read and consider this Quarterly Report on Form 10-Q, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties (many of which are beyond our control) and assumptions.
Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual operating and financial performance and cause our performance to differ materially from the performance expressed in or implied by the forward-looking statements. We believe these factors include, but are not limited to, the following:
● our dependence on the overall demand for advertising, which could be influenced by economic downturns;
● any slow-down or unanticipated development in the market for programmatic advertising campaigns;
● the effects of health epidemics;
● operational and performance issues with our platform, whether real or perceived, including a failure to respond to technological changes or to upgrade our technology systems;
● any significant inadvertent disclosure or breach of confidential and/or personal information we hold, or of the security of our or our customers’, suppliers’ or other partners’ computer systems;
● any unavailability or non-performance of the non-proprietary technology, software, products and services that we use;
● unfavorable publicity and negative public perception about our industry, particularly concerns regarding data privacy and security relating to our industry’s technology and practices, and any perceived failure to comply with laws and industry self-regulation;
● restrictions on the use of third-party “cookies,” mobile device IDs or other tracking technologies, which could diminish our platform’s effectiveness;
● any inability to compete in our intensely competitive market;
● any significant fluctuations caused by our high customer concentration;
● our limited operating history, which could result in our past results not being indicative of future operating performance;
● any violation of legal and regulatory requirements or any misconduct by our employees, subcontractors, agents or business partners;
● any strain on our resources, diversion of our management’s attention or impact on our ability to attract and retain qualified board members as a result of being a public company;
● as a holding company, we depend on distributions from Direct Digital Holdings, LLC (“DDH LLC”) to pay our taxes, expenses (including payments under the Tax Receivable Agreement) and dividends;
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● DDH LLC may make distributions of cash to us substantially in excess of the amounts we use to make distributions to our stockholders and pay our expenses (including our taxes and payments under the Tax Receivable Agreement), which, to the extent not distributed as dividends on our Class A common stock, would benefit Direct Digital Management, LLC, the entity indirectly owned by our Chairman and Chief Executive Officer and President, as a result of its ownership of Class A common stock upon an exchange or redemption of its LLC Units; and
● other factors and assumptions discussed under “ Risk Factors ” and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.
Should one or more of these risks or uncertainties materialize or should any of these assumptions prove to be incorrect, our actual operating and financial performance may vary in material respects from the performance projected in these forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made, and except as required by law, we undertake no obligation to update any forward-looking statement contained in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances. New factors that could cause our business not to develop as we expect emerge from time to time, and it is not possible for us to predict all of them. Further, we cannot assess the impact of each currently known or new factor on our results of operations or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Overview
Direct Digital Holdings, Inc. and its subsidiaries (collectively the “Company,” “DDH,” “we,” “us” and “our”), 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. is the holding company that, since the completion of our initial public offering on February 15, 2022, owns certain common units, and serves as the manager, of DDH LLC, which operates the business formed in 2018 through the acquisition of Huddled Masses, LLC (“Huddled Masses™” or, “Huddled Masses”), a buy-side marketing platform, and Colossus Media, LLC (“Colossus Media”), a sell-side marketing platform.
On September 30, 2020, DDH LLC acquired Orange142, LLC (“Orange142”) to further bolster its overall programmatic buy-side advertising platform and enhance its offerings across multiple industry verticals such as travel, healthcare, education, financial services, consumer products and other sectors, with particular emphasis on small- and mid-sized businesses transitioning into digital with growing digital media budgets.
The subsidiaries of Direct Digital Holdings, Inc. are as follows:
Advertising
Solution
Date
Current %
and
of
Subsidiary
Ownership
Segment
Date of Formation
Acquisition
Direct Digital Holdings, LLC
100
%
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 advertising businesses, Huddled Masses and Orange142, offer technology-enabled advertising solutions and consulting services to clients through multiple leading demand side platforms (“DSPs”). Colossus Media is our proprietary sell-side programmatic platform operating under the trademarked banner of Colossus SSP™ (“Colossus SSP”). Colossus SSP is a stand-alone tech-enabled, data-driven sell-side platform (“SSP”) that helps deliver targeted advertising to diverse and multicultural audiences, including African Americans, Latin Americans, Asian Americans and LGBTQIA+ customers, as well as other specific audiences.
Providing both the front-end, buy-side advertising businesses coupled with our proprietary sell-side business, enables us to curate the first through the last mile in the ad tech ecosystem execution process to drive higher results.
Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by our chief operating decision maker in deciding how to allocate resources and assessing performance. Our chief operating decision maker is our Chairman and Chief Executive Officer. We view our 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.
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Key Factors Affecting Our Performance
We believe our growth and financial performance are dependent on many factors, including those described below.
Buy-side advertising business
New Customer Acquisitions
On the buy-side of our business, our customers consist of purchasers of programmatic advertising inventory (ad space) looking to place their advertisements. We serve the needs of approximately 227 small and mid-sized clients annually, consisting of advertising space buyers, including small and mid-sized companies, large advertising holding companies (which may manage several agencies), independent advertising agencies and mid-market advertising service organizations. We serve a variety of customers across multiple industries including travel/tourism (including destination marketing organizations (“DMOs”)), energy, consumer packaged goods, healthcare, education, financial services (including cryptocurrency technologies) and other industries.
We are focused on increasing the number of customers that use our buy-side advertising businesses as their advertising partner. Our long-term growth and results of operations will depend on our ability to attract more customers, including DMOs, across multiple geographies.
Expand Sales to Existing Customers
Our customers understand the independent nature of our platform and our relentless focus on driving results based on return on investment (“ROI”). Our value proposition is complete alignment across our entire digital supply platform beginning with the first dollar in and last dollar out. We are technology, DSP and media agnostic, and we believe our clients trust us to provide the best opportunity for success of their brands and businesses. As a result, our clients have been loyal, with approximately 90% client retention amongst the clients that represent approximately 80% of our revenue on an annual basis during the six months ended June 30, 2023. In addition, we cultivate client relationships through our pipeline of managed and moderate/self-serve clients that conduct campaigns through our platform. The managed services delivery model allows us to combine our technology with a highly personalized offering to strategically design and manage advertising campaigns.
Shift to Digital Advertising
Media has increasingly become more digital as a result of three key ongoing developments:
● Advances in technology with more sophisticated digital content delivery across multiple platforms;
● Changes in consumer behavior, including spending longer portions of the day using mobile and other devices; and
● Better audience segmentation with more efficient targeting and measurable results.
The resulting shift has enabled a variety of options for advertisers to efficiently target and measure their advertising campaigns across nearly every media channel and device. These efforts have been led by big- budgeted, large, multi-national corporations incentivized to cast a broad advertising net to support national brands.
Increased Adoption of Digital Advertising by Small-and Mid-Sized Companies
Only recently have small and mid-sized businesses begun to leverage the power of digital media in meaningful ways, as emerging technologies have enabled advertising across multiple channels in a highly localized nature. Campaign efficiencies yielding measurable results and higher advertising ROI, as well as the needs necessitated by the COVID-19 pandemic, have prompted these companies to begin utilizing digital advertising on an accelerated pace. We believe this market is rapidly expanding, and that small-to-mid-sized advertisers will continue to increase their digital spend.
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Seasonality
In general, the advertising industry experiences seasonal trends that affect the vast majority of participants in the digital marketing ecosystem. Our buy-side advertising revenue is weighted to DMOs and historically, marketing spend is higher in the second and third quarters of our fiscal year with the increase in marketing spend taking place over the summer months. As a result, the fourth and first quarters tend to reflect lower activity levels and lower revenue. We generally expect these seasonality trends to continue and our ability to effectively manage our resources in anticipation of these trends may affect our operating results.
Sell-side advertising business
Increasing revenue from publishers and advertising spend from buyers
Colossus Media operates our proprietary sell-side programmatic platform operating under the trademarked banner of Colossus SSP. The buyers on our platform include DSPs, agencies and individual advertisers. We have broad exposure to the ecosystem of buyers, reaching on average approximately 136,000 advertisers per month in the six months ended June 30, 2023, an increase of 72% over the 79,000 advertisers per month in the six months ended June 30, 2022. As spending on programmatic advertising increasingly becomes a larger share of the overall ad spend, advertisers and agencies are seeking greater control of their digital advertising supply chains. To take advantage of this industry shift, we have entered into Supply Path Optimization agreements directly with buyers. As part of these agreements, we provide advertisers and agencies with benefits ranging from custom data and workflow integrations, product features, volume-based business terms, and visibility into campaign performance data and methodology. As a result of these direct relationships, our existing advertisers and agencies are incentivized to allocate an increasing percentage of their advertising budgets to our platform.
We have broad exposure to the ecosystem of buyers, which has generally increased since the formation of Colossus Media in September 2017. Our growing sales team seeks to increase our business with the addition of new and existing publishers as well as by increasing our universe of buyers. In addition, establishing multiple header bidding integrations by leveraging our technology capabilities allows us to maximize our access to publishers’ ad formats, devices and various properties that a publisher may own. We may also up-sell additional products to publisher customers including our header bidding management, identity, and audience solutions. Our business strategy on the sell-side advertising business represents growth potential, and we believe we are well positioned to be able to bring underserved multicultural publishers into the advertising ecosystem, thereby increasing our value proposition across all clients, including our large clients.
Monetizing ad impressions for publishers and buyers
We focus on monetizing digital impressions by coordinating daily real-time auctions and bids. The publisher makes its ad inventory available on Colossus SSP and invites advertisers to bid based on the user’s data received. Each time the publisher’s web page loads, an ad request is sent to multiple ad exchanges and, in some cases, to the demand side platform directly from Colossus SSP. In case of real-time bidding (“RTB”) media buys, many DSPs would place bids to the impressions being offered by the publisher during the auction. The advertiser that bids a higher amount compared to other advertisers will win the bid and pay the second highest price for the winning impression to serve the ads. We continuously review our available inventory from existing publishers across every format (mobile, desktop, digital video, OTT, CTV, and rich media). The factors we consider when determining which impressions we process include transparency, viewability, and whether or not the impression is human sourced. By consistently applying these criteria, we believe the ad impressions we process will be valuable and marketable to advertisers.
Enhancing ad inventory quality
In the advertising industry, inventory quality is assessed in terms of invalid traffic (“IVT”) which can be impacted by fraud such as “fake eyeballs” generated by automated technologies set up to artificially inflate impression counts. As a result of our platform design and proactive IVT mitigation efforts, in the six months ended June 30, 2023, we determined that approximately 1% of inventory was invalid, resulting in minimal financial impact to our customers. We address IVT on a number of fronts, including sophisticated technology, which detects and avoids IVT on the front end; direct publisher and inventory relationships, for supply path optimization; and ongoing campaign and inventory performance review, to ensure inventory quality and brand protection controls are in place.
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Growing access to valuable ad impressions
Our recent growth has been driven by a variety of factors including increased access to mobile web (display and video) and mobile app (display and video) impressions and desktop video impressions. Our performance is affected by our ability to maintain and grow our access to valuable ad impressions from current publishers as well as through new relationships with publishers.
Expanding and managing investments
Each impression or transaction occurs in a fraction of a second. Given that most transactions take place in an auction/bidding format, we continue to make investments across the platform to further reduce the processing time. In addition to the robust infrastructure supporting our platform, it is also critical that we align with key industry partners in the digital supply chain. The Colossus SSP is agnostic to any specific demand side platform.
We automate workflow processes whenever feasible to drive predictable and value-added outcomes for our customers and increase productivity of our organization. In the first quarter of 2023, we transitioned our server platform to HPE Greenlake, which provides increased capacity, faster response time, and expansion capabilities to align with growth in our business.
Managing industry dynamics
We operate in the rapidly evolving digital advertising industry. Due to the scale and complexity of the digital advertising ecosystem, direct sales via manual, person-to-person processes are insufficient for delivering a real-time, personalized ad experience, creating the need for programmatic advertising. In turn, advances in programmatic technologies have enabled publishers to auction their ad inventory to more buyers, simultaneously, and in real time through a process referred to as header bidding. Header bidding has also provided advertisers with transparent access to ad impressions. As advertisers keep pace with ongoing changes in the way that consumers view and interact with digital media, we anticipate further innovation and expect that header bidding will be extended into new areas such as OTT/CTV. We believe our focus on publishers and buyers has allowed us to understand their needs and our ongoing innovation has enabled us to quickly adapt to changes in the industry, develop new solutions and do so cost effectively. Our performance depends on our ability to keep pace with industry changes such as header bidding and the evolving needs of our publishers and buyers while continuing our cost efficiency.
Seasonality
In general, the advertising industry experiences seasonal trends that affect the vast majority of participants in the digital marketing ecosystem. In our sell-side advertising segment, many advertisers allocate the largest portion of their budgets to the fourth quarter of the calendar year in order to coincide with increased holiday purchasing. As a result, the first quarter tends to reflect lower activity levels and lower revenue. We generally expect these seasonality trends to continue and our ability to effectively manage our resources in anticipation of these trends may affect our operating results.
Components of Our Results of Operations
Revenue
On the buy-side advertising segment, we generate revenue from clients that enter into agreements with us to provide digital marketing and media services to purchase digital advertising space, data, and other add-on features. On the sell-side advertising segment, we generate revenue from publishing clients by selling their advertising inventory to national and local advertisers.
We report revenue on a gross basis inclusive of all supplier costs because we bear the full obligation of any costs to provide our services. We pay suppliers for the cost of digital media, advertising inventory, data and any add-on services or features.
Our revenue recognition policies are discussed in more detail under “—Critical Accounting Policies and Estimates.”
Cost of revenues
Cost of revenues for our buy-side advertising segment consists primarily of digital media fees, third-party platform access fees, and other third-party fees associated with providing services to our customers. For the sell-side advertising segment, we pay publishers a fee, which is typically a percentage of the value of the ad impressions monetized through our platform. Cost of revenues consists
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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.
Operating expenses
Operating expenses consist of compensation expenses related to our executive, sales, finance, and administrative personnel (including salaries, commissions, bonuses, stock-based compensation, benefits, and taxes), general and administrative expenses for rent expense, professional fees, independent contractor costs, selling and marketing fees, and administrative and operating system subscription costs, insurance, as well as amortization expense related to our intangible assets.
Other income (expense)
Other income. Other income includes income associated with recovery of receivables and other miscellaneous credit card rebates.
Interest expense. Interest expense is mainly related to our debt as further described below in “ - Liquidity and Capital Resources .” In connection with the acquisition of Orange142, we issued mandatorily redeemable non-participating preferred A and B units, and the value of these units was classified as a liability, and the corresponding distributions were recognized as interest expense for the six months ended June 30, 2022. The preferred A and B units were fully redeemed as of March 31, 2022.
Contingent loss on early termination of line of credit. In January 2023, we entered into a Loan and Security Agreement (the “Loan Agreement”), by and among Silicon Valley Bank (“SVB”), which provided for a revolving credit facility (the “Credit Facility”). In March 2023, we issued a notice of termination and recognized a loss on the write-off of the deferred financing fees.
Loss on early redemption of non-participating preferred units. In February 2022, we redeemed the non-participating Class B Preferred Units and recognized a loss on the redemption of $590,689 in connection with the write-off of the fair value associated with the units.
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Results of Operations
Comparison of the Three and Six Months Ended June 30, 2023 and 2022
The following tables set forth our consolidated results of operations for the periods presented. The period-to-period comparison of results is not necessarily indicative of results for future periods.
For the Three Months Ended
For the Six Months Ended
June 30,
Change
June 30,
Change
2023
2022
Amount
%
2023
2022
Amount
%
Revenues
Buy-side advertising
$
11,803,092
$
9,321,267
$
2,481,825
27
%
$
19,242,758
$
15,152,308
$
4,090,450
27
%
Sell-side advertising
23,600,708
11,940,041
11,660,667
98
%
37,383,952
17,479,337
19,904,615
114
%
Total Revenues
35,403,800
21,261,308
14,142,492
67
%
56,626,710
32,631,645
23,995,065
74
%
Cost of revenues
Buy-side advertising
4,587,897
3,154,471
1,433,426
45
%
7,537,050
5,223,817
2,313,233
44
%
Sell-side advertising
20,743,266
9,771,017
10,972,249
112
%
32,583,972
14,291,209
18,292,763
128
%
Total cost of revenues
25,331,163
12,925,488
12,405,675
96
%
40,121,022
19,515,026
20,605,996
106
%
Gross profit
10,072,637
8,335,820
1,736,817
21
%
16,505,688
13,116,619
3,389,069
26
%
Operating expenses
7,818,189
5,271,673
2,546,516
48
%
14,392,579
9,467,601
4,924,978
52
%
Income from operations
2,254,448
3,064,147
(809,699)
(26)
%
2,113,109
3,649,018
(1,535,909)
(42)
%
Other expense
(985,180)
(363,108)
(622,072)
(171)
%
(2,252,423)
(1,619,602)
(632,821)
(39)
%
Income (loss) before taxes
1,269,268
2,701,039
(1,431,771)
(53)
%
(139,314)
2,029,416
(2,168,730)
(107)
%
Tax expense (benefit)
74,312
86,676
(12,364)
(14)
%
(336)
86,676
(87,012)
100
%
Net income (loss)
$
1,194,956
$
2,614,363
$
(1,419,407)
(54)
%
$
(138,978)
$
1,942,740
$
(2,081,718)
(107)
%
Adjusted EBITDA (1)
$
3,059,679
$
3,568,009
$
(508,330)
(14)
%
$
3,607,653
$
4,689,316
$
(1,081,663)
(23)
%
(1) Adjusted EBITDA is a non-GAAP financial measure. For a definition of Adjusted EBITDA, an explanation of our management’s use of this measure, and a reconciliation of Adjusted EBITDA to net income (loss) see “ – Non-GAAP Financial Measures .”
Revenues
Our revenues increased from $21.3 million for the three months ended June 30, 2022 to $35.4 million for the three months ended June 30, 2023, an increase of $14.1 million or 67%. Buy-side advertising revenue increased $2.5 million, or 27%, primarily due to expanded spending from our existing customer base as well as new middle market client spending. Sell-side advertising revenue increased $11.7 million, or 98% over the 2022 three-month results, due to a continued increase in impression inventory, as well as increased publisher engagement across general market and underrepresented publisher communities.
Our revenues increased from $32.6 million for the six months ended June 30, 2022 to $56.6 million for the six months ended June 30, 2023, an increase of $24.0 million or 74%. Buy-side advertising revenue increased $4.1 million, or 27%, primarily due to expanded spending from our existing customer base as well as new middle market client spending. Sell-side advertising revenue increased $19.9 million, or 114% over the 2022 six-month results, due to a continued increase in impression inventory, as well as increased publisher engagement across general market and underrepresented publisher communities.
Cost of revenues
Along with the increase in revenues across both segments, we correspondingly experienced an increase in cost of revenues from $12.9 million for the three months ended June 30, 2022 to $25.3 million for the three months ended June 30, 2023, an increase of
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$12.4 million, or 96%. Buy-side advertising cost of revenues increased $1.4 million to $4.6 million, or 39% of revenue, for the three months ended June 30, 2023, compared to $3.2 million, or 34% of revenue, for the three months ended June 30, 2022. Sell-side advertising cost of revenues increased $11.0 million, to $20.7 million, or 88% of revenue for the three months ended June 30, 2023, compared to $9.8 million, or 82% of revenue, for the same period in 2022. The increase in sell-side advertising costs was primarily due to the related increase in revenue, while the 6% increase as a percentage of revenue was due to an increase in fixed costs of approximately $0.6 million related to an increase in server capacity to support the growth as well as the mix and concentration of publishers and the related costs.
Cost of revenues increased from $19.5 million for the six months ended June 30, 2022 to $40.1 million for the six months ended June 30, 2023, an increase of $20.6 million, or 106%. Buy-side advertising cost of revenues increased $2.3 million to $7.5 million, or 39% of revenue, for the six months ended June 30, 2023, compared to $5.2 million, or 34% of revenue, for the six months ended June 30, 2022. Sell-side advertising cost of revenues increased $18.3 million, to $32.6 million, or 87% of revenue for the six months ended June 30, 2023, compared to $14.3 million, or 82% of revenue, for the same period in 2022. The increase in costs was primarily due to the related increase in revenue, while the 5% increase as a percentage of revenue was due to an increase in fixed costs of approximately $0.6 million related to an increase in server capacity to support the growth as well as the mix and concentration of publishers and the related costs. We expect these higher costs to continue in future fiscal periods.
Gross profit
Gross profit also increased in the three months ended June 30, 2023 to $10.1 million, or 28% of revenue, compared to $8.3 million, or 39% of revenue, for the three months ended June 30, 2022, an increase of $1.7 million or 21%. Gross profit increased in the six months ended June 30, 2023 to $16.5 million, or 29% of revenue, compared to $13.1 million, or 40% of revenue, for the six months ended June 30, 2022, an increase of $3.4 million or 26%. The change in margin for the three and six months ended June 30, 2023 is attributable to the mix in revenue between our business segments as well as the additional fixed costs related to an increase in server capacity. Our sell-side segment, whose revenues grew as a percentage of our overall revenue, has a lower gross margin than our buy-side segment.
Buy-side advertising gross profit increased $1.0 million and $1.8 million for the three and six months ended June 30, 2023, respectively, as compared to the same period in the prior year, primarily due to higher revenue. Buy-side advertising gross margin was 61% for the three and six months ended June 30, 2023 compared to gross margin of 66% for the three and six months ended June 30, 2022. Buy-side gross margin decreased in 2023 to a level the Company believes is sustainable reflecting strategic efforts by the Company to ensure customer retention and increase revenue per customer. Sell-side advertising gross profit increased $0.7 million and $1.6 million for the three and six months ended June 30, 2023, respectively, as compared to prior year, primarily due to the increase in revenue. Sell-side advertising gross margin was 12% and 13% for the three and six months ended June 30, 2023 compared to gross margin of 18% for the three and six months ended June 30, 2022. Sell-side gross margin in 2023 was negatively impacted by additional fixed costs of approximately $0.6 million incurred in the three months ended June 30, 2023 related to an increase in server capacity to support our growth. About half of these incremental costs are expected to continue each quarter through March 2024.
Operating expenses
The following table sets forth the components of operating expenses for the periods presented.
For the Three Months Ended
For the Six Months Ended
June 30,
Change
June 30,
Change
2023
2022
Amount
%
2023
2022
Amount
%
Compensation, tax and benefits
$
4,553,029
$
3,494,692
$
1,058,337
30
%
$
8,187,325
$
6,049,728
$
2,137,597
35
%
General and administrative
3,265,160
1,776,981
1,488,179
84
%
6,205,254
3,417,873
2,787,381
82
%
Total operating expenses
$
7,818,189
$
5,271,673
$
2,546,516
48
%
$
14,392,579
$
9,467,601
$
4,924,978
52
%
Compensation, taxes and benefits
Compensation, taxes and benefits increased from $3.5 million for the three months ended June 30, 2022 to $4.6 million in for the three months ended June 30, 2023, an increase of $1.1 million, or 30%. The increase is due to headcount additions primarily in shared services to support our public company infrastructure and growth as well as $0.3 million for severance.
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Compensation, taxes and benefits increased from $6.0 million for the six months ended June 30, 2022 to $8.2 million in for the six months ended June 30, 2023, an increase of $2.1 million, or 35%. The increase is due to headcount additions primarily in our operations area to support our growth as well as in our shared services to support our public company infrastructure, bonus expense and severance of $0.3 million. In connection with our IPO, the Company adopted the 2022 Omnibus Incentive Plan (“2022 Omnibus Plan”) to facilitate the grant of equity awards to our employees, consultants and non-employee directors. On June 10, 2022, March 20, 2023 and June 10, 2023, our board of directors granted stock options and restricted stock units (“RSUs”) to certain of our employees and non-employee directors. The increase in compensation, taxes and benefits expense related to stock options and RSUs granted was $0.2 million and $0.3 million for the three and six months ended June 30, 2023, respectively. We expect to continue to invest in corporate infrastructure and incur additional expenses associated with our transition to and operation as a public company, including increased compensation associated with additional headcount to support our sales initiatives.
General and administrative expenses
General and administrative (“G&A”) expenses increased from $1.8 million for the three months ended June 30, 2022 to $3.3 million for the three months ended June 30, 2023. G&A expenses as a percentage of revenue was 9% and 8%, respectively, for the three months ended June 30, 2023 and 2022.
The increase in G&A costs during the three months ended June 30, 2023 was primarily due to costs associated with supporting our growth and ongoing marketing initiatives. During the three months ended June 30, 2023, we incurred higher professional fees, sales and marketing expenses including investor and public relations costs and travel expenses. We expect to continue to invest in and incur additional expenses as we grow, including increased professional fees, investment in automation, and compliance costs associated with developing the requisite infrastructure required for internal controls.
G&A expenses increased from $3.4 million for the six months ended June 30, 2022 to $6.2 million for the six months ended June 30, 2023. G&A expenses as a percentage of revenue was 11% and 10%, respectively, for the six months ended June 30, 2023 and 2022.
The increase in G&A costs during the six months ended June 30, 2023 was primarily due to costs associated with our transition to and operation as a public company as of February 2022. During the six months ended June 30, 2023, we incurred higher professional fees, sales and marketing expenses including investor and public relations costs, travel expenses and insurance. We also completed the transition of our servers for Colossus Media to HPE Greenlake and incurred higher consulting and transition costs for this one-time project. We expect to continue to invest in and incur additional expenses associated with our transition to operating as a public company, including increased professional fees, investment in automation and compliance costs associated with developing the requisite infrastructure required for internal controls.
Other income (expense)
The following table sets forth the components of other income (expense) for the periods presented.
For the Three Months Ended
For the Six Months Ended
June 30,
Change
June 30,
Change
2023
2022
Amount
%
2023
2022
Amount
%
Interest expense
(1,027,493)
(650,251)
(377,242)
58
%
(2,044,794)
(1,364,038)
(680,756)
50
%
Contingent loss on early termination of line of credit
—
—
—
nm
(299,770)
—
(299,770)
nm
Loss on early redemption of non-participating preferred units
—
—
—
nm
—
(590,689)
590,689
(100)
%
Forgiveness of Paycheck Protection Program loan
$
—
$
287,143
$
(287,143)
(100)
%
$
—
$
287,143
$
(287,143)
(100)
%
Other income
42,313
—
42,313
nm
$
92,141
$
47,982
$
44,159
92
%
Total other expense
$
(985,180)
$
(363,108)
$
(622,072)
171
%
$
(2,252,423)
$
(1,619,602)
$
(632,821)
39
%
nm – not meaningful
Other expense for the three months ended June 30, 2023 primarily consists of $1.0 million of interest expense. Other expense for the three months ended June 30, 2022 is comprised of $0.7 million of interest expense, partially offset by forgiveness of the PPP loan.
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Other expense for the six months ended June 30, 2023 primarily consists of $2.0 million of interest expense and $0.3 million related to the contingent loss on early termination of the line of credit with SVB. Other expense for the six months ended June 30, 2022 is comprised of $1.4 million of interest expense and $0.6 million associated with the loss on the early redemption of DDH LLC’s previously outstanding Class B Preferred Units partially offset by other income and forgiveness of the PPP loan.
Interest expense increased for the three months ended June 30, 2023 to $1.0 million compared to $0.7 million for the three months ended June 30, 2022. Interest expense increased for the six months ended June 30, 2023 to $2.0 million compared to $1.4 million for the six months ended June 30, 2022. The increase in interest expense in the three and six months period is due to an additional $4.3 million in borrowings in July 2022 under the 2021 Credit Facility, as amended by the Term Loan Amendment, as well as higher interest rates.
Liquidity and Capital Resources
The following table summarizes our cash and cash equivalents, working capital, and availability under our Revolving Credit Facility (as defined below) on June 30, 2023 and December 31, 2022:
June 30, 2023
December 31, 2022
Cash and cash equivalents
$
5,668,479
$
4,047,453
Working capital
$
5,871,607
$
5,712,680
We anticipate funding our operations for the next twelve months using available cash and cash flow generated from operations and borrowings under the 2023 Credit Facility, as defined below. As of June 30, 2023 and December 31, 2022, we had cash and cash equivalents of approximately $5.7 million and $4.0 million, respectively. On July 7, 2023, the Company entered into a Credit Agreement (the “Credit Agreement”), by and among East West Bank (“EWB”), as lender, and the Company and its subsidiaries, as borrowers.
Based on our expectations of continued growth in revenue and cash generated from operations in the coming year, the available cash held by us, and the amounts we may borrow under the Credit Agreement executed in July 2023, we believe that we will have sufficient cash resources to finance our operations and service any maturing debt for at least the next twelve months following the issuance of this Quarterly Report on Form 10-Q. To fund our operations and service our debt thereafter, depending on our growth and results of operations, we may have to raise additional capital through the issuance of additional equity and/or debt, which could have the effect of diluting our stockholders. Any equity or debt financings, if available at all, may be on terms which are not favorable to us. As our debt or credit facilities become due, we will need to repay, extend or replace such indebtedness. Our ability to do so will be subject to future economic, financial, business and other factors, many of which are beyond our control.
Credit Agreement entered into on July 7, 2023
On July 7, 2023, the Company entered into the Credit Agreement which provides for a revolving 2023 Credit Facility (the “2023 Credit Facility”) in the original principal amount of up to $5 million, subject to a borrowing base determined based on eligible accounts, and an up to $5 million uncommitted incremental revolving facility. Loans under the 2023 Credit Facility mature on July 7, 2025 (the “Maturity Date”), unless the 2023 Credit Facility is otherwise terminated pursuant to the terms of the Credit Agreement.
Borrowings under the 2023 Credit Facility bear interest at a rate per annum equal to the one-month Term Secured Overnight Financing Rate, as administered by the CME Group Benchmark Administration Limited (“CBA”) (or a successor administrator of the secured overnight financing rate) and displayed by Bloomberg LP (or any successor thereto, or replacement thereof, as approved by EWB) and as determined by EWB on the first day of the applicable interest period, plus 0.10% (10 basis points), plus 3.00% per annum (the “Loan Rate”); provided, that, in no event shall the Loan Rate be less than 0.50% of the Loan Rate effective as of the date of the Credit Agreement nor more than the maximum rate of interest allowed under applicable law. Upon an event of default under the Credit Agreement, the outstanding principal amounts of any advances will accrue interest at a rate per annum equal to the Loan Rate plus five percent (5%), but in no event in excess of the maximum rate of interest allowed under applicable law.
At the Company’s option, the Company may at any time prepay the outstanding principal balance of the 2023 Credit Facility in whole or in part, without fee, penalty or premium. All accrued but unpaid interest on outstanding advances under the Credit Agreement is payable in monthly installments on the last day of each monthly interest period until the Maturity Date when the then-outstanding principal balance of the advances and all accrued but unpaid interest thereon becomes due and payable.
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The Company and the other borrowers are required to maintain compliance at all times with the following financial covenants on a consolidated basis: (i) a fixed charge coverage ratio of not less than 1.25 to 1.0, beginning with the fiscal quarter ended on June 30, 2023 and at the end of each fiscal quarter thereafter; (ii) a total funded debt-to-EBITDA ratio of 3.50 to 1.00 as of the last day of each fiscal quarter from June 30, 2023 through December 31, 2023, 3.25 to 1.00 as of the last day of each fiscal quarter from March 31, 2024 through March 31, 2025 and 3.00 to 1.00 as of the last day of each fiscal quarter from June 30, 2025 and thereafter; and (iii) a liquidity covenant requiring the Company and the other borrowers to maintain minimum liquid assets at all times (calculated using unencumbered cash and cash equivalents and marketable securities), in one or more accounts held with EWB plus Revolving Credit Availability in the amount of $1,000,000. Revolving Credit Availability is defined as an amount such that the ratio of the value of eligible accounts to the aggregate amount of all outstanding advances under the credit agreement at such time is not less than 2.0 to 1.0.
The obligations under the 2023 Credit Facility are secured by all or substantially all of the borrowers’ assets.
The Credit Agreement contains customary representations and warranties and includes affirmative and negative covenants applicable to the borrowers thereto and their respective subsidiaries. The affirmative covenants include, among others, covenants requiring the Company to maintain its legal existence and governmental compliance, deliver certain financial reports and maintain insurance coverage. The negative covenants include, among others, restrictions on indebtedness, liens, investments, mergers, dispositions, prepayment of other indebtedness and dividends and other distributions.
The Credit Agreement also includes customary events of default, including, among other things, non-payment defaults, covenant defaults, inaccuracy of representations and warranties, defaults under any of the loan documents, certain cross-defaults to other indebtedness, certain bankruptcy and insolvency events, invalidity of guarantees or grant of security interest, certain ERISA-related transactions and events, certain orders of forfeiture, change of control, certain undischarged attachments, sequestrations, or similar proceedings, and certain undischarged or non-stayed judgments, in certain cases subject to certain thresholds and grace periods. The occurrence of an event of default could result in the acceleration of the obligations under the Credit Agreement of the Company or other borrowers.
Credit Facilities as of June 30, 2023
On December 3, 2021, DDH LLC entered into the Term Loan and Security Agreement (the “2021 Credit Facility”) with Lafayette Square Loan Servicing, LLC (“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 “Delayed Draw Loan”). The loans under the 2021 Credit Facility bear interest at a rate per annum equal to LIBOR plus the applicable margin minus any applicable impact discount. The applicable margin under the 2021 Credit Facility as amended by the Term Loan Amendment (as defined below) is determined based on the consolidated total net leverage ratio of the Company and its consolidated subsidiaries, at a rate of 7.00% per annum if the consolidated total net leverage ratio is less than 1.00 to 1.00 and up to 10.00% per annum if the consolidated total net leverage ratio is greater than 3.50 to 1.00. The applicable impact discount under the 2021 Credit Facility is a discount of 0.05% per annum based upon DDH LLC’s participation in each of 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). On June 1, 2023, the Company entered into an agreement with Lafayette Square to convert the existing LIBOR-based rate to a Term SOFR Rate with a credit spread of 0.15% per annum for the interest periods of three months and provides for a credit spread adjustment of 0.10%, 0.15% or 0.25% per annum for interest periods of one month, three months or six months, respectively. The maturity date of the 2021 Credit Facility is December 3, 2026.
On July 28, 2022, the Company entered into the Second Amendment and Joinder to Term Loan and Security Agreement (the “Term Loan Amendment”) and received proceeds of $4,260,000 borrowed under the Delayed Draw Loan to pay the balance owed on the common unit redemption as well as costs associated with the transaction.
Pursuant to the Term Loan Amendment, DDH LLC will indemnify the Company from and against any claims, losses, expenses and other liabilities incurred by the Company arising from the Company’s guarantor obligations under the 2021 Credit Facility and related term loan documents. The Delayed Draw Loan is required to be repaid in quarterly installments payable on the last day of each fiscal quarter in an amount equal to (i) commencing with the fiscal quarter ending December 31, 2022 through and including the fiscal quarter ending December 31, 2023, $26,250, and (ii) commencing March 31, 2024 and continuing on the last day of each fiscal quarter thereafter, $52,500, with a final installment due December 3, 2026 in an amount equal to the remaining entire principal balance thereof. After giving effect to the Delayed Draw Loan on the effective date of the Term Loan Amendment, no additional delayed draw loans will be available under the 2021 Credit Facility.
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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. As of June 30, 2023, the Company owed a balance on the 2021 Credit Facility of $25,356,250. The 2021 Credit Facility contains affirmative and negative covenants that, among other things, require the Company to maintain a net leverage ratio of no more than 3.50 to 1.00 as of the last day of each fiscal quarter through December 31, 2023, as adjusted thereafter, and a fixed charge coverage ratio of not less than 1.50 to 1.00 as of the last day of each fiscal quarter, as well as restrictions on the ability to incur indebtedness, create certain liens, make certain investments, make certain dividends and other types of distributions, and enter into or undertake certain mergers, consolidations, acquisitions and sales of certain assets and subsidiaries. The Company was in compliance with all the financial covenants under the 2021 Credit Facility as of June 30, 2023.
Consolidated Statement of Cash Flow Data:
For the Six Months Ended June 30,
2023
2022
Net cash provided by operating activities
$
3,182,591
$
73,514
Net cash used in investing activities
(136,978)
—
Net cash provided by (used in) financing activities
(1,424,587)
157,870
Net increase in cash and cash equivalents
$
1,621,026
$
231,384
Cash Flows Provided by Operating Activities
Our cash flows from operating activities are primarily influenced by growth in our operations, increases or decreases in collections from our customers and related payments to our buyers and suppliers of advertising media and data. Cash flows from operating activities have been affected by changes in our working capital, particularly changes in accounts receivable, accounts payable and accrued liabilities. The timing of cash receipts from customers and payments to suppliers can significantly impact our cash flows from operating activities. We typically pay suppliers in advance of collections from our customers, but our collection and payment cycles can vary from period to period. In addition, we expect seasonality to impact cash flows from operating activities on a quarterly basis.
For the Six Months Ended June 30, 2023 and 2022
Cash flows from operating activities increased from $0.1 million for the six months ended June 30, 2022 to $3.2 million for the six months ended June 30, 2023. The period-over-period increase in cash from operations of $3.1 million was primarily due to a $3.7 million increase for changes in accounts receivable, a $2.3 million increase related to changes in accounts payable, and a $1.3 million increase for changes in deferred revenue related to the increase in revenue and timing of payments received and made. This is partially offset by a $2.1 million decrease in net income and a $1.4 million decrease related to changes in accrued liabilities.
Cash Flows from Investing Activities
For the Six Months Ended June 30, 2023 and 2022
During the six months ended June 30, 2023, the Company acquired property, equipment and software for $136,979.
Cash Flows Provided by (Used in) Financing Activities
For the Six Months Ended June 30, 2023 and 2022
Our financing activities consist primarily of distributions to DDH LLC members, payments under our notes payable, and during 2022, net proceeds from our IPO as well as the redemption payments for DDH LLC’s common units and Class B Units held by USDM Holdings, Inc. Net cash provided by financing activities has been and will be used to finance our operations, including our investment in people and infrastructure, to support our growth.
During the six months ended June 30, 2023, net cash used in financing activities increased by $1.6 million, from $0.2 million provided by financing activities for the six months ended June 30, 2022 to $1.4 million used in financing activities for the six months ended June 30, 2023. During the six months ended June 30, 2023, we made distributions to members of $0.8 million, payments on the Revolving Credit Facility of $0.3 million, and payments of $0.2 million in deferred financing costs.
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During the six months ended June 30, 2022, we received net proceeds of $11.2 million related to our issuance of Class A common stock in our initial public offering and used a portion of the proceeds to redeem the common units and Preferred B units held by USDM Holdings, Inc. for approximately $10.3 million. Also, during the six months ended June 30, 2022, we made payments of $0.3 million on the 2021 Credit Facility, distributions to members of $0.3 million and payments of $0.2 million in deferred financing costs.
Contractual Obligations and Future Cash Requirements
As of June 30, 2023, our principal contractual obligations expected to give rise to material cash requirements consist of non-cancelable leases for our various facilities and the 2021 Credit Facility. We lease furniture and office space in Houston and Austin from an unrelated party under non-cancelable operating leases dating through February 2030. These leases will require minimum payments of $74,502 in 2023, $110,215 in 2024, $156,077 in 2025, $159,755 in 2026, $163,474 in 2027 and $366,830 thereafter. We anticipate that the future minimum payments related to our current indebtedness over the next five years will be $327,500 in 2023, $1.3 million in 2024, $1.3 million in 2025, $22.4 million in 2026, $3,337 in 2027 and $142,975 thereafter, assuming we do not refinance our indebtedness. We believe our cash on hand in addition to our cash generated by operations will be sufficient to cover these obligations as well as the future cash requirements of being a public company.
Non-GAAP Financial Measures
In addition to our results determined in accordance with U.S. generally accepted accounting principles (“GAAP”), including, in particular operating income, net cash provided by operating activities, and net income, we believe that earnings before interest, taxes, depreciation and amortization, as adjusted for contingent loss on early termination of line of credit, loss on early redemption of non-participating preferred units, stock-based compensation and forgiveness of PPP loan (“Adjusted EBITDA”), a non-GAAP measure, is useful in evaluating our operating performance. The most directly comparable GAAP measure to Adjusted EBITDA is net income.
The following table presents a reconciliation of Adjusted EBITDA to net income for each of the periods presented:
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Net income (loss)
$
1,194,956
$
2,614,363
$
(138,978)
$
1,942,740
Add back (deduct):
Interest expense
1,027,493
650,251
2,044,794
1,364,038
Stock-based compensation
209,475
15,407
304,014
15,407
Amortization of intangible assets
488,455
488,455
976,909
976,909
Depreciation and amortization of property and equipment
64,988
—
121,480
—
Contingent loss on early termination of line of credit
—
—
299,770
—
Tax expense (benefit)
74,312
86,676
(336)
86,676
Forgiveness of PPP loan
—
(287,143)
—
(287,143)
Loss on early redemption of non-participating preferred units
—
—
—
590,689
Adjusted EBITDA
$
3,059,679
$
3,568,009
$
3,607,653
$
4,689,316
In addition to operating income and net income (loss), we use Adjusted EBITDA as a measure of operational efficiency. We believe that this non-GAAP financial measure is useful to investors for period-to-period comparisons of our business and in understanding and evaluating our operating results for the following reasons:
● Adjusted EBITDA is widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as depreciation and amortization, interest expense, provision for income taxes, stock-based compensation, and certain one-time items such as acquisition transaction costs and gains from settlements or loan forgiveness that can vary substantially from company to company depending upon their financing, capital structures and the method by which assets were acquired;
● Our management uses Adjusted EBITDA in conjunction with GAAP financial measures for planning purposes, including the preparation of our annual operating budget, as a measure of operating performance and the effectiveness of our business strategies and in communications with our board of directors concerning our financial performance; and
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● Adjusted EBITDA provides consistency and comparability with our past financial performance, facilitates period-to-period comparisons of operations, and also facilitates comparisons with other peer companies, many of which use similar non-GAAP financial measures to supplement their GAAP results.
Our use of this non-GAAP financial measure has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our financial results as reported under GAAP.
Critical Accounting Policies and Estimates
There have been no significant changes in our critical accounting policies and estimates during the six months ended June 30, 2023, as compared to the critical accounting policies and estimates referred in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under “Critical Accounting Policies and Estimates” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 (the “Annual Report”).
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements for recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
As a “smaller reporting company,” we are not required to provide the information required by this Part I, Item 3.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.