Digital Turbine, Inc. Q3 FY2024 Earnings Call

Good afternoon and welcome to the Digital Turbine Report for the Fiscal 2024 Third Quarter Results Conference Call. Please note that this event is being recorded. I would now like to turn the floor over to Brian Bartholomew, Head of Investor Relations. Please go ahead.

Thank you. Good afternoon and welcome to the Digital Turbine fiscal year 2024 third quarter earnings conference call. Joining me today on the call to discuss our results are CEO, Bill Stone; and CFO Barrett Garrison. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. These forward-looking statements are based on our current assumptions, expectations, and beliefs including projected operating metrics, future products and services, anticipated market demand and other forward-looking topics. Although, we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. Except as required by law, we undertake no obligation to update any forward-looking statements. For discussion of the risk factors that could cause our actual results to differ materially from those contemplated by our forward-looking statements, please refer to the documents we filed with the Securities and Exchange Commission. Also during this call, we will discuss certain non-GAAP measures of our performance. Non-GAAP measures are not substitutes for GAAP measures, please refer to today's press release for important information about the limitations of using non-GAAP measures, as well as reconciliations of these non-GAAP financial results to the most comparable GAAP measures. Now I will turn the call over to our CEO, Mr. Bill Stone.

Thanks, Brian, and thank you all for joining our call tonight. I'm going to break my remarks into three areas. First, I want to summarize our December results. Second, I want to describe the current state of our technology migrations and operations and the changes we are making to improve our execution. And finally, I want to discuss the progress we're making against the future opportunities, which are very encouraging. For the December quarter, we achieved $143 million of revenue, $25 million of EBITDA, and $0.15 of non-GAAP earnings per share. We finished in line with our outlook expectations for our HEP business, but were below our expectations for our ODS business. We experienced three unique issues in our ODS business late in the quarter that were the difference between coming in below versus above our overall outlook. First, despite our forecast in U.S. device sales, we continued facing headwinds year-over-year, and they were even more disappointing than what our conservative expectations were. Secondly, we finalized the migration of our cloud hosting platform late in the quarter. The good news is that this major milestone is now complete. However, some elements of our software that were working fine on our prior platform were not performing the same on the new platform for a few weeks. These issues have now been fixed. Finally, we made some changes to our AI machine learning models for the holidays to drive improved engagement from our customers. The good news is that it happened, but it happened at the expense of advertisers willing to pay more money to be on the platform for the holiday season and less focus on engagement. Combined, these three things were the difference between our results being below versus above our outlook. I'll discuss later in my remarks what we are changing to improve our execution going forward. However, we do view all three of these issues as temporary in nature and not structural. From a segment perspective, our AGP or ad tech business showed sequential growth driven by improved eCPMs rates from our advertisers, despite our sunsetting of our legacy AdColony exchange. Now we are fully operational on our consolidated DT exchange. We are also now seeing growth from our new features, such as SDK bidding, contributing more material revenues to our business. Bigger picture, we are seeing demand and advertisers return, which is much improved from 12 months ago. In particular, our brand business experienced more than 25% sequential growth, despite one of our largest brand advertisers having their own temporary internal issues that impacted their spend on ours and others' networks. I'll provide more color later in my remarks on how we will continue to grow and scale our AGP business. The ODS business declined by 2% in the quarter, driven by short-term issues described above. With one U.S. carrier exception that was only marginally up, our U.S. operators had declined in devices from the prior quarter, which is unusual, given it was the holiday selling season. We have heard some recent encouraging reports from chipset suppliers on future device volumes, which tend to be lead indicators for future demand. So we are hopeful for better trends in the future. But for now, it is a major headwind, and it is reflected in our guidance for the March quarter. In addition to this, we are working to expand our device pipeline. I'm pleased to announce that we are expanding our relationship with Motorola, adding more devices in more countries, and also our relationship with ONE Store in Korea that will add nearly 40 million devices with SingleTap capability. Our pipeline remains robust, and we look forward to sharing more device supply opportunities into the future. Improving revenue per device outside of the United States to mirror where we are seeing device growth is a top priority for us. We have also made progress with different advertisers on SingleTap in the quarter as we continue to expand with new contracts and new advertisers. We are not yet live with our large social media partner pilot. There is no operational or technical issue preventing us from launching, but a final administrative issue that is being worked on on their side. The relationship with that party continues to be positive and is becoming more strategic, but we understand the frustration we all feel on translating this enthusiasm into revenue. I want to spend a few moments describing the changes we are making to improve our short-term execution that will drive future growth. Our issue is unique, and it is neither the what nor the why. We are confident that we are working on the correct items as we can demonstrate product-market fit and also how to make money on those prioritized items. We also have a very clear vision on why we are here. Digital Turbine can be a major disruptive force in alternative app distribution with our unique assets and subject matter expertise. Most companies facing headwinds suffer from one of those two issues. We are unique as those are not our issues. Rather, we have two things we need to do to improve our execution that will drive future growth and cash flow. The first is the material investment we are making on the modernization of our tech stack, which impacts short-term results, and the second is how we are working to execute. We need to demonstrate the ability to ramp new items into the market at scale to replace the exited businesses and headwinds described earlier in my remarks. Those require new systems, new processes, and new leadership models. On tech stack modernization, we have approximately 40% of our product and tech organization working on building for the future versus working on short-term, non-strategic revenues. We're seeing early positive results from these modernization activities with things like our exchange consolidation, our hosting migrations, and new ERP systems now live in the market. But we still have much work to do as we are implementing a lighter, more modular version of Ignite, a new demand-side platform, or DSP, new backend tools that will scale our AI and machine learning efforts on the platform, and so on. All of this work is mission critical to build a long-term company that will scale to all of our expectations, and we have made a conscious decision to prioritize this work. I want to be clear that it does come at the expense of a few items that could drive short-term revenue in EBITDA, but for long-term investors, I want to emphasize the importance of finishing the swing on these initiatives, and you will see continued progress over the upcoming quarters as we are very close to completing these activities that have been in the works now, in some cases, for many years. In addition to the system level work, we are also changing our leadership model, our organizational structure, making some leadership changes, changing our internal processes for decision making, and finally, improving our focus on the things that will drive short and long-term growth. As we change these things, we are confident that the revenue and cash flow will follow as we know we have demand for our offerings in the marketplace. We are laser-focused on these changes, which are being implemented in the current quarter, and these how things are working to change the what we're willing to be for the catalyst of returning Digital Turbine to a growth company. And what makes all of this worth it is the bright future. We are uniquely positioned with our on-device technology, including our first-party data, our AI machine learning tools, and SingleTap, plus our extensive publisher relationships and our operator and OEM relationships. We've launched our first alternative app distribution products, branded as DT Hub, with five operators here in the United States. We are leveraging our Aptoide investment and are generating revenue today. And as a reminder, our equity investment in Aptoide is now approximately 20%. We've also taken a minority investment in Flexion, allowing us to improve our partnership on building excellent alternative app experiences, as Flexion is a leading porting source for many alternative app stores, such as Amazon, Samsung, Huawei, Xiaomi, and many others. Many of you may have seen our press release from yesterday announcing our equity stake in ONE Store. ONE Store is the largest alternative app store in Korea, and for context to investors not familiar with them, they generate more revenue than Apple does in Korea for the Apple App Store. We are beginning our relationship with ONE Store by enabling SingleTap on all of their 40 million Korean devices. This has three benefits. One is that it will allow us to leverage our DSP to deliver friction-free app downloads of alternative app versions to Korean customers. Secondly, it's a way for us to expand the scale of developed market device supply versus being constrained with the issues I mentioned earlier in the United States. Finally, we look to enhance our partnership with ONE Store into the future outside of Korea. Combined with our Aptoide and Flexion relationships, we possess the building blocks to be a dominant force in the alternative app market. As a reminder for investors, the Digital Markets Act or DMA will launch in early March in the EU, and we encourage investors to pay close attention to the launch and the opportunities it will present. I also want to emphasize that the alternative app strategy is not just about new revenues, but perhaps more importantly, will also be a catalyst to return our current business to growth. Today, approximately 50% of our business is driven by user acquisition and 50% driven by in-app advertising. Our app providers want to find ways to acquire more users at a lower cost with those alternative users, which we believe will open up new app providers to leverage our ad tech stack as part of this strategy, thereby driving more AGP or ad tech revenue growth. We are live today running both alternative app user acquisition campaigns and in-app advertising, leveraging our technologies into our current results. In other words, improving our present revenues and cash flows are both closely linked to the future strategy. To close out my preferred remarks, our future continues to be very exciting, but we need to improve our short-term execution and return our business to growth. We have many specific growth drivers from devices, products, media partners, and cost optimization activities in the works that will accomplish this year. Those initiatives are the ones that will return DT to a growth company in the short term while we continue to pursue our bright, longer-term vision. With that, I'll conclude my prepared remarks and turn it over to Barrett to take you through the numbers.

Thanks, Bill. And good afternoon, everyone. Total revenue of $142.6 million in the quarter was flat sequentially and down 12% year-on-year. Within our on-device solutions, or ODS segment, revenues of $94.3 million were down 2% compared to the prior year's December quarter. These results were below our expectations we provided in our November earnings call, largely due to further softening in U.S. carrier device volumes during the holiday season, even against our conservative outlook. Combined with the temporary execution issues Bill referenced, stemming from certain platform integration efforts. These headwinds were partially offset by continued strength from improved U.S. revenue per device year-on-year. Our content media revenues were slightly up sequentially in the quarter. While this part of our business has experienced headwinds from prepaid content media based on a year-on-year comparison, this headwind was fully lapped in the December quarter. We're encouraged by the developments of our new partnership that Bill shared and our robust pipeline, providing the opportunity to leverage our existing device footprint and grow revenues on new supply, particularly outside the U.S. In our app growth platform, or AGP business, Q3 revenues of $49.2 million performed in line with our guidance expectations, grew 6.5% sequentially, and declined 27% over the prior year. We saw improving signs of spend levels, particularly within brands, evidenced by greater than 25% sequential revenue increases. While the overall decline in AGP year-on-year continues to be short-term impacted by the consolidation and exiting of certain legacy business lines that we have discussed previously, we're pleased that as of the beginning of this calendar year, the revenue lines have been integrated and fully operational onto our consolidated DT exchange. I'd reiterate Bill's earlier comment that despite the near-term headwinds, we're encouraged by the platform consolidations we're making to bring the businesses together and expect these actions to have a positive return on our future growth. Our consolidated gross margin was 45% in Q3, which was down 180 basis points sequentially from Q2 and compares to 50% from Q3 in the prior year. Sequentially, margins were influenced by modest ODS product mix shifts, where we experienced an increase in the mix of certain lower-margin products. Last year's Q3 results also included the benefit of a contractual revenue share adjustment with an ODS partner, which was not repeated in this quarter. Within AGP, we saw strength year-on-year in expanding margins of 500 basis points from improvement in overall brand margins and favorable product mix within the segment. As a reminder, while gross margin rates can fluctuate from quarter to quarter, we generally anticipate long-term margin expansion as we continue to execute on our growth strategies. We remain disciplined with expenses, and cash operating expenses were $38.8 million in Q3, a reduction of 6% from the prior year, representing 27% of revenues in the quarter. During the period, we incurred lower-than-normal performance compensation expenses, and total GAAP operating expenses were $72.9 million, which were up 4% compared to the prior year, driven primarily by business transformation costs that we've discussed previously. Lean into the initiatives focused on integrating the technology platforms and back-office systems across our assets. While recent periods have incurred increased costs due to the completion of these efforts and new growth initiatives, we expect both efficiencies and growth to begin to be reflected in our results throughout fiscal 2025 and beyond. During this phase, we remain highly focused on operating efficiency and are encouraged by the savings we're realizing from these platform consolidations. Turning to profitability, our adjusted EBITDA of $25.4 million in the quarter declined $2.2 million sequentially and was down from $40 million in the prior year, driven primarily from lower revenues and partially offset by a reduction in cash OpEx. Our EBITDA margin of 18% compared sequentially to 19% in the September quarter. Given the inherent operating leverage in our business model, we expect the active focus on expense measures and integration efforts will strengthen the platform as we return to growth and enable a greater portion of those dollars to fall to the bottom line. In the quarter, we achieved non-GAAP adjusted net income of $15.7 million or $0.15 per share, compared to $30 million or $0.29 per share in the third quarter of last year. As compared to the prior year, we incurred greater interest expense driven by rising rates and partially offset by lower outstanding debt balance. Our GAAP net loss was $14.1 million or negative $0.14 per share based on 103.3 million diluted shares outstanding, compared to prior year net income of $4.1 million or $0.04 per share. We generated $14.1 million in free cash flow during the quarter, which enabled us to execute with $49 million in cash after paying down an additional $10 million in debt using free cash flow from operations to further deleverage our debt position. Our debt balance entering the quarter was $376 million, drawn on our revolving credit facility. In support of the key growth initiatives we've discussed, specifically around pursuing our alternative app store strategic opportunity, and realizing the benefits from consolidating and modernizing our tech platforms, we recently amended our credit facility to provide additional flexibility and align our capital requirements with overall business needs. With these enhancements, we are confident in our ability to execute on our growth plans, and we continue to focus on balancing growth opportunities and cash flows to optimize financial performance and long-term enterprise value. Before covering our outlook, I wanted to provide some visibility into our guidance assumptions. Within our revenue guidance, we anticipate the headwinds associated with volume device declines to continue into Q4, principally on U.S. operators. While we believe future device trends should improve, we've seen accelerating declines early in the March quarter, and at this time have limited visibility to the performance of the recent Samsung flagship device launch, and therefore we have further tempered our ODS volume expectations. We are optimistic about future revenue growth from new partners and successful execution against our pipeline in FY25. However, we do not expect material new revenues from these partner launches in our March quarter. I'd also point out that in addition to the typical historical seasonal sequential impact experienced in Q4, with the exchange platform migration now completed, there will be approximately a $4 million sequential revenue migration headwind from this completed exchange platform consolidation in Q4. And as we've highlighted previously, we're encouraged by the future benefits of this integration. Now let me turn to our outlook. We currently expect revenue for full year fiscal 2024 to be between $547 million and $553 million, adjusted EBITDA to be between $90 million and $94 million, and non-GAAP adjusted net income per diluted share to be between $0.50 and $0.54, based on approximately $104 million diluted shares outstanding and an effective tax rate of 25%. With that, let me hand it back to the operator to open the call for questions.

And our first question today comes from Darren Aftahi from ROTH MKM.

Hey guys, thanks for taking my questions. Just to clarify, if I may. I know the first one may not be an easy one to answer, but it seems like the device headwind is pretty persistent. I'm just curious, are there any green shoots you're seeing in the market? I know, Barrett, you've made some comments about accelerated declines in the U.S. But any sense for when this kind of reverses itself? To Bill, your comments about the tech stack, I'm just curious; when are we going to be fully complete with the implementation of that? And lastly, on the open app store initiatives and some of the stuff you're doing and investing in, when do you think that's going to start to have an impact on your P&L in a more material way? Thanks.

Yes, thanks, Darren. I'll jump in on those and Barrett can provide any color on the device headwinds. Yes, here in the United States, we saw double-digit year-over-year declines with our U.S. partners, which was something that we weren't expecting to have such a precipitous decline, even though we'd forecasted one. That continues to be an issue for us. As Barrett referenced in his comments, January was off to a slow start, which reflects some of the things you saw in our outlook. The first weekend was encouraging for the S-24, although weekends do not make a trend. We'll see, but we want to make sure that we're being extra cautious regarding that. Based on some of the comments we've heard from chipset suppliers, it sounds like those device supplies will get better as the year goes on. Also, as we start seeing anniversaries and out of three-year anniversaries of lease contracts here in the United States on both Apple and Android devices, I think we'll also be helpful. Our focus is on what we can control, which is getting more devices in places like Korea that I mentioned. We can also expand our relationships with some of our other partners and take advantage of a competitive environment right now by bringing in new device supply. So we're really focused on doing that instead of being reliant upon some of the operators here in the United States. Regarding the tech stack, improvements will roll out each quarter over the next 12 months. You can expect material improvements in the next quarter and the following quarters based on our tech stack modernization initiatives. It's a super high priority for us, and while it may cannibalize some very short-term revenue, it's crucial for our scalable business. Lastly on the App Store P&L, it's already in our business. We're running campaigns through our pipes in terms of the ad tech side and the user acquisition side. This is not just theoretical; we are on a growth trajectory looking to build each quarter into 2024.

Our next question comes from Omar Dessouky from Bank of America.

Hi guys, thank you for taking my question. I was intrigued by your partnership and your investment in ONE Store. I was hoping you could talk about the economics of the deal. For example, what's the fee structure like, price per install, revenue share, things like that? Secondly, what part of the consumer journey are you going to be involved in with regards to Korean customers? Is it just going to be the app install, or the in-app ads, or potentially the in-app purchases as well?

Yes, sure, Omar. We're viewing our relationship with ONE Store as phase one of something that we plan to expand further in the future. As the Digital Markets Act becomes active over the next 30 days, we're looking forward to collaborating with them in the EU regarding the opening of the Google Play Store and Apple Store. For Korea, we need to accomplish three things. First, we must improve our device counts, which we can do quickly by getting our tech onto 40 million devices. Second, we can drive user acquisition with SingleTap to acquire more users into the ONE Store through our DSP and ONE Store capabilities. Lastly, we work with local app publishers in Korea to integrate our in-app advertising tech stack, which provides new revenue streams for our AGP side. I'm not going to disclose specific terms regarding the revenue with ONE Store, but I believe it's a win-win partnership.

And could I just ask as well how should we think about the strategic value of these deals kind of coming together? You have Aptoide, ONE Store. How do we think about synergies and the strategic value across regions and with multiple assets now?

Absolutely. For investors, if you believe that the alternative app store space is going to grow and be disruptive, which we certainly believe, we are uniquely positioned in partnering with companies that bring these capabilities. Enabling this process requires a lot of behind-the-scenes work, such as porting apps, managing payments, and working with publisher relationships. By establishing these partnerships, we aim to create a one-stop shop for app publishers that addresses the significant fees they currently pay to the app store duopoly.

Our next question comes from Dan Day from B Riley Securities.

Yes, guys, thanks for taking the question. Bill, in the prepared remarks, you talked about changes in leadership and new organizational structure. It would be great if you could elaborate on that: are you planning to bring in totally new people to run certain business lines, or just switching around positions or reports? It would be good to get a sense of what you're looking to accomplish with those changes.

Yes, absolutely. The primary concern we have is to improve our execution by aligning the organization better. We need to make faster decisions and have clearer accountability around what we're driving now. One of the changes we're implementing is moving our business into a GM model to create clearer accountability for results and drive profit and loss for different business lines each quarter. We are making leadership changes focused on better external focus and internal alignment between our various functions. We've standardized many processes across the legacy companies we've acquired, and now we can decentralize that alignment to be closer to customers with clear accountability for decision-making.

Okay, great. Thanks. And just for me, you've consistently stated that U.S. RPD has remained above $5 over the last few quarters. Has that stayed pretty stable even though device numbers have been much softer than you expected?

Yes, device RPDs have remained relatively consistent. They were marginally down in the December quarter from the September quarter due entirely to the two execution issues I previously mentioned. Excluding those two issues, RPDs would have remained steady.

Our next question comes from Anthony Stoss from Craig-Hallum.

Hey, Bill, I just wanted to follow up on your comment about why the SingleTap trial wasn't live. You talked about administrative issues. Can you provide a bit more color on that and when you expect it to be resolved? I had a couple of follow-ups as well.

Yes, sure, Tony. We've all been impatiently awaiting the launch, and we've been addressing final tech and ops issues. There are some final administrative decisions that the partner is considering with some other factors they're looking at on a bigger picture. They're going through that internal discussion right now. Once that discussion is complete, I expect us to go live with the pilot, but I can't commit to a specific timeline at this point.

Got it. Maybe this is more for Barrett: for your March guide, can you break out how much of the decline was from ODS versus AGP? Are they both down equally or is one worse than the other?

Hey, Tony. We don't typically guide by segment, but generally, our seasonality shows if you review our historical trends for AGP business, it's relatively stable. There is some headwind due to the consolidation of the exchange. The primary factor affecting the decline is the accelerating drop in U.S. devices, which we accounted for in our guidance.

Got you. Bill, back to you. What's your view on the competitive environment? Are there issues with one source or not? What do you expect?

The competitive environment has seen a lot of announced changes among our competitors, which represents an opportunity for us, especially amid the softness in U.S. device supply. We expect that to rebound, but we must also take proactive measures. We see some of those macro-level changes in the environment positively impacting our business, with encouraging developments occurring within our pipeline.

It's been a frustrating stock for some time. When you look over the next 12 months, fiscal 2025, would you expect at least revenue growth over fiscal 2024?

All the things we're working towards and our execution plans are aimed at driving growth next year, and that's our expectation.

And ladies and gentlemen, with that, we'll be ending today's question and answer session. I'd like to turn the floor back over to our CEO, Bill Stone, for any closing remarks.

Yes, thanks everyone for joining the call tonight. We look forward to reporting on our progress against all the points we made on the call tonight. We'll talk to you again on our fiscal '24 fourth quarter call in a few months. Thanks, and have a great night.

Ladies and gentlemen, that will conclude today's conference call. We thank you for attending today's presentation. You may now disconnect your lines.