Digital Media Solutions, Inc. (NYSE: DMS) Q2 2020 earnings call dated
Aug. 07, 2020
Corporate Participants:
Joe Marinucci — Co-Founder and Chief Executive Officer
Randall Koubek — Chief Financial Officer
Analysts:
Maria Ripps — Canaccord — Analyst
Presentation:
Operator
Ladies and gentlemen, thank you for standing by and welcome to the Digital Media Solutions Second Quarter 2020 earnings call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session time permitting. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions].
I’d now like to hand the conference over to your moderator for today. Edward Parker, Investor Relations. Please go ahead.
Joe Marinucci — Co-Founder and Chief Executive Officer
Thank you for joining us to discuss DMS’s financial results for the second quarter of 2020. With me on the call are Joe Marinucci, Co-Founder and CEO, and Randy Koubek, CFO.
By now, everyone should have access to our earnings announcement. This announcement may also be found on our Investor Relations website. Before we begin, I would like to call your attention to our Safe Harbor provision for forward-looking statements in our financial results press release. The Safe Harbor provision identifies risk factors that may cause actual results to differ materially from the content of our forward-looking statements. For a more detailed description of the risk factors that may affect our results including disclosure about the effects of the coronavirus outbreak, please refer to our financial results press release and our SEC filings, including the statement filed on Form S-4 of our predecessor company Leo Holdings Corp.
Also during this call, management commentary will include non-GAAP financial measures, reconciliation between GAAP and non-GAAP financial measures for reported results can be found in the tables of our financial results press release, which we have posted to our Investor Relations website at investors.digitalmediasolutions.com. The additional financial and other information to be discussed on this call can also be found on our Investor Relations website.
Now I’d like to turn the call over to Joe. Thank you, Edward. And good morning everyone. We’re excited to be hosting our first call as a public company today. Before we start, I’d like to thank our shareholders, employees, clients and partners for their support through the business combination process during what has been an incredibly difficult time for so many around the country and around the world. I would also like to acknowledge all of the essential workers who continue to work tirelessly to fight this global pandemic. Our thoughts are with everyone who has been impacted by COVID-19.
Despite the ongoing challenges and work in front of us, we’re clearly excited about DMS, a strong position to serve a large and growing digital advertising market with our unique brand direct and marketplace solutions. Solutions that help our clients efficiently deploy ad dollars that result in them interacting and engaging with new customers. On today’s call, we’ll discuss our second quarter 2020 results and also talk about our plans for continued growth this year and beyond. Let me begin with some second quarter highlights. In the face of unprecedented volatility and uncertainty, we had a strong quarter, as our business benefited from strong demand for digital performance marketing solutions.
Our Q2 revenue finished at $75.2 million, representing growth of 3.4% quarter-over-quarter and 30% year-over-year. Specifically we’ve seen outpaced growth within the insurance segment of our business, we’ll will touch on this a bit more later in the call. Our adjusted EBITDA for Q2 totaled $12.6 million representing growth of 5.7% quarter-over-quarter and an adjusted EBITDA margin of approximately 17%. Randy Koubek, our CFO will provide more detail on our Q2 2020 financial results in a moment. Before handing this call over, since this is our first earnings call with public investors. I want to share a bit about the DMS story in our strategy for continued growth.
DMS is a digital performance marketing company that supports the advertising and customer growth needs of blue chip brands across a wide range of high-value verticals, including insurance, consumer finance, education, on services, health and wellness and a variety of other e-commerce and direct to consumer segments. Through our online marketplaces and our brand direct performance solutions, where we digitally engage consumers with advertiser branded messages, we are able to derisk advertiser marketing spend for our advertiser clients. We do this with the revenue model that aligns directly with driving results for our advertising clients rather than simply charging those clients for audience, reach and impressions.
Our differentiated pay for performance model provides a linear path for advertisers to calculate marketing ROI. Our solutions are enabled by our people who represent some of the most impressive digital performance marketing expertise in the industry combined with our proven processes and our suite of proprietary technology and data assets. As a result we help brands across North America scale their businesses by helping them interact with consumers showing high intent to purchase products and services. Simply put, we help our advertising clients efficiently and effectively deploy their ad spend as they look to acquire new customers. At the same time, we’re creating efficient and valued processes for consumers to make more effective buying decisions.
DMS was founded in 2012 and we have consistently delivered revenue and EBITDA growth organically and through acquisitions. Over the past three years, we’ve grown our topline 50% and our EBITDA 30% on a compound annual basis. Our digital performance marketing solutions continue to scale by creating tangible results through linear connectivity between media spend and marketing ROI for our advertisers. As a result, we have achieved an advertiser client retention rate averaging approximately 95% over the past three years. As of July, we are listed on the New York Stock Exchange as a result of our business combination with we are holding score.
I think a little deeper into the components of our business, we have three primary lines of business. Brand direct Performance Solutions, marketplace solutions and other. First, the largest segment of our business is our brand direct Performance solutions. This is where we provide top down omnichannel solutions with our end-to-end capabilities which are designed to deliver high-end consumers to our advertiser clients. We build bespoke programs for our advertisers, whereby DMS controls and manages marketing spend on their behalf to create high intent, one on one consumer engagements between the advertiser brand and the prospective customer across digital media channels, including search, social, email and display amongst others.
In addition, we leverage our proprietary database of more than 150 million consumer profiles display ads to those consumers we believe have the highest intent and who are the most likely to engage with those ads. By displaying the right ads at the right times to the right consumers, we increased the efficacy of our media dollars, improved interactions with consumers and delivered advertising ROI to our clients by helping them convert I intent consumers into actual customers.
Most importantly, our pay-for-performance model puts us in close alignment with our advertising clients because DMS recognizes revenue by delivering measurable marketing results which directly translate to marketing ROI unlike traditional impression-based advertising. Second, our marketplace solutions, which our DMS owned and operated websites provide valuable mediums for advertisers to connect with consumers who are looking to make efficient and effective buying decisions and specific verticals. These marketplaces drawing consumer audiences through targeted media spend and provide relevant advertiser offers to those consumers. Consumers can then make decisions enterprise shop.
As consumers interact with us, we utilize these insights in these interactions and the associated permission-based data to augment our proprietary database of millions of precedent interactions to enhance future consumer interactions while at the same time creating efficiency in media spend. This in turn drives higher value to our brand direct solutions propelling a virtuous flywheel effect. And third, we offer additional services. Including a host of proprietary software capabilities which our clients and bed and integrate into their marketing systems and processes. Use of our internally developed software delivery platform is exclusively in the form of long-term contracts and drive stickier client relationships contributing to our ability to cross sell brand direct performance in marketplace solutions to our software clients.
As I mentioned because DMS works on a pay-for-performance model, our solutions provide a transparent ROI measurement and predictive capabilities for our advertiser clients. As a result, there is clear attribution with regard to media dollars spent on consumer engagement and customers acquired. I would like to take a minute to discuss in slightly greater detail what makes the DMS model powerful and unique. First and foremost, we are a first-party data driven technology platform. We’ve developed systems and software that track consumer engagement, user interactions, click, read and call routing at enormous scale.
We currently track. More than 1.4 billion monthly ad unit impressions. Our technology has facilitated more than $1 billion of lifetime ad spend through our platforms, which creates a synergistic motion whereby dollars are being deployed and connected to better outcomes and higher ROI driving optimized campaigns and better decision making. Second we boast a robust first party data asset of 150 million consumer profiles attributes and self declared data that allows us to display ads, more specifically based on unique advertiser needs as well as ensuring we engage consumers who have interest and intend to interact with our ads. Our proprietary data pool distinguishes us from our competitors who are displaying ads by leveraging general media platform attributes and using media targeting options that are shared by many.
Third, we offer proprietary SaaS solutions, which enables our clients to be more efficient and effective and how they deploy, manage and measure their marketing spend. Our advertiser clients use our software to track KPIs in real time from all marketing channels, integrate and automate their marketing systems with multiple third-parties and drive cross channel attribution. Fourth, we are diversified digital advertising business. We have no single channel dependency and we are truly an agnostic solution across media channels and verticals. This provides us with agility to quickly pivot to take advantage of outpacing advertiser spend and as a result we can quickly match up advertiser demand with our digital performance marketing solutions.
We’ve seen the strength of our model drive resilience during the recent volatility as a result of COVID-19. Fifth, while we lead with our proprietary solutions, we believe M&A is a core competency of our company. We have established a strong track record of successfully executing transactions and driving both meaningful revenue and cost synergies having successfully executed 10 acquisitions since 2016. Most recently, in July, we announced the acquisition of smarter chaos, a premiere digital marketing, and online performance management agency along that she is media a female centric performance to ad network. We will continue to execute our proven M&A playbook as a key part of our long-term growth strategy.
I would also like to mention that our model is distinct for many of the big tech ad platforms; such as Amazon Facebook and Google, as our revenue model goes beyond impressions. Since we’re compensated for creating high intent one on one consumer engagements between the advertiser brand and the prospective customer we’re aligned with our advertisers, and are able to derisk advertiser spend. That said, we do leverage many of the largest media platforms for our advertisers. These platforms are the front runners of digital marketing transformation and as they continue to grow we believe our value proposition will resonate further because the need to derisk ad spend will continue to grow as ad spend continues to scale. We are also highly focused on growing our business organically and note the following growth drivers that will propel our business for the back half of the year and beyond.
First, we continue to invest behind the strength in demand, we have seen in our insurance marketplaces and plan to build on that momentum we have seen since entering this space last year. Second, we will continue to invest in order to continue the growth of our insurance agent base. Additionally, we will focus on our expansion into the Life and Health segments of the insurance market. Third, we have begun integrating our recent acquisition of smarter chaos and expect to see the benefits of incorporating this new client roster into our broader set a brand direct performance solutions. Fourth, we continue to drive greater efficiency and leveraging our first-party data asset to drive meaningful growth and margin expansion across both our marketplace and brand direct solutions. And fifth, we continue to drive for deeper technology integrations with clients across brand direct and marketplace solutions which lead to stickier relationships and expanded revenues with our clients. Now that you have an understanding of what we do.
I want to touch on our market and the macro trends driving our business. We serve a large and growing addressable digital ad spending market of more than $150 billion anticipated to grow a 12% compounded annual growth rate through 2023. Since its founding in 2012 DMS is recognize that amidst the accelerating shift from offline to online advertising, marketers would increasingly demand partners that can prove clear ROI on ad spend. We’re seeing this play out in many of our key verticals such as insurance, financial services, healthcare and automotive are still in the early stages of a transition away from traditional channels like TV to digital channels that we service. So we see a lot of opportunity for growth. Finally, I’d like to touch on some of the verticals we serve.
We work with top brands across a wide range of high-value verticals, including insurance, consumer finance, Home Services, health and wellness and a variety of e-commerce and direct to consumer segments and education. Each of our advertiser clients across all the verticals we serve rely on DMS’s versatility to provide both brand direct and marketplace solutions that enable their digital advertising to meet evolving consumer demand. In fact, with our education vertical, we added 24 new advertiser clients during Q2. As we are now supporting the enrollment growth needs of diversified education offerings ranging from traditional, not-for-profit institutions, for-profit institutions, boot camps and accelerated non certificate course programs. We saw particular strength in our insurance vertical and insurance is now one of our strongest verticals. Currently, five of the largest US insurance firms across Home and Auto, our DMS client and we had a particularly strong quarter in the insurance segment in Q2 with revenue from our top five insurance clients growing 29% quarter-over-quarter through a combination of expanding our insurance agent base and growing our existing advertiser client base.
Now I’d like to take a minute to discuss the impact of COVID-19 on our industry and our business. Like so many others we’ve had to adapt to the unprecedented challenges and broader macro economic volatility as a result of the crisis. We responded rapidly and decisively in late March ceasing all non-essential travel, closing our offices and equipping our employees to work remotely, including our call center, which was fully remote and performing at full capacity by March ’18. Around the same time starting in late March, we saw a material change in demand for Tier 1 display channels, including major social media platforms, indicating that major brands, we’re pulling ad budgets given uncertainty on how well they be able to monetize their media expenditure.
Additionally, we saw a modest impact to demand at some advertising clients deferred ad spend as a result of experiencing disruption while urgently prioritizing actions to enable their workforce to work remotely. However, beginning in early April, we started to see a recovery and engagement for our social and search advertising while also seeing improvement in our reach and impressions in our core verticals. These trends continued into June and have continued into July led by a resurgence in the targeting of higher intent consumers. Furthermore, we began to see indications that many advertiser clients that pulled back ad spend as a result of shifting resources to transition to work from home are poised to resume spending in the second half of 2020 in an effort to deploy deferred budgets. Despite these challenges, we believe that we gained impression share during the quarter due to other advertisers actively reducing their media spend and thus their impression share.
Additionally our vertical and media agnostic solutions serve a diversified client base and we have limited exposure to the most impacted areas of the economy. For example, while we are seeing some softness in areas such as consumer finance, we are seeing strong demand for auto, health and life insurance, which is one of our strongest areas of focus. That said while we are cautiously optimistic regarding the next several months, the environment continues to be uneven and given limited visibility we prudently assume that the current volatility could persist for at least the remainder of the year.
Our forward guidance takes these factors into consideration and we believe we are in a strong position to deliver against this plan, despite some of the more troubling trends we’ve seen in some areas of the country. While we all continue to face significant challenges in defeating COVID-19. We believe the current environment is only adding pressure for markers to spend their dollars as effectively as possible. And even the largest brands have shown a need to quickly pivot to optimize marketing spend and performance to match audiences preferences. Only digital performance marketing offers this type of agility.
In summary, our second quarter was strong despite the challenging environment. We’re excited by the breadth of opportunities that are large and growing addressable market, strong competitive position, diverse client base, proven M&A track record and our robust suite of differentiated services and solutions provide us as we further our expansion and continue to drive long-term shareholder value. With that let me turn it over to Randy Koubek.
Randall Koubek — Chief Financial Officer
Thanks, Joe. Good morning, everyone. We hope that you’re keeping safe and healthy. I’ll start by providing a brief overview of our business model and then I’ll go through our second quarter results before moving on to our guidance for fiscal 2020.
Our business generates revenue, primarily through the delivery of a variety of performance-based marketing services, which include our brand direct in our marketplace solutions as well as other solutions, which encompasses our SaaS technology. We report revenue on a net basis, which represents gross sales net of sales adjustments related to pattern components of cost of revenue.
As many of you are aware, we completed our business combination with LEO holding on July 15th and filed our S-1 on July 31st 2020. Now turning to our results. In terms of revenue for the second quarter, total revenue was $75.2 million, an increase of 3.4% from Q1 2020% and 30% over the same quarter last year.
The sequential increase in our revenue was primarily due to strength behind the investment in our marketplace solutions, specifically in the insurance vertical offset by some softness in the consumer finance vertical. We are pleased with our sequential performance given the some challenging environment. Breaking down our revenue by segment. Brand direct Performance Solutions revenue in the quarter was $45.3 million, up a 11% sequentially and 1% year-over-year, holding the line in the face of COVID.
Our marketplace Solutions revenue was $35.2 million, increasing 3% from Q1 due to the growth in the insurance sector revenues, which more than offset a decline in consumer finance product line. Market solutions increased 124% year-over-year primarily due to our successful expansion into the insurance sector with the UE authority acquisition.
Other solutions revenue was $1.4 million, which was up 13% from Q1 and down slightly year-over-year. In regards to gross margin. Second quarter gross margin was 30.3% compared to 31% in the first quarter of 2020%. And 33% in the same quarter a year ago. Breaking down gross margin by segment. Q2 brand direct gross margin was 24% in line with Q1 2020 and down slightly from 26% in the same quarter last year.
The reduction in gross margin from the year ago period was primarily attributable to expanding our advertiser media reach. Q2 marketplace solutions gross margin was 30% up sequentially from 29.2% and down from 37% the year-ago period. The reduction in gross margin was due to our expansion into the insurance market, which carries gross margins of approximately 30%. Other solutions gross margins was 98% in the quarter, in line with previous periods.
I’d like to add that our gross margin is subject to quarterly variation, primarily due to changes in sales mix, as segments of our business carry different gross margin profiles. At the same time we’re just on driving efficiency and expect to continue to see cost benefits as we scale our business. As such, we believe that over time. We’re targeting to maintain a gross margin of 30% or higher.
Turning to operating expenses. We remain focused on improving the leverage in our business while balancing our investments for growth. Our total operating expense was $17 million in the second quarter, down 5.6% from Q1 2020 and up 2% year-over-year. As a percent of revenue, total opex was 22.5% in the second quarter, down from 24.7% in Q1 and 29% a year ago period.
We are pleased with our expense performance in the quarter as we made substantial progress in achieving operational leverage and consolidating operations from our recent acquisition of UE authority while decreasing G&A expenses as a result of COVID. Salaries and related costs in the second quarter were $7.9 million, an increase of 12% year-over-year and down 5% from Q1 2020.
Additionally salaries are down as a percent of revenue, representing 11% of total revenue, down from 12% of total run at the same period in the prior year. The year-over-year increase was due to workforce expansion in our marketplace segment as well as an increase in commission due to our revenue increases. The sequential decline in salaries and related costs from Q1 2020 reflecting efficiency gains in our platform.
SG&A expenses were $4.7 million for the quarter representing 6% of total revenue and a 2% decline year-over-year. The decrease in G&A was due primarily to a decline in general expenses associated with travel and office expenses due to COVID-19 restrictions as well as the associated office closures and reduction in bad debt expense. We ended the quarter with a total headcount of approximately 340 full-time employees.
In terms of profitability. Adjusted EBITDA in the second quarter was $12.6 million or an adjusted EBITDA margin of 16.8%. This represents growth of 5.7% from Q1 and was essentially flat from Q2 2019. The sequential improvement resulted from quarter-over-quarter revenue increase and operating expense savings as previously noted.
Net income in the second quarter was $2.1 million up $2.3 million from prior year and $1.4 million from the prior quarter representing earnings per share of $0.05 for both Class A and Class B units based on $23.96 million Class A and $20.5 million Class B units outstanding respectively. We had an effective tax rate of 9% in the quarter. Cash flow from operations was $3.7 million or 3.4% of net revenue.
Unlevered free cash flows $10.6 million in Q2 compared to $11.3 million last year is $8.9 in the first quarter 2020. And lastly turning to the balance sheet and liquidity, we ended the quarter with $8 million in cash, cash equivalents and marketable securities, and our total debt, net of issuance cost was $212 million. At June 30, 2020, our total net leverage ratio was 4.76x, which is in compliance with our company’s credit agreement.
In conjunction with the July 2020 business combination $40 million in cash was directed to the company, of which $10 million was used to pay down our revolving line of credit. The net cash balance. Following the business combination is approximately $22 million. Additionally, we have an available balance on our revolving credit facility of $11 million. Looking forward, we expect continued positive cash flow generation with similar high unlevered free cash flow conversion rates in line with historical performance between 80% and 90% of adjusted EBITDA to note most of our adjusted EBITDA drops to normalized free cash flow due to the relatively low capital requirements of our business model.
We are comfortable at these factors will provide sufficient cash generation and liquidity. And we do not anticipate any additional financing. With the exception of potential acquisition activity.
Turning to our outlook for fiscal 2020. We currently expect revenue of approximately $340 million and adjusted EBITDA of approximately $57 million. The guidance contemplates an ongoing strong secular backdrop for digital performance marketing, the continuation of our strategy for organic growth discussed earlier by Joe and the continuation of our strong track record in executing M&A through further tuck-in acquisitions offset by uncertainty and volatility with respect to business conditions as a result of COVID.
So in summary, we are pleased with our financial performance and remain optimistic about the underlying strength of our business over the long term. DMS is a highly resilient business model and we have proven our ability to perform well.
With that, Joe and I are happy to take questions.
Questions and Answers:
Operator
[Operator Instructions] Maria Ripps with Canaccord. Your line is open.
Maria Ripps — Canaccord — Analyst
Good morning and thank you for taking my questions. Thanks for the overview of the business. One area that since — that stands out is your success with customer growth in the educational vertical, can you maybe talk about the process for gaining this customers and what’s the sales cycle look like? And what historical experience do you have in gaining share wallet as advertisers sort of become more familiar with your platform?
Joe Marinucci — Co-Founder and Chief Executive Officer
Hi, Maria, and good morning. This is Joe Marinucci the CEO speaking. I’ll take the first two parts to that question. To start and then maybe we could touch on the 3rd, which was more general. So you were asking specifically about the education vertical that we do work in and why we’re continuing to gain share there and what the sales process is like. So for us sales is led by our Chief Revenue Officer and we’ve consistently had the same processes there that we’ve had for the last couple of years. And there has been no change in terms of how that process operates in terms of how we go out and prospect put those prospects in pipeline and how they move through pipeline.
Then the education segment of our business. It’s probably one of the longer sales cycles in that it’s typically anywhere from two to four months as opposed to other areas of the business where it’s a little bit quicker than that. So we’re continuing to see just strong demand across all the verticals that we do business in just because of the efficacy of media spend in the digital performance marketing channel and the educational institutions that we work with continue to take advantage of the channel and the efficacy and spend as we continue to meet or exceed their key performance indicators, which is why we’re seeing success there.
Could you maybe repeat the third part of that question, so I can address that as well.
Maria Ripps — Canaccord — Analyst
Yeah, I just wanted to kind of ask about sort of the historical experience that you have been gaining share of wallet as sort of advertisers become more and more familiar with your platform.
Joe Marinucci — Co-Founder and Chief Executive Officer
Yes. So, generally it really is very bespoke to the advertiser. And the reason for that is most of the advertisers are going to have different key performance indicators that they’re looking to work towards. Those indicators are usually grouped based on vertical so an insurance, they’re going to be somewhat similar, same thing and education. Same thing and consumer finance.
So on the individual advertiser basis as we’re dealing with those advertisers and we’re working to meet or exceed those key performance indicators that they’ve established. They will scale spend as they see efficacy in the media spend as a measure of ROI against that spend and those key performance indicator. So, so long as we are meeting or exceeding those key performance indicators, we are going to scale span and that’s what drives success and growth in the different verticals that we do business in.
Maria Ripps — Canaccord — Analyst
Thank you. That’s very helpful. I appreciate the color.
Joe Marinucci — Co-Founder and Chief Executive Officer
You’re welcome.
Operator
[Operator Instructions] There are no further questions at this time, I would now like to turn the call back over to Joe Marinucci for final remarks.
Joe Marinucci — Co-Founder and Chief Executive Officer
Yes, thanks to everybody that listen today and for your interest in DMS. I’m looking forward to speaking with you all soon. I hope everybody continues to be well and safe in this very challenging environment. Have a great day.
Operator
[Operator Closing Remarks]