Good day and thank you for standing by. Welcome to Taboola's Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, [Renwick Johnson] with Investor Relations. Please go ahead.

Thank you. Good morning, everyone, and welcome to Taboola's Third Quarter 2022 Earnings Conference Call. I'm here with Adam Singolda, our Founder and CEO; and Steve Walker, our CFO. We issued our earnings press release today before market and it is available along with our Q3 shareholder letter in the Investors section of our website. Now I'll quickly cover the safe harbor. Certain statements today, including our expectations for future periods, are forward-looking statements. They are not facts and are subject to material risks and uncertainties described in our SEC filings. These statements are based on currently available information and we undertake no duty to update them except as required by law. Today's discussion is also subject to the forward-looking statement limitations in the earnings press release. Future events could differ materially and adversely from those anticipated. During this call, we will use terms defined in the earnings release and refer to non-GAAP financial measures. For definitions and reconciliations to GAAP, please refer to the non-GAAP tables in the earnings release posted on our website. And with that, I'll turn the call over to Adam.

Thanks, Renee. Good morning, everyone, and thank you all for joining us for our third quarter call. Q3 was a good quarter. We beat or came near the high end of our guidance on all metrics delivering $129 million of ex-TAC and $24 million of adjusted EBITDA. We're holding our annual adjusted EBITDA guidance for 2022 at $152 million to $160 million while generating strong cash flow. Lastly, due to continued softness in the advertising market and to be cautious, we decided to lower 2022 revenue guidance by 4% and ex-TAC guidance by 6%. We adjusted our cost structure a few months back and I can tell you we're committed to executing our strategy as a profitable growth company. Our track record demonstrates our ability to succeed in that strategy and despite everything that's going on in the world, we're not anticipating a decline in ex-TAC this year versus last. Q4 is historically a high-performing quarter especially for e-commerce. Additionally, this year we also have the potential of positive effect of the World Cup, but we're not counting on it in our forecast given uncertainties in the market. More than ever, our ability to generate cash matters and I'm proud of where we are. For 2022, we expect $17 million to $25 million of free cash flow. We also expect $58 million to $66 million of cash generated before $21 million of net prepayments to publishers and $20 million of cash interest payments, which is another way we look at this internally. We add back publisher prepayments and cash interest payments because publisher prepayments are an investment in our business that we consistently earn back and over time will become insignificant portion of our business to none and cash interest payments are a capital structure decision. Taking a step back,…

Thanks, Adam, and good morning, everyone. As Adam shared, we had a solid third quarter. We met or exceeded our Q3 guidance on all measures despite macro headwinds. Revenue in Q3 was $332.5 million. ex-TAC gross profit was $129.3 million and adjusted EBITDA was $24.2 million. This represented ex-TAC growth of 1.9% year-over-year or 5.7% on a constant currency basis. Pro forma with Connexity, ex-TAC would have declined 5% year-over-year on a constant currency basis. Our adjusted EBITDA margin or the ratio of adjusted EBITDA to ex-TAC gross profit was 18.7%. Q3 revenues decline of $6 million was driven by decreased revenue from our existing digital property partners of $29 million. The weak macroeconomic situation that started in Europe in Q1 spread to the U.S. and much of the rest of the world around the middle of June, continued into Q3 which translated to a pullback by advertisers and resulted in weaker yields and a decline in revenue. Our ex-TAC net dollar retention for our existing publishers was 86% for Taboola on a stand-alone basis. which is an extremely unusual event in our business to have an NDR below 100%. On the positive side, new digital property partners drove $22 million in growth in our gross revenue. As we have said previously, 2022 will be one of our best years on record in terms of the addition of new supply. We also saw growth in our revenues and ex-TAC gross profit from the addition of Connexity to our business as well as growth in Taboola News. Looking at operating expenses, they were up $16.3 million year-over-year. The increase was driven by $12 million of higher employee related costs, which was largely driven by a competitive labor market entering 2022 and approximately $3.4 million of restructuring costs. A majority of the…

[Operator Instructions] Our first question comes from Andrew Boone with JMP Securities.

You highlighted the $21 million of publisher prepayments on the call. Given the macro environment still hit smaller players like RevContent, Gemini, kind of five or six players that may be out there may pull back. Can you just talk about your appetite in 2023 to either invest more in publisher prepayments and try to take more share or how do we think about that? And then, Adam, you quadrupled your engineers focused on performance advertising. Can you just talk about where you're pointing them? Is there low-hanging fruit that you see out there on the product front? What are you guys thinking about in terms of improving the performance advertising tool set for advertisers?

Andrew, good questions. So first, I'll take the question about the publisher prepayments. The way we view this is we generated -- we expect to generate over $60 million of cash this year before about $21 million of net publisher prepayments and about $20 million of cash interest expenses. So we feel like that's a healthy level of cash flow. Those publisher prepayments, we look at those as an investment in our business because it's an investment in locking in long-term exclusive supply with publishers. So it helps us do two things. One is it helps us get new publishers to come to us because it's one way that we put our money where our mouth is and really guarantee them that they're going to make the money they expect. And two is it helps us lock in longer-term contracts. So if you're talking to a publisher about a three- to five-year contract, you can get them to move towards five years by upping the amount of cash they get upfront. So that helps us also lock in longer-term agreements. We think these are actually one of the best investments we can make in our business so we do expect to continue to use these as a tool both to win new publishers and to lock in longer-term publisher agreements. So we will continue to use those. We do expect to continue to use them into 2023 and beyond. Having said that, the way we look at it is we set a budget for ourself on those. We look at using it for publishers that we consider strategic so we try and use these where we think we're going to win a publisher that is particularly impactful to our business and we also make sure that we use this on publishers that have very good credit rating. So we basically have very rarely ever lost any of this money that we've used so it's something that we look at as kind of a credit risk. So generally speaking, we have an appetite to continue using those. I think we'll be judicious about it though and we'll always make sure that we generate positive free cash flow even after we use that as a tool. So as we head into 2023 when we budget for these, we'll make sure that we're still generating positive free cash flow even before them. But at the end of the day, it's a great use of cash because it's an investment in our business and getting that long-term exclusive supply that we find so valuable and that helps us win advertisers and grow our business over time.

Let me just add, Andrew, that in addition to that, over time, and I mentioned that in the letter, the more we invest in helping publishers drive audience from Taboola News and things of that nature, homepage for you on the engagement front, e-commerce to drive more revenue. So the more we invest in technology and diversify our business, publishers will have more reasons to work with Taboola beyond just traditional revenue, and that will help us win more publishers. And over time, I suspect that the prepayment will become insignificant to potentially nothing. So that's something that I mentioned in my letter. So right now, it's a great investment. Over time, as we continue to be bigger in investment technology, I suspect this will go to become insignificant or nothing.

Yes. That's a good point. I'll just add one other thing, which is if -- we released some numbers in Adam's shareholder letter, if you look at 2020, when we were in eye of the pandemic, we decided to cut back on those publisher prepayments, and they were actually -- the net of them were a source of cash in 2020. So they're also controllable. So they're something that we can control when we want to.

Yes. So that's on that. And then on the performance advertising, it's our number one as a reminder, and again, it's in my letter, but there are four things we're investing in right now as a company, performance advertising, which will help us drive yields and revenue from our existing publisher base. And that's a huge upside because Taboola already reaches 0.5 billion people a day. So that's big. We have 15,000 advertisers. Google and Facebook each has 10 million. So there's such a huge opportunity there. The second one is header bidding and display advertising. The third one is e-commerce and the fourth one is Taboola News. Specifically about performance advertising and SmartBid, there are a few things that I can mention just specifically right now in the context of your question about what's low-hanging fruit. So the first one is DCO. We're seeing SmartBid is able to look at Connexity. This is one of the synergies that we're most excited about. SmartBid is able to look at Connexity's data and retail advertisers and automatically find supply on our publishers now that it makes sense to put those retailers and automatically change the creative of the retailer on our publishers' site. That is now about 4% of Connexity's revenue. So this is pretty big. If you remember, when we talked about the synergies of e-commerce and Connexity, we said the largest one will be to bring e-commerce to advertisers in our existing supply globally, and that would be probably the top synergies. So that's gaining traction. I would say 50 out of the top 100 Connexity retailers are on DCO now as part of SmartBid ability to do that. So that's one thing that's gearing up and getting a lot of momentum and growing very fast. And if you…

One moment for our next question, please. And our next question comes from Laura Martin with Needham & Company.

Can you hear me okay?

Yes.

Of course.

Fantastic. So just following up -- just building on that last question, where we're going into these very uncertain times and a lot of guys are taking down sort of 4Q and next year, does that affect the cost of your guarantees, like you get better deals in environments like this because you're willing to give them guarantees in an environment where there's so much uncertainty. So building on that last question. And then my second question and last is, I know you guys really like cut down on your employees and cut the free cash flow. But I'm just wondering, so we have Twitter laid off half of its workforce the other day, Meta this morning announced 13% layoff. Does it help you to buy this really great engineering talent that's coming available right now that we couldn't have known when you were sort of tightening your belt a couple of quarters ago. Does it tempt you to try to come into market and buy some of these talented engineers that are getting laid off sort of indiscriminately right now by big tech?

Thanks, Laura. So good questions again. So I'll start with the cost of the guarantees one. So I think these kind of tougher economic times like right now with the macro effect our guarantees in two ways. So on the one hand, our yields are a bit lower, and therefore, we come up closer against those guarantees. The good news is that our guarantees are not a hugely significant part of our business. So we've been around 10% in terms of our tax paid out under guarantees. This past quarter, we were at 12%. So we're still in basically the same range, and it has not had a significantly material impact in that regard. The other effect, which I think is what you were getting at is, can we sign up publisher deals at better margins given the macro and given kind of potential weakness among our competitors. And I -- it's hard to say exactly because every deal is a competitive bidding situation unto itself. But what I will say is, we are having a record year in terms of signing new publishers, as Adam mentioned. And it's basically -- some of that probably has to do with what you're talking about there, where -- while we're seeing yield softness, I think it's affecting some of our competitors even more. So yes, I do think it helps us to sign up more publishers more profitably, and we are seeing a record year in that regard. We're also seeing, by the way, one of the lowest years we've had on record in terms of our churn rate of our publishers as well. So we're signing more, we're losing less. And we have said before, but we think that coming out of this, when the demand recovers, we're positioning ourselves from a supply perspective to be -- to have a really nice growth path coming out of this because supply side is growing really, really well. The only thing that is holding us back a bit right now is the demand weakness. So we're positioning ourselves well coming out of this. So I do think it's the weak macro is helping in some ways.

Yes. I also think, jumping on that, to follow up, I think the fact Taboola is well invested in a variety of services and technologies publishers want is a big deal. So if you're a publisher now and you're about to sign a three-year, five-year, five-year partnership, one, Taboola is very diversified. We have e-commerce revenue. I just mentioned DCO, being 4% of Connexity and 50 of the top 100 clients are using DCO. You know that video is growing for us. We have Taboola News on the audience front with integration with top OEMs. So publishers, especially right now, they're looking for partners that can do more than just revenue. So one, Taboola's revenue is further diversified and stronger than others. We're also among the largest players in the space, but also they have a lot of technologies that can use at no cost, which help them recover their own business and drive growth. So all of those things, I mean, really contribute to some of the most amazing publishers who chose Taboola just in the last 90 days, I mean Buzzfeed and Huffington Post, MOPO in Germany, Terra in Brazil, Cyzo in Japan. I mean these are incredible partners that choose Taboola. And I think now more than ever, we're getting that level of momentum. And that also why it helps us to reaffirm $152 million EBITDA this year, which I'm very proud of, I think, which leads to your second question, we're trying to run a business that not only is a great business now, but can be even stronger on the other side of it. And especially, you're able to generate strong EBITDA and strong cash flow, I think we'll have many, many opportunities other companies might not, right? In 2008, it was one of the best years for Google attracting talent. So we're hard at work looking for great people. At the management level, we're seeing what companies do make what type of changes. We already have a relationship with different engineers that work in other companies. So my hope is that, we'll be able to have opportunities with talent, but not only -- I mean we might have other things that will come our way, smaller M&A opportunities and different things. So having cash flow and EBITDA in times of uncertainty is a huge source of strength.

One moment for our next question. And our next question comes from James Kopelman with Cowen.

The first is for Adam. It certainly looks like you're seeing a lot of strength with new publisher wins. Can you talk about the biggest factors that are attracting these publishers over to Taboola? And then as you look out maybe a year or two ahead, what are the key areas of focus and investments that will help you to continue to improve these value-added services that you offer the publishers? And then I have a follow-up for Steve.

Yes. So there are three reasons now why we're in. And I can tell you where I think it's going two, three years from now. So right now, if you look at what can publishers do, most companies in our space invest millions of dollars to maybe low tens of millions of dollars in R&D, and we invest close to $100 million or around $100 million a year for a bunch of times. So if you look at just Taboola News as an example, we've been working on this for five years. If you're a publisher working with Taboola now, some of our larger publishers get 5% to 10% of traffic from Taboola News. Now to give you an example, if you were to buy traffic at that level from anyone, it could cost you millions of dollars, but working with us, you get the traffic for free. Now we all know that Google became a very important piece of the open web because they were able to drive SEO traffic. So those who control traffic and are able to help people discover things and get to publish your websites, it's as important, if not more than revenue. That's $50-plus million of revenue for Taboola this year. And I already mentioned last earnings that -- we'll spend about $0.5 billion clicks to publishers in 2022, $0.5 billion. You can only imagine what happens to us when we're going to grow that business to billions of clicks a year. So audience is one of them. The second thing is that when you think about revenue because we're diversified because we're able to bring different types of advertisers because we invest in AI so much, I believe our revenue is between 30% to 50% higher than any other companies in our space.…

Great. And then just a quick follow-up for Steve. Steve, as we think about the broader macro into October, now into November, can you provide any color on what you're seeing in terms of what may be driving additional softness in ad demand or what you think might have changed from an advertiser spend perspective? Any color there would be helpful, especially if you could call out any ad verticals or maybe regions that are seeing potentially additional deterioration relative to the third quarter?

Sure. So first of all, we're seeing relatively normal Q4 seasonality at this point. So we're not seeing anything that's kind of out of the normal for Q4 knowing that we entered the quarter kind of weaker. So we're seeing kind of a little bit more stability there. In terms of verticals and the like, we're pretty well diversified. So we're fairly well shielded from any single vertical. We've seen things come and go over the course of the year. Cars at one point were really weak or the auto vertical is very weak, and now it's a bit stronger again. Travel, obviously, at one point was much weaker, and now it's much stronger again. So there are ups and downs in various verticals, but it kind of gets balanced out in our business, and we don't see any particular area that stands out. I think the way we're looking at things right now is, we can't really predict the macro, but the fundamental -- the underlying fundamentals of our business are very strong. So we've mentioned a few times that we continue to add new supply like Buzzfeed, which just launched with us and all of that is very strong. And we feel like there will, obviously, at some point, demand will be coming back, and that's going to really give us a good growth path from there. I think in general, what we're seeing on the demand side is, we're keeping our advertisers, they're just spending less with us. And so at some point, we think those budgets are open back up. But in general, fundamentals are still strong, and it's not like there's a particular vertical or anything like that, that's driving softness. It's just advertisers have reduced budgets a bit right now.

[Operator Instructions] Our final question comes from Stephen Ju with Credit Suisse.

Okay. So Adam, given what you're talking about in terms of the potential for higher yield for your publisher partners, I mean, in the event that you lose existing partners or lose an RFP process, what is the reason business may be heading to some of the competitors at all?

Yes. So one, let me just say we win a lot more than we lose, and that's not an event we see a lot of times. But when we do lose, usually someone else was able to -- or wanted to commit for a level of revenue we thought would be not responsible and not something that would be a good partnership for a long time. So I would say one reason would be some revenue commitment that we would model as a bad partnership. And from our experience, we have T-shirts, many of our employees here have, it's called always come back. They always come back. And what happens when you sign a best partnership, in the moment, you might find it to be satisfying because you want. But over time, tension is being built. You're not able to generate that revenue. You're not able to pay that revenue and those companies tend to eventually break the relationship and those publishers, a lot of times come back. And there are many of those cases, and that's why we have the T-shirts, they always come back. So I'll say one reason is revenue. The second thing is, it could be relationship. We're still a small company, only $1.4 billion out of $64 billion. So a lot of times, there may be a publisher that works with someone else for the last 10 years in the strong relationship. And at times, those relationships matter and we appreciate that. So that can be another reason why we lose. So I would say mainly when we do not win, it's either some revenue irrational decision by someone else, which can happen many times. But when it happens, that's the reason we can lose. And second thing is relationship, which, over time, we hope to build those relationships ourselves and win the deal.

At this time, I'd like to hand the conference back over to Mr. Adam Singolda for closing remarks.

Thank you. So I wanted to just say thanks, everyone, for joining today. There's obviously a lot going on. I'll say a few things that I mentioned in my letter. One, personally, I feel more focused than ever. I just talked to a few people this morning. A select Taboolas of 30 people start up and how energized and focused people are. Our people are strong. And I'm energetic about the future of Taboola to become the leading recommendation engine for the open web and our ability to change the way consumers discover information outside of the walled garden, especially during these days with the privacy and all this madness that we're seeing. I'm so optimistic about trusted source of information and how consumers will discover news. Our fundamentals, the metrics that our management team is tracking every single day. We're getting daily e-mail with those things. Those are strong, perhaps the strongest they've ever been. Our culture is strong, we have the strong EBITDA, we generate cash and we have growth engines that can double and triple Taboola, e-commerce, header bidding into display advertising inventory, performance advertising and Taboola News. So when I look at all those things, I know those times are crazy, but we're focused. I'm excited about the future, and I look forward to talking to many of you. Thanks for joining today.

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.