PubMatic, Inc. Q3 FY2022 Earnings Call

Good afternoon everyone and welcome to PubMatic's Earnings Call for the Third Quarter Ended September 30, 2022. This is Stacie Clements of The Blueshirt Group and I'll be your operator today. Joining me on the call are Rajeev Goel, Co-Founder and CEO; and Steve Pantelick, CFO. Before we get started, I have a few housekeeping items. Today's prepared remarks have been recorded, after which Rajeev and Steve will host a live Q&A. A copy of our press release can be found on our website at investors.pubmatic.com. I would like to remind participants that during this call, management will make forward-looking statements, including, without limitation, statements regarding our future performance, market opportunity, growth strategy, and financial outlook. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy, and other future conditions. These forward-looking statements are subject to inherent risks, uncertainties, and changes in circumstances that are difficult to predict. You can find more information about these risks and uncertainties and other factors in our reports filed from time to time with the Securities and Exchange Commission, including our most recent Form 10-K and any subsequent filings on Forms 10-Q or 8-K which are on file with the Securities and Exchange Commission and are available at investors.pubmatic.com. Our actual results may differ materially from those contemplated by the forward-looking statements. We caution you, therefore, against relying on any of these forward-looking statements. All information discussed today is as of November 8, 2022, and we do not intend and are under no obligation to update any forward-looking statements, whether as a result of new information, future developments, or otherwise, except as may be required by law. In addition, today's discussion will include references to certain non-GAAP financial measures, including adjusted EBITDA and non-GAAP net income. These non-GAAP measures are presented for supplemental informational purposes only and should not be considered substitutes for financial information presented in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measures is available in our press release. And now, I will turn the call over to Rajeev.

Thank you, Stacie and welcome, everyone. As we suspected, Q3 marked an inflection point with respect to a deteriorating economic environment. However, despite the impact on global ad spend, we delivered adjusted EBITDA margins of 39%, above our expectations, and significant free cash flow, highlighting the durability and differentiation of the PubMatic business. Year-over-year revenue growth in the quarter was lighter than we expected and more pronounced in the back half of the quarter, including in the U.S., which is our largest market. On the bottom line, our single omnichannel platform with fully owned and operated infrastructure gives us a high degree of operating agility to create leverage in our business and sustainable profitability. Despite the near-term economic pressure, I am confident in the medium- to long-term outlook for PubMatic because of our ability to consolidate activity on our platform and grow our market share. Historically, we have seen that in times of economic stress, our ecosystem leans into deeper partnerships with technology leaders that provide innovation, efficiency, and automation. Our customers and prospects want to do more with fewer, trusted partners. We are well positioned to continue to gain market share in this kind of environment, even if absolute rates of growth are lower. Our high-margin profile is a distinct competitive advantage and allows for continued selective investment. With that investment, we widen the competitive gap and further strengthen our market leadership with a focus on positioning ourselves well for the economic upswing that will inevitably return. Our role in the ecosystem is only getting stronger. I co-founded PubMatic with the mission of delivering a more profitable digital advertising business to publishers so they can invest in the content experiences we all love. We built our platform to help publishers monetize their inventory across ad formats and geographies while providing the tools and levers to control how their inventory enhances our access. Today, we partner with nearly 1,600 publishers, which provides the critical scale required by global ad buyers. Our growth and market leadership stem from years of investment and focus in both technology and strong customer relationships, which are difficult to replicate. Today, as consumer privacy is increasingly important and third-party cookies are going away, sell-side technology is becoming even more critical to the digital advertising ecosystem. This is manifesting in a variety of ways, all of which strengthen PubMatic's long-term outlook. There's no question that the open internet is gaining share of digital ad budgets at the expense of walled gardens, in part due to content quality and diversification. This, along with the shift to fast-growing video and connected CTV formats, is forcing buyers and publishers alike to seek greater transparency into and control over their advertising strategies, which independent technology providers like PubMatic are best positioned to provide. Finding target audiences and delivering relevant ads in a privacy-safe manner is evolving rapidly. The need for publishers to leverage their audience data at scale is increasingly moving to open and transparent sell-side technology platforms like PubMatic and coincides with our multiyear investment in PubMatic Connect. Without a technology partner like PubMatic, the majority of publishers will not be able to do this, which is becoming fundamental table stakes in commanding higher CPMs and monetizing premium inventory. PubMatic Connect offers a variety of methods for buyers to find target audiences across our publisher base. Case study after case study shows that PubMatic Connect audiences provide greater ROI and longevity than cookie-based solutions. For example, Wunderkind ran a month-long test campaign using audiences sourced through PubMatic compared to various alternatives. Performance metrics showed audiences delivered via PubMatic Connect had response rates nearly 9x those of alternative data used. Plus, PubMatic delivered impressive win rates and scale benefits. These performance benefits highlight the value that marketers see in moving their targeting efforts to the sell side, closer to the publisher and the consumer. What's more, our strength in data activation and addressability is also unlocking growth opportunities in the fast-growing retail media market. As retailers are increasingly looking for incremental revenue opportunities, data monetization becomes an even more important aspect of their businesses. Kroger Precision Marketing, for example, works with PubMatic as a scalable technology provider to help their brand and agency clients activate their retail data science and CTV, video, and display inventory. This also allows PubMatic's buyer and publisher customers to gain improved campaign performance and monetization opportunities using our sell-side platform. Agencies and advertisers are seeking greater control and efficiency of their ad budgets. Supply Path Optimization, or SPO, is a way for buyers to consolidate ad spend and gain greater control and efficiencies. We pioneered SPO several years ago and it continues to grow as a share of our business. In Q3, over 30% of activity on the PubMatic platform was SPO-related. We continue to expand SPO relationships as we did with Havas Media Group North America in Q3, adding new capabilities, workflows, and data integrations for buyers. In September, we acquired Martin to bring more robust solutions to buyers and accelerate our SPO efforts. Martin brings robust measurement and reporting capabilities as well as workflow tools and is in direct response to what buyers are looking for. We have begun the integration process and we expect Martin to accelerate our product roadmap by up to 12 months. We expect the end result to be increased consolidation of ad budgets onto PubMatic. Connected TV is moving from insertion orders to a programmatic approach. Both buyers and streaming content providers are leaning into the efficiency, measurability, and scale that automation can provide. I expect the challenging economic environment will accelerate the shift. Advances in data-driven advertising technology like Connect will further fuel the growth of programmatic CTV. As automated buying of CTV becomes ubiquitous across the ecosystem, we are seeing more interest in programmatic buying or unified auctions. As an omnichannel platform, we have been singularly focused on scaling this automated approach to CTV buying and selling. No surprise, the results are compelling. Finecast, a subsidiary of WPP focused on addressable TV buying, bought 10% more inventory when compared to non-programmatic approaches as a result of the application of data, automation, and the granular inventory access our platform provides. Advances in data-driven advertising technology, like Connect, will further fuel the growth of programmatic CTV. We recently released a suite of enhanced capabilities for OpenWrap OTT, helping publishers drive more revenue and increase flexibility and control while also making it easier to extend their monetization strategies to CTV. Multicultural media company, My Code, saw benefits from managing all of their inventory types in one place, allowing them to compare, manage, and optimize across platforms. Similarly, True Digital, a business unit of the leading telco conglomerate in Thailand, saw increased fill and higher CPMs for their CTV inventory with OpenWrap OTT. Stepping back, we've built a resilient software business that enables publishers and buyers to grow their businesses and compete effectively in the digital advertising ecosystem. Our platform is sticky as our usage-based model drives high net dollar retention rates and increased ad spend from buyers. I have never been more confident in our business and the endless opportunities ahead. We continue to move toward our long-term goal of 20% market share. Propelling this forward is our historical and long-term commitment to the dual objectives of revenue growth and profitability. Our strong profit margins and free cash flow generation give us the ability to invest in products and customer relationships even in today's down cycle when others may not. Accordingly, in this environment, we are focused on two operating objectives: first, continued investment in long-term innovation. This unlocks incremental revenue opportunities today but more importantly, should result in outsized gains when ad spending inevitably reaccelerates. Key areas of innovation include supply path optimization, accelerated by our acquisition and integration of Martin, CTV, addressability, and retail media. And second, we are focused on maximizing the efficiency of our CapEx and OpEx investments that have already been made. Over the last three years, we believe we have expanded our competitive moat as a result of significant CapEx investments in our infrastructure and impression processing capacity. We are now focused on optimizing our infrastructure and increasing utilization which will allow us to materially reduce next year's CapEx spend. On the OpEx front, we feel confident with the scale of our go-to-market teams in the near term and will lower the rate of headcount growth with a bias toward selective hiring in engineering and innovation in order to be well-positioned for when ad spend growth reaccelerates. Our long track record of profitable growth and significant cash flows, coupled with our strong balance sheet and zero debt, gives us confidence that we will come out of the downturn stronger than most. I’ll now turn the call over to Steve Pantelick, our Chief Financial Officer, to walk through the financials.

Thank you, Rajeev and welcome, everyone. In Q3, we delivered outstanding profit and cash flows. Although revenue came in light due to global ad spend deceleration, we continue to gain market share. These operating results underscore the robustness of our business model and our team's proven ability to navigate challenging macro conditions. Importantly, amidst these conditions, we made targeted investments for future growth and strengthen our financial position. On revenues of $64.5 million, we achieved adjusted EBITDA of $25.3 million, a 39% margin. We generated $28.1 million in net cash from operating activities and $10.7 million in free cash flow. It is clear from economic data across the globe that conditions have worsened over the last several months. In all likelihood, some markets are already in recession or soon will be. With this backdrop, I want to remind investors about several fundamental reasons why we are confident that we can continue to navigate through the current headwinds and be well positioned to accelerate our growth when the operating environment stabilizes. First, our business is well-diversified. Our omnichannel platform supports numerous programmatic ad channels and formats, enabling thousands of advertisers across 20-plus verticals to reach the audiences they want. With more than 60,000 advertisers purchasing our publishers' inventory in Q3, we saw spending in aggregate across the top 10 ad verticals increased approximately 19% year-over-year. The impact of diversification was clearly demonstrated. Travel, food and drink, and business were each up over 40% year-over-year which helped offset softness in shopping, technology, and personal finance. Our Q3 omnichannel video business grew 45% year-over-year and represented 34% of revenues. This growth is particularly notable as it was on top of 80-plus percent growth in the prior year. These results were propelled by our CTV business which increased by over 150% year-over-year. This achievement marks the sixth straight quarter of 100% plus growth for CTV. Display revenues declined 3% year-over-year. High levels of inflation, recession concerns, and rising cost of capital put pressure on consumers and advertisers. These factors particularly affected demand for the display format more than other formats. We saw a similar pattern in the depths of the pandemic and based on our prior experience, we anticipate that this format will return to growth. Our total Q3 revenues grew 11% on top of the prior year's 54% growth. We believe we are outpacing market growth and gaining share based on the results of other public companies in our industry that have reported thus far this quarter. PubMatic's U.S. business grew double digits year-over-year but decelerated compared to Q2's growth. EMEA's growth slowed as anticipated. With the likelihood that difficult economic conditions will continue in the coming quarters, the durability and strength of our financial model is the second fundamental factor that gives us confidence we can successfully manage through this volatile period. To begin with, we have built a business with a high degree of control over our unit economics. For example, through innovation and focus, we have been increasing our revenue mix towards high-value channels and formats like mobile and video. We saw the benefit of this in Q3 with higher video CPMs offsetting lower display CPMs. Overall, our total company CPM was stable year-over-year. In terms of unit costs, by owning and operating our infrastructure, we have multiple ways to optimize and drive down our unit costs. One important lever is having control over the magnitude and timing of infrastructure CapEx. Over the last two years, we have strategically invested to grow our competitive moat and ensure we avoid supply chain disruptions. Since Q1 '21, we have more than doubled our ad processing capacity. Looking ahead to 2023, we see many opportunities to optimize our infrastructure and expect to be able to significantly lower our CapEx. In aggregate, we anticipate these efforts will lead to higher gross margins and improve free cash flow margins as ad spending normalizes. Another area of strength comes from our usage-based model which aligns incentives and leads to long-term relationships with the world's leading publishers and buyers. Innovation, customer focus, and initiatives like supply path optimization helped us achieve strong net dollar-based retention. On a trailing 12-month basis, our net dollar-based retention was 120%. PubMatic has consistently achieved high adjusted EBITDA margins and profits. Q3 was our 26th consecutive quarter of positive adjusted EBITDA. For 19 of the last 20 quarters, we have generated positive cash from operating activities with the only exception being the pandemic quarter of Q2 2020. For the trailing 12 months through Q3, we generated approximately $96 million in cash from operations and $50 million of free cash flow, which represented a growth of 40% and 91%, respectively, compared to the prior year period. At the end of Q3, we had no debt and $166 million in cash, cash equivalents, and marketable securities. Excluding our recent acquisition of Martin, our overall ending Q3 cash position would have been $194 million. With our strong balance sheet and efficient business model, we believe our position in the ecosystem will continue to grow via new and expanded customer relationships. We also anticipate being able to strategically invest in future growth opportunities where others may be constrained. Beyond our current balance sheet, we have enhanced our financial resources with a new $110 million undrawn committed credit facility. The third fundamental factor that gives us confidence in our future is our proven innovation engine. We have built this competency over the last 16 years and have consistently invested in high ROI growth opportunities. We have a distinct advantage as a result of our development organization in India. In Q3, we increased our India-based headcount by 46% year-over-year compared to a global headcount increase of 29%, supporting further innovation and cost efficiency in 2023 and beyond. One important area where we continue to innovate and lead is in supply path optimization. In Q3, SPO represented over 30% of activity on our platform. With our recent acquisition of Martin, we added key technical talent and new tools to fulfill buyer requests for more robust measurement and reporting capabilities. In spite of the top line headwinds that increased through the quarter, our Q3 adjusted EBITDA came in above expectations. We achieved this outcome because we have significant control over our cost structure and have been proactive over the last several months optimizing costs across the company while adjusting discretionary spend. Operating expenses in the third quarter were $33.3 million, up 19% year-over-year, reflecting the combination of increased headcount for growth and stock-based compensation. Q3 GAAP net income was $3.3 million. Note, Q3 net income includes a noncash impairment charge of $6.4 million related to an equity investment made several years ago. Non-GAAP net income, which adjusts for unrealized gain or loss on equity investments, stock-based compensation expense, acquisition-related and other expenses and related adjustments for income taxes, was $12.4 million or 19% of revenue. Q3 diluted EPS was $0.06 and non-GAAP diluted EPS was $0.22. Turning to Q4. The softness in advertising demand that began early in the year has continued. It is clear that advertisers are wrestling with a myriad of economic challenges and preparing their businesses for the likelihood of a global recession. We expect these impacts to persist at least through the first quarter of 2023 and possibly longer. Nonetheless, based on the unique strengths of our business, our omnichannel platform, our financial strength, and our ability to continue making investments in innovation, we anticipate continue to grow faster than the market. Q4 headwinds include continued pressure on our display formats that will be disproportionately impacted by macro conditions. We also expect Q4 seasonality to be muted with lower-than-normal holiday ad spend. In terms of tailwinds, we anticipate our omnichannel video revenues will continue to grow and SPO activity to increase. Given the range of macroeconomic pressures, we believe there could be a wider range of outcomes in Q4 than we typically see, especially as our Q4 revenue tends to be back-end-weighted. Our revenue expectations for Q4 are $75 million to $78 million. This guidance is consistent with the rate of year-over-year growth we have seen in the month of October. As communicated last quarter, we proactively initiated cost-saving measures to unlock several million dollars by the end of the year relative to our original planned expenses. This agile execution and strong unit economics supports our high margin rate now and in the future. We expect adjusted EBITDA between $33 million and $36 million or approximately 45% margin at the midpoint. Note, included in our Q4 adjusted EBITDA expectations are the incremental operating costs of approximately $1 million for our recent Martin acquisition. Based on our Q4 revenue guidance, the applied full year revenue range is $257 million to $260 million or 14% growth at the midpoint. With digital advertising projected to grow less than 10% in 2022, we are well positioned to continue to grow our market share. Consistent with the revenue range and cost-saving plans already in place, we anticipate our full year adjusted EBITDA range to be between $98 million and $101 million or 38% margin at the midpoint. We anticipate CapEx between $34 million and $36 million this year. Based on equipment availability and logistics, the bulk of our CapEx occurred in Q3 which reduced our period gross margin and our free cash flow. With much of our multiyear CapEx investment plan completed, our team is now focused on optimizing these investments. We expect 2023 CapEx to be at least 50% lower than 2022, which will result in higher gross margins and improved free cash flow margins when macro conditions stabilize. We also anticipate that our increasing mix of video and other high-value formats will provide another tailwind to higher gross margins and improved free cash flow margins. With regard to the strengthening of the U.S. dollar, we anticipate the impact on our revenues to be neutral to positive because the transactions flowing through our platform are largely denominated in U.S. dollars. On the expense side, we also expect the U.S. dollar's strength relative to the Indian rupee and U.K. British pound sterling to have a neutral to positive impact. In closing, there are multiple reasons we are confident in our long-term prospects despite the difficult macro conditions dampening global ad spend. Our business has structural advantages emanating from our owned and operated infrastructure and offshore R&D that enables us to expand our competitive moat and consistently invest in innovation on behalf of our publishers and buyers. We have numerous growth drivers and see a long runway of growth ahead of us as our TAM continues to grow. We are consolidating the sell side as one of the few scaled global omnichannel platforms. And our profitability gives us a high degree of agility to weather challenging economic conditions and invest in long-term market share gains.

With that, the first question comes from Jason Helfstein from Oppenheimer.

It seems that programmatic advertising is becoming increasingly difficult to predict, especially as purchases are made more last minute. Could you elaborate on what you are observing? Additionally, when you reach the end of the month or quarter with remaining budget, you can also access those funds, unlike IO orders which have become more challenging. Moreover, it appears that display advertising may negatively impact the fourth quarter. Can you provide insights on what your growth projections look like excluding display, as it seems that other areas will still experience significant growth?

Great. I'll take that. Good to connect, Jason. So a couple of points. With respect to programmatic, certainly, the pros are that it's data-driven and provides a level of transparency that many other forms of digital advertising do not provide. And with that comes the ability to bid in real-time. So there is a bit of that yin and yang with respect to the timing. But overall, the long-term secular trend is incredibly positive for programmatic advertising. And so quarter-to-quarter, there might be some variations but the reality is the long-term trend is moving in the right direction. And the reality is the visibility that any companies in this space, ours included, are largely driven by factors outside of our control. The most important thing that we focus on is, what does it look like for the long-term perspective? And from the way we think about it is the fundamentals of our business remain very robust and they're intact. And this gives us confidence. As I indicated in our comments, we are expanding our SPO relationships. We're able to continue to grow our omnichannel video business very strongly. And these have really helped us continue to grow faster than the market over the last couple of years. Now with respect to the display format, as I referenced in my comments, this is a path we saw during the pandemic and it was one of the first formats to really feel the pressure of shifting buying. I do expect it to come back. It's a very long-term, stable format. But for the coming quarter or two, there will be pressure. And I anticipate the format will probably decline to high single digits in Q4. Hard to say right now in terms of Q1. Overall, of course, our growth would be much higher if that format was more stable. Now just as a reference point, though, last quarter, Q2, our display format business grew 19%. So clearly, we are doing things right in this space regarding display format. And overall, as an omnichannel platform, we really find pockets of growth when there's softness in other areas.

Our next question comes from Brent Thill at Jefferies.

Rajeev, could you share what you are hearing from your barrier partners regarding their observations and explanations? Are these pullbacks due to macro uncertainties, supply chain issues, or something else? What seems to be the common reasoning behind these trends?

Sure. Yes. So I think what we are hearing and what we're seeing is that there was a deceleration through Q3 and that's a pretty common macro state, right? And what we are focused on and I think what's most important to me personally, is that we continue to consolidate ad spend and gain market share. So if we just look at some of the Q3 numbers that are out there, Meta was down minus 4% to minus 5%. Google and their network business, minus 2%. I think Snap was plus 6%; Pinterest, plus 8%; Roku, plus 12%. And our full-year guidance has us at roughly 14% for the year which is well above the market rate of growth which is running at 10% or lower. So clearly, there's a step function down for our Q4 guidance, but we think the vast majority of that is driven by the macro environment. What does give us confidence as we go into the downturn is that we've got many tools at our disposal. So first of all, significant profit margins and that gives us the agility and the ability to focus on long-term innovation in select high-growth areas. And then as we highlighted, we're going to be very focused on optimizing the infrastructure and the capacity that we've already put in place and that allows us to commit to reducing CapEx by half at least next year which will be reflected in gross margins as well as on the bottom line. And then third is that we've got a management team that's got a long tenure. We've seen this play out before in both the great financial crisis as well as COVID and come through with flying colors. So we definitely cannot control the macro, but we feel good about our ability to execute and create differentiated outcomes.

Rajeev, this might be difficult to estimate, but do you have any indication of when conditions might start to improve? Do you think it will be in the second half of '23, or is it too early to say?

Yes. I mean I can start and maybe, Steve, you want to chime in on it, but I would say it's too hard to say at this point. I know everybody is looking for the bottom, of course, but I think we got to kind of take it one month at a time and see what's out there. Obviously, the big unknowns, right which you know well, are what happens with inflation and then resulting interest rate changes and then what happens with the war in Europe. And I don't think anybody has any ability to predict those things. So we just got to take it a month at a time. And I think from our perspective, again, we feel really good about our ability to be very agile in this environment given the strong profitability and balance sheet that we have.

Let me add, Brent, to the points that Rajeev made. From my perspective, as CFO, what I focus on is the fact that we can grow faster than our peers, that we can leverage our very efficient business model and that we stay ahead in terms of investments for future growth. So wherever that bottom is, we feel very good about the point that we're going to be when we exit this current cycle. It's hard to say what that growth rate will be over the coming quarters but historically, we've proven that we can grow faster than market and I don't see any reason why that premise doesn't hold true. And I really want to reinforce the point that Rajeev made that going into this cycle, we feel that we're on the front foot. We've been proactive and we believe that we are uniquely positioned because we continue to make growth investments over the last several years. And as Rajeev said, we're now turning our attention to further optimization of our infrastructure and selected targeted growth investments. So overall, we feel really good about where we are in the cycle and our ability to exit very strongly out of it.

Steve, can you clarify if the end of October showed a tightening as you mentioned for the end of the quarter? How did things trend in October? Did it continue to worsen slowly, or did it stabilize compared to the end of September?

The weakness we experienced in the third quarter persisted into October. There are macroeconomic factors we are all aware of that contributed to this situation. I noticed this trend in various areas. Looking ahead to the fourth quarter, we typically see a seasonal increase each year. When we analyzed the numbers, we considered not only how we ended Q3 but also what has occurred up to today. Shopping remains under pressure, showing flat performance year-over-year for the early part of this quarter. In some other areas, such as personal finance, there's been a decline of about 15%. That said, we do have other categories, like travel and automotive, that continue to perform well. The diversity of our business helps us manage the ups and downs. For our Q4 guidance, I reviewed the year-over-year trends from a detailed publisher perspective and considered the seasonal expectations. One notable point is that as we entered the fourth quarter, we anticipated mid-30s sequential growth compared to Q3, but it's more likely to be around 20%. This signifies positive growth sequentially, although it falls short of the median average of about 35% sequential growth we've observed over the last decade. Clearly, there is some softness in the business currently, but we are confident in our financial strength and our capacity to continue investing during this time, positioning ourselves well for stabilization.

Our next question comes from Shweta Khajuria at Evercore.

Could you please explain, Steve, you just talked about the fourth quarter guidance but what is the assumption that’s included in your guidance? To reach the high end of the guidance, what is the assumption? And what would need to occur for you to be at the low end of the guidance regarding the growth rates from October to November to December? Additionally, how are you considering operating expenses not only for this year but also generally for next year? You mentioned capital expenditures; could you comment on operating expenses?

Sure. I'm happy to provide that. For our Q4 expectations, it's quite simple as I've described. We analyze the trends we've seen up to this past weekend and project them forward. We did notice a slight increase due to political spending this year, but it was not a major part of our forecasts. We assess the current trends on a publisher-by-publisher basis, identifying areas of strength and weakness. The weaknesses are primarily in categories that typically perform well at this time of year, like food and drink. That said, we've aimed to establish a range we believe we can achieve. That's my outlook. There may be some fluctuations, but we have provided a realistic range based on our observations. Regarding operating expenses, I want to emphasize how we view the opportunities ahead. As we've mentioned before, our focus is on innovation and cost-effectiveness. We have built a strong development team in India and will continue to selectively invest in supporting that team and innovation. However, we are reducing investment in certain go-to-market teams. We believe we are entering this cycle in a solid financial position and are capable of continuing our investments. During the pandemic, especially in the downturn of Q2, we were one of the few companies that maintained our investments, and we reaped the benefits in the following quarters and years. From our standpoint, we will keep a close watch on operating expenses. Rajeev and I have talked about our commitment to optimization, which will remain a focus across the organization, with the expectation of improved productivity in all functional areas. There will be some growth in operating expenses, although not at the historical rates we've seen. Nevertheless, we recognize an opportunity that we cannot afford to overlook given the long-term trends and our growing role in the ecosystem, especially with the Martin acquisition helping to consolidate more advertising spending onto our platform.

Okay, Steve. Is there any contribution from Martin included in the guidance?

No. In fact, in the fourth quarter, I assumed roughly $1 million impact cost and that's included in our financials.

Our next question comes from Matt Swanson at RBC.

So starting, Rajeev, last quarter, we talked a little bit about the challenging macro potentially being a tailwind for SPO, right, with advertisers really focusing on ROI. And I was just curious if you saw anything like that again this quarter. And then maybe if you could remind us a little bit about like the deal cycle time on SPO in terms of when a conversation starts to where it’s kind of like up and running.

Yes. Sure. So why don't I start with the second part of your question, then I'll get to the first. So in terms of the deal cycle, there's a wide variety of ranges. Some advertisers are relatively quick. Agency holdcos tend to be longer. So we could see from an advertiser perspective, maybe a couple of months, a holdco to get a deal in place could take 12 to 18 months. And then from there, there's the actual implementation process. Advertisers, again, tend to be simpler and quicker to implement. That can be a matter of, again, a couple of months, whereas a holdco, you've got to go region by region, country by country and bring those trading teams on board. And so that can take another 6, 12, 18 months, depending on the agency. So that kind of gives you a reference in terms of the timeframe. I think what we typically tend to see on the first part of your question is that in a time of economic stress, that there is a consolidation within our ecosystem. So the buyers, the publishers, they need to figure out how to do more with less resources, how to become more efficient. And so they typically tend to streamline the number of partners that they work with and lean into those activities that can make them more efficient. And I think we're going to see that play out here. Still a little bit early in the slowdown cycle from an economic perspective, but I suspect that we will see that play out here. And that was part of the reason why we made the acquisition of Martin is really to build upon the 40-year investment that we've made in supply path optimization and continue to have that as a very strong lever of spend consolidation on our platform and therefore, share gains. So we are absolutely talking every day with our buy-side customers and partners about what are the challenges, what are the opportunities, how data-driven advertising, how the ROI that can be driven from real-time bidding can increase accountability and increase client outcomes and grow their business and grow our business.

Yes. No, that’s super helpful. And can I get some context based on the sales cycles that SPO revenue might kind of be a lagging indicator for how fast the business is growing in terms of your OpenWrap? The other question I wanted to ask was on the CTV side and obviously, a lot of focus on the streaming services switching to AVOD. And I was just curious, in 2023, with this much inventory coming to the market, do you think that pushes the CTV market more in your direction with publishers maybe in to turn to biddable environments sooner, right? Just not able to handle so much direct with more competition.

Yes, I believe we are definitely going to see a shift, driven by both the buy side and the sell side. From a buyer's perspective, a couple of years ago, there were only a few large CTV streaming platforms available for purchase. It was straightforward from an operational perspective to handle the insertion orders. Now, looking ahead to today's or next year's landscape, there could be numerous high-scale inventory sources in any given region. In this environment, buyers will want to access all of these scalable supply sources. This introduces operational and economic complexities and the need to ensure clients achieve strong ROI. Therefore, a bidded approach will be necessary. I anticipate continued pressure from the buy side, which will influence the sell side to align with buyers' purchasing preferences. As a result, the sell side will feel compelled to adopt more data-driven strategies for selling their ad space to effectively measure and provide ROI to buyers. We believe the momentum is already shifting towards a bidded CTV environment, and any economic pressures, including a potential recession, will likely amplify this trend.

Our next question comes from Andrew Marok from Raymond James.

You talked about areas of investment that will position the company better coming out of the downturn. Can you talk about prioritization of these initiatives kind of in the context of slowing ad com growth?

Yes, absolutely. First and foremost, I want to emphasize our focus on engineering and innovation. As ad spend growth slows, our profitability and strong balance sheet give us the opportunity to consider how we can maximize our market share when the recovery begins. This will depend on having the right products and solutions available. To achieve this, we are directing our investments towards products, engineering, software, and infrastructure to ensure we have the necessary offerings. Our focus areas include four primary aspects. The first is supply path optimization, ensuring we have the right tools and products for buyers so we can capture ad dollars effectively as spending consolidates. The second is on video and connected TV (CTV), as there is a significant increase in the consumption of this ad format, which advertisers appreciate for its storytelling potential and the availability of first-party data. The third area is addressability, which involves adapting to new methods of delivering relevant ads as we move away from cookies or IDFA. Finally, the fourth focus is retail media, which we identify as a large addressable market, estimated between $100 billion and $150 billion, as we enhance our capabilities and develop more products and market strategies.

Great. And then you spoke a little bit about the U.S. versus some of your international markets performance. I guess anything to call out in the macro situation versus your expectations in some of the different regions. I think Europe, in particular, was called out prior as a place that was experiencing some macro pressure earlier. Was that kind of in line, worse, better, and same for APAC?

The expectations we had for the third quarter in the EMEA payment line indicated a deceleration, and that is exactly what occurred. The significant change was in the trajectory for the Americas. In Q2, our Americas business grew by 27% year-over-year, but in the third quarter, that growth slowed to about 10%. The main reasons for this are the same points I mentioned earlier. The key sectors of shopping, personal finance, and technology all started to decelerate from August. Since the Americas account for approximately two-thirds of our total revenue, this change was felt across the entire business unit. However, we still achieved strong EBITDA with a 39% margin in the third quarter, demonstrating our ability to manage various aspects of our business effectively. We will maintain our focus and continue to refine our investments. I expect that the Americas business will align with broader macro trends moving forward, and while a recovery is anticipated, uncertainty remains. Additionally, I want to highlight the significant progress we've made in omnichannel video, which grew by 45% in the third quarter following an 80% increase last year. We are performing well across the board. It's important to note that omnichannel video now represents 34% of our revenues. In contrast, the display segment, which includes mobile web, app, and desktop display, is currently under pressure due to macroeconomic conditions. Despite this, our diverse mix is growing over time, positioning us well for the future, both financially and in terms of what lies ahead. The Americas will certainly play a key role in that scenario.

Our next question comes from Andrew Boone at JMP.

I have a big picture question as we think about kind of the market growing 10% or lower which I think you guys referenced earlier, versus kind of guidance for 14% growth for 2022. Can you just talk about the competitive environment as we go through a downturn? There’s long been a thought that ad tech will consolidate. Does this accelerate that? Or is there anything else that you guys are seeing on your end as we think about the competitive set within ad tech?

Yes, I'll start and then Steve can add his thoughts. Our primary focus is on continuing to capture a larger share of the market. It’s possible that our actions or those of others could lead to consolidation. However, when I assess our growth rate compared to the market, historically, we have been growing at approximately double the market's growth rate. There’s no reason to believe we won’t continue to outpace the market, even if the absolute growth rate slows down due to the current macroeconomic conditions. We are well positioned, especially with a strong balance sheet and ongoing profitability. We believe there will be more chances for consolidation in the future, whether that comes from internal growth or acquisitions. It’s difficult for me to predict the industry's future, but we see challenging times as opportunities to increase our market share, supported by our long-term commitment to revenue growth and profitability. Now, I’ll turn it over to Steve for any additional comments.

Sure. I think core to the point of view we have is that we feel really good about our business in terms of the model, in terms of the fundamentals that I outlined in my prepared comments. And I’ll just sort of summarize because I think it really underscores the point that we’re making. We believe that we built a very efficient business. We’ve owned and operated our equipment for many years. We’ve been driving efficiencies out of that at significant rates. We’ve gone through a multiyear investment cycle and doubled the capacity that we could process. That all is raw material for us to leverage and grow over time. We don’t need to then build more to generate incremental revenue in the near term. So that’s a really big leverage point for us. So we’re going to be focused on optimization. And we think by virtue of the fact that we are one unified platform, we’re going to be able to deliver innovation on quicker cycles. And we have a credible asset, as I commented on earlier, in terms of our R&D organization in India that we have been growing over time and they are all pointed towards high ROI investments. And if you factor all those things together by, I’d say, definition, we should end up consolidating the business because there are going to be companies that cannot keep pace on any of those or altogether those fronts.

Yes. I just want to kind of underscore the magnitude, I think, of our owned infrastructure advantage. As Steve mentioned, we're going to reduce the CapEx by at least half for next year. If you're in AWS or something like that, maybe you can reduce your infrastructure bill by 10%, if you really focus on it but it's going to be hard to get significant gains beyond that. So that's just, I think, an example of the significant advantage that we have.

That’s helpful. And then secondly, if I think about your CTV publisher wins, it steadily continues to increase over the last few quarters. Can you just talk about where you guys are actually winning share? Like what publishers are coming on the platform? Is there a trend there of a type or anything else you can share?

Yes. I believe we are experiencing growth in two main areas: net new publishers and deeper penetration of our existing publisher base. We are seeing progress in both categories. Regarding the types of publishers, there are generally three or four categories we are targeting. First, there are Tier 1 publishers, which are large platforms and broadcasters with substantial monthly user bases. The second category includes more niche content providers, which may have 20 to 30 million unique users each month. They produce high-value content but are smaller in scale and fit well into a biddable auction environment that requires automation to optimize ad revenue. The third category encompasses the FAST, or free ad-supported TV sector, where we see significant players that are integral to our business. Lastly, we are also collaborating with top TV OEMs or manufacturers, with partnerships among four or five of the leading companies in that area. Overall, this is the landscape we are pursuing across various geographies. I anticipate further penetration and new publisher acquisitions, alongside initiatives like SPO that will help generate additional revenue for our existing publishers.

Our next question comes from Justin Patterson at KeyBanc.

Great. If I can ask two questions. First, Rajeev, I appreciate your comments on Retail Media as a growth opportunity. There's clearly a lot of companies focused on that space. Considering the assets PubMatic has today and the investments needed to gain market share, could you provide more insight on where you believe you can achieve some successes and what the timeline might look like for that? That's my first question. Then, Steve, I wanted to get more details on some of the optimizations you mentioned. If I take a step back, it seems positive that you're increasing utilization of the data center while also shifting from lower-priced desktop to potentially more mobile video. Acknowledging that the growth rate for 2023 is uncertain, how should we view how margins are protected amid these optimizations and the shift in mix?

Yes, Justin. Regarding the retail media question, we see it as a long-term growth opportunity and a natural extension of our platform. You're correct that several companies are pursuing this space, but we believe our programmatic DNA and infrastructure, combined with our global capabilities, various ad formats, and our investment in Connect, which is our data and addressability platform, positions us well to offer a competitive product. We are already collaborating with companies like Kroger, eBay, Asda, Rakuten, Groupon, and Bed Bath & Beyond, among others. The components include both on-site and off-site advertising. On-site, our core SSP business is a vital product, while off-site, we see strong potential, partly due to the Martin acquisition. Currently, we are focusing on sponsoring listings for on-site ads, which are the types you might encounter while shopping on a retailer's site. This is a newer area for us, and we expect some development there. In terms of timing, this year and next are crucial for product innovation and building, with meaningful revenue contribution expected after 2023. Now, I'll pass it to Steve for the second part of your question.

Certainly. Justin, to elaborate on the optimization aspect, you are spot on in thinking that the optimizations we are implementing will enhance both our gross and EBITDA margins. There are various reasons for this, starting with our owned and operated infrastructure, which has consistently proven to be a significant strength. Firstly, we have control over the timing and scale of our capital expenditures; we decide when to invest, reduce spending, or relocate equipment since it belongs to us. We assess market signals and make informed decisions on management strategies. Over the past few years, we made a strategic choice to strengthen our competitive edge and increase our impression processing capacity, motivated by the vast potential in areas like CTV and omnichannel video. We've approached this prudently. Looking ahead, especially in light of current macro conditions that suggest a natural decline in ad spending for a while, we can leverage the infrastructure we've established. These high ROI outcomes are advantageous from a cash generation standpoint because we've already incurred these costs. On the GAAP P&L front, we depreciate our equipment over three years while typically maintaining it for four to six years, showcasing the leverage we will achieve over time. Optimization extends beyond infrastructure; our company has always sought ways to enhance productivity. In times like this, as we strategically focus our investments in technology and engineering rather than go-to-market efforts, it's essential to refine and automate our workflows. Our organization is very capable of this and has a history of success in these efforts. Given our EBITDA margins, which were in the high 30s and above 40 over the last couple of years, I anticipate that both gross and EBITDA margins will steadily rise. This is primarily influenced by how we organize ourselves, our execution of opportunities, and our consistent investment in innovation while also focusing on optimization when needed. Thus, as I mentioned, we are well-positioned going into this cycle, and we are genuinely excited about the competitive progress we will achieve in the upcoming quarters.

We have time for one more question from Maxwell Michaelis from Lake Street.

My question focuses on customer behavior. Are you noticing any consolidation in spending from customers who may be shifting from several SSPs to one or two? If so, are they selecting your services, and what factors are influencing their choice?

We have not observed a significant trend toward consolidation among publishers at this time. However, on the buy side, particularly with supply path optimization, we are noticing some movement. For example, last quarter we announced an expanded relationship with Havas in this area, and in the second quarter, we also expanded our global relationship. We definitely see the buy side leading the way in terms of consolidation. On the sell side, it is possible some publishers may consolidate due to the need for operational investments and the challenges of managing multiple SSPs. However, I have yet to see this trend emerge in the current cycle.

And we have no additional questions in the queue. I'll now turn the call back to Rajeev for some quick closing remarks.

Thank you, everyone, for joining us today. There’s no doubt that it’s a softer macro environment today versus a year ago. Ad spend growth is decelerating market-wide but we continue to consolidate and grow market share. Our focused investments and continued innovation set us apart from others while still delivering high margins and cash. And while we can’t control the macro, our business model provides resiliency and highlights our ability to execute and create differentiated outcomes. We do anticipate that ad spend will come back even bigger at some point in the future as it historically has and we intend to be well positioned to maximize further market share gains. I look forward to connecting with many of you at upcoming investor conferences.

Thank you, everyone.

Thank you, all.

This concludes our call this afternoon. Thank you, everyone, for joining us. Take care.