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Presentation

Operator: Good morning, and welcome to the Outbrain, Inc. First Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. Now I’d like to turn the call over to your Outbrain management team.

McKenna Elves: Good morning, and thank you for joining us on today’s conference call to discuss Outbrain’s first quarter 2023 results. Joining me on the call today we have Outbrain’s co-founder and co-CEO, Yaron Galai; co-CEO, David Kostman; and CFO, Jayson Kiviat. During this conference call, management will make forward-looking statements based on current expectations and assumptions. These statements are subject to risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. These risk factors are discussed in detail in our Form 10-K filed for the year ended December 31, 2022, and in subsequent reports filed with the Securities and Exchange Commission. Forward-looking statements speak only as of the call’s original date, and we do not undertake any duty to update any such statements.

Today’s presentation also includes references to non-GAAP financial measures. You should refer to the information contained in the company’s first-quarter earnings release for definitional information and reconciliations of non-GAAP measures to the comparable GAAP financial measures. Our earnings release can be found on our IR Web site, investors.outbrain.com, under news and events. With that, let me turn the call over to David.

David Kostman: Thank you, McKenna. In Q1, we exceeded the guidance we provided delivering $52.2 million in extra gross profit and positive adjusted EBITDA of $0.7 million. In what is still an uncertain macro environment, we are focused on first, driving growth of usage and better performance in our current marketplace; and second, growing our addressable market both on the advertiser side and the publisher side to a focused product and technology-led strategy, while maintaining tight controls on costs. I would start with a macro environment where the outlook continues to be uncertain. The softness in advertising budgets continues. From a geographical perspective, we are seeing some more favorable trends in advertiser budgets in Europe versus a more cautious approach in the U.S. From an industry perspective, we are encouraged by the accelerating trend of advertisers from enterprise brands to performance marketers, increasingly making budget decisions based on measurable outcomes, driven by user attention and engagement, and leveraging contextual data.

This is why for the last few months we’ve been accelerating our focus, helping enterprise brands deliver experiences that drive deeper engagement, attention, and measurable results. We believe that we are well-positioned to deliver on this market need, thanks to our heritage and strength in predictive AI-based performance. We’ve been working with some of the top global agencies and enterprise brands on validating our unique selling proposition and testing it on our platform. We are encouraged by the initial signs, and we’ll be making several announcements regarding this product launched in the coming weeks. In order to support our efforts in these growth areas, we’ve also announced several organizational changes, such as the appointment of Andraz Tori, the former founder, and CTO of Zemanta, who has led Outbrain recommendations and data science department for the past four years to also become chief product officer and worked closely with our new CTO, Yonatan Maman, who’s led our engineering organization for the past five years.

We have also announced several changes in our business organization under the new leadership of our CRO, Alex Erlmeier, who previously led our international business to ensure the right focus on our growth areas with teams in local markets, while at the same time consolidating into hubs certain segments of advertisers and publishers, to better serve them with centralized know-how and generate cost efficiencies. Andraz, Yonatan, and Alex have each been with us for over decades. With that, I will move to the publisher side of our business. We continued to solidify our position with premium publishers globally. We signed several new deals including an emphasis on financial publishers with Fortune, Entrepreneur, and Coindesk. We renewed multi-year deals with several anchor premium publishers including The Washington Post, Le Monde in France at the end of Q4, ANSA in Italy, Hearst and Vocento in Spain, and Orange in France.

We remain focused on premium publishers as we believe the trust they built with their audiences on the open Internet leads to a deep and meaningful relationship with their readers, which is a flywheel for a better user experience and better attention and engagement moments for advertisers. On the product side, our publishers are enjoying the constant architectural improvements we are making to smart logic, such as optimizing the experiences, reducing widget latency, which is expected to increase revenue. They also continued the adoption of new products and capabilities to optimize the performance on their properties. An additional growth driver is the increase of in-article integrations to header bidding or code on page. In Q1, we added about 70 of such in-article integrations, which is also an important part of our enterprise brand strategy.

On the non-publisher supply side of the business, which includes our direct-to-device partnerships that we highlighted as one of our growth drivers, we also continued to expand. And in the last few months, we signed partnerships with SmartNews, Flipboard, Quora, and others, enabling us to expand our advertiser campaigns to such platforms, leveraging our real-time building capabilities that optimize the engagement and performance. In Q1 2023, these partnerships contributed approximately 10% of our revenue. On this front, we are particularly excited about the launch of [Update News] (ph), an access [indiscernible] on Samsung devices in the US, replacing the resisting news app provider. Through our partnership with Update, we’ll now also be able to access that highly valuable inventory for our advertisers.

Moving to the advertiser side of our marketplace, I refer to the macro trends impacting demand and resulting in stable but still lower CPCs than last year. On our end, we continue to improve the programmatic access to our network. In Q1, we fully integrated our performance DSP Zemanta into our core, such that all our advertisers can select the platform of their choice to access the outbreak supply and our extended network of supply via the Zemanta platform or through our Amplify dashboard. We are also leveraging many of the AI-driven ROAS improvements in our Amplify dashboard into our programmatic marketplace. We are seeing some promising success stories for our advertisers, and we believe that we could see significant upside from further scaling the use of the demand technology for our core advertisers.

Bringing together our investment in AI and CBS conversion strategy, I wanted to highlight the results of one of our customers, Babbel, one of the world’s top-selling language learning apps. They used Outbrain title suggestions, a tool powered by AI technology that automatically suggested titles by scanning the brand landing pages alongside conversion bid strategy, which resulted in an improvement of 20% average click-through rate and a 20% conversion rate improvement. The combination of these products resulted in quality leads and a more effective use of campaign dollars for Babbel’s team. Another growth driver we highlighted and excited about is our video business, which includes the VI acquisition in our out-stream video product. In Q1, we saw significant new wins with VI’s smart video product, including the SPIEGEL and [indiscernible] Germany, ANSA in Italy, and Evening Standard in the U.K. These represent just a few examples of the new innovative placements born in Q1, alongside more than 190 implementations of the product in existing Outbrain publishers.

The power and impact that we do experiences can have in capturing attention and driving engagement is one of the keys for the future of our enterprise brand strategy. To sum it up, we are pleased that we exceeded our guidance for Q1 and considering the macro headwinds we are hosting with caution, we are focused on product and technology-led improvements of the performance of our marketplace and in growing our addressable market for advertisers in publishers, particularly our offering for enterprise brands. At the same time, we are maintaining cost discipline across the company, consistent with our previously stated objective of generating positive cash flow in 2023. I now hand it over to Yaron.

Yaron Galai: Thanks, David. Times like this are the perfect opportunity to keep inventing and innovating around product algorithms and AI. I want to highlight a few of the areas where we brought new innovations to our platform during the last quarter. Let’s start with algorithms. On our last call, I shared some of the progress we made on the algorithmic side during 2022, culminating in a 9.5% improvement of our yield potential. This is based on our internal A-B testing of algorithms. While these improvements were muted in last year’s numbers due to the macro demand challenges, they are spring loaded so to speak into our platform. During the first quarter, we released five new algorithm updates which are internal A-B testing indicates a further improves our RPM yield potential by another 2.7%.

Here are two examples. First, we released a new exploration strategy based on what academics call Wilson Score interval, which improves the efficiency of how our system tests new ads. This algorithm allows us to save ad impressions that were previously used for testing ads and instead serve high — higher yielding ads. Second, we’ve doubled the number of model parameters in our online prediction algorithm, and boosted the throughput of predictions, we can process to about 1 billion predictions per second. We’ve done that while maintaining a very low latency of processing of our recommendations. These are just two examples of the five algorithm upgrades we released in Q1. When advertiser demand is robust, we expect the 2.7 increase in yield potential to continue compounding our results on top of the previous upgrades.

Switching gears to serving efficiency, which is another example of how we’re using these times to innovate by improving our operating model. We’ve been intensely focused on reducing our cost of sales while maintaining our serving capabilities in RPM yield levels. As a reminder, the majority of our data center capabilities are operated by us in-house with a certain footprint on public clouds like Microsoft Azure. We find this to be much more cost efficient at our scale than relying on public clouds, but more importantly it allows our engineers better control and the ability to better optimize serving architecture for our specific needs and for efficiency. In Q1, we released a new framework that calculates in real-time the revenue potential of each ad we serve, and based on that, it dynamically allocates more or less compute resources for handling best ad.

We’ve started implementing this on some of the ads we serve, and initial results are showing an approximately 10% saving on cost of sales on those specific ads without the noticeable impact on RPM. In fact, we believe that over time this technology may help us increase RPMs by allocating more compute resources to boost specific ads with the highest potential of driving high RPMs while staying disciplined on cost of sales. Lastly, AI is obviously an area we’re very focused on. I spoke about this in more detail last quarter and our engineers are obviously exploring multiple ways of leveraging AI on our platform. As I mentioned previously, we’ve been using our AI solutions for a while to assist advertisers with scaling headline creatives. David mentioned Babbel is one example of an advertiser successfully using this technology to achieve better outcomes.

We’ve now built a more robust solution that includes AI headline creatives from OpenAI’s ChatGPT, and by April about 50% of the ad headlines we suggested to outbrain advertisers were originating from ChatGPT. Another area our engineers have been focusing AI efforts on is predictions of ad viewability. Late last year, we started including our AI-predicted viewability within programmatic channels. As David mentioned, viewability is an important factor for our enterprise brand strategy. They’re building or evaluating AI solutions on areas such as code writing and automated code review testing with solutions such as GitHub copilot on inch creation and enhancement for ad images on PTR predictions, etc. Overall, we’re very excited with the new opportunities that this wave of AI creates for us on many vectors of our technology and business.

And with that, I’ll hand it over to Jason to cover our financials.

Jason Kiviat: Thanks, Yaron. As David mentioned, we beat our Q1 guidance for both gross profit and adjusted EBITDA. From a demand perspective, we experienced a continued soft but fairly normal pattern in Q1, with strengthening demand over the course of the quarter in both Europe and the US. The early portion of two has remained volatile. We’ve seen a softer start in the US and more relative strength in Europe. Revenue in Q1 was approximately 232 million, a decrease of 7% year over year on a constant currency basis and 9% on an as-reported basis. The decrease year over year was driven primarily by lower yields as we continue to lap a prior year period that was not meaningfully impacted by the headwinds on advertising demand affecting our industry.

These headwinds were partially offset by growth via new supply partners. New media partners in the quarter contributed 11 percentage points or approximately $29 million of revenue growth year over year, which compares favorably to the approximately seven points of growth from new media partners that we had averaged in 2020 and 2021. Net revenue retention of our publishers was 80%, reflecting the continued impact of the demand environment on yields, which drove the majority of the decline year over year. Our churn remains very low by our standards, and our three largest churns year over year contributed just four total points of net revenue retention headwind in Q1. As another data point, our logo retention was 95% for all partners that generated at least $10,000 in Q1 2022.

Ex-TAC gross profit was 52.2 million, a decrease of 17% year over year on a constant currency basis and 18 % as reported. Consistent with what we’ve seen in the past several quarters in this environment, the steeper decline of ex-TAC gross profit year over year versus revenue was driven by an unfavorable mix of revenue, lower performance on certain media partners driven in part by the demand headwinds we’re seeing, which impacts the portion of our take rates with certain partners, and the impact of onboarding and optimizing significant new supply partners, which is challenged by the weaker than normal demand environment. Moving to expenses, operating expenses decreased approximately 3.4 million year over year to 50.5 million in the first quarter.

The decrease is driven largely by lower personnel-related costs coming from lower headcount year over year, favorability of FX rates, and lower variable compensation. This was partially offset by higher bad debt expense and higher severance costs, the latter of which relates to some of the organizational changes that David referred to, to prioritize the efforts of our team. As mentioned in previous quarters, we implemented a series of cost-reduction efforts to adjust the current business headwinds. And as we said in the prior quarter, we plan to keep our expenses essentially flat over the remaining quarters of the year. We finished Q1 with a headcount of across 970 FTE, which is down 4 % year over year, and down 8 % since we began the cost reductions in Q2 of last year.

We continue to focus on driving greater efficiencies in our operations, and as noted in the prior quarter, headcount accounts for around 70% of our operating expenses. As a result, adjusted EBITDA was approximately 1 million in Q1. Moving to liquidity, free cash flow, which as a reminder, we defined as cash from operating activities less CapEx and capitalized software costs, with a net use of cash in the period of approximately 27 million. The use of cash was primarily due to a significant slowdown in collections of customer receivables, driven most meaningfully by the sudden closure of Silicon Valley Bank in March. Upon the news, we asked customers to hold payments for over a week until we were able to set up supplemental operating accounts at additional financial institutions.

We have regained full access to all of our funds held at the bank and collections in April have returned to more normal levels as we switch over customers to the new accounts. We estimate around $15 million as the temporary impact of reduced cash and cash equivalents on our balance sheet as of March 31, resulting from this and other operational challenges impacting collections as of the balance sheet date. As these issues have been resolved, we expect that DSO and cash balance to normalize to our historical levels in the coming months. So, while it impacted our cash flows for Q1, we do not expect it will impact our cash flow on a full-year basis. As we said, our objective is to achieve positive free cash flow for the year. As a result, we ended the quarter with 318 million of cash, cash equivalents, and investments in marketable securities on the balance sheet and 236 million of long-term convertible debt.

On April 14, we repurchased 118 million aggregate principal amount of the convertible notes for approximately $96.2 million in cash, including accrued interest, representing a discount of approximately 19% to the principal amount of the repurchase notes. Review the opportunity to repurchase a portion of the debt at a considerable discount to be opportunistic, given the strength of our balance sheet, with the remaining cash balance that retains the optionality to invest in any organic or inorganic opportunities that can drive further shareholder value. In December, the company’s board of directors authorized a $30 million share repurchase program, incremental to the $30 million program fully executed in 2022. We began executing the new program in Q1, though we temporarily pause share repurchases upon the news of SBS closure and due to our purchase of the convertible notes in April.

We are monitoring closely as our cash collections normalize, and we continue to believe is an attractive way to enhance shareholder value under current market conditions. Now turning to our outlook, as discussed today and in prior quarters, visibility to advertising budgets remains limited. In our guidance, we assume that current macro conditions persist with no material deterioration or improvement, regular seasonality, and as noted in the prior quarter, continued execution of our growth drivers such as optimization of new supply partners, algorithmic improvements, expansion of our video and full-funnel offerings, and attracting new partners. With that context, we have provided the following guidance. For Q2, we expect gross profit of $52 million to $55 million, and we expect adjusted EBITDA of $0.5 million to $1.5 million.

We maintain our previous full-year 2023 guidance provided at the beginning of the year of at least $237 million of ex-TAC gross profit and at least $28 million of adjusted EBITDA. Now I’ll turn it back to the Operator for Q&A.

Operator: Thank you. [Operator instructions] Our first question comes from the line of Shweta Khajuria with Evercore ISI. Please proceed with your question.

Operator: Thank you. Our next question comes from line of Andrew Boone with JMP Securities. Please proceed with your question.

Operator: Thank you. Our next question comes from the line of Ross Sandler with Barclays. Please proceed with your question.

Operator: Thank you. Our next question comes from the line of Laura Martin with Needham and Company. Please proceed with your question.

Operator: Thank you. [Operator instructions] Our next question comes from the line of Ygal Arounian with Citi. Please proceed with your question.

Operator: Thank you. Thank you, ladies and gentlemen. This concludes our question-and-answer session. I’ll turn the floor back to management for any final comments.

David Kostman: Hi, this is David. So, thank you very much for joining us, and we look forward to seeing you on our next call. Thank you.

Operator: Thank you. This concludes today’s conference call. You may disconnect your lines at this time. Thank you for your participation.