Tremor Video Bull Case Strengthened Following Review Of First Annual Report

| About: Telaria, Inc. (TLRA)
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Tremor released their first 10-K annual report on Friday to investors.

Nearly 100% YOY growth in small but high-margin analytics licensing business.

Fear of heavy client concentration in a few key accounts is outright dismissed.

Aggressive expansion of patent portfolio consisting of proprietary advertising technologies.

On Friday, Tremor Video (TRMR) released their first ever 10-K annual report. Previous to this filing, the last detailed report that investors have had access to was the S-1 filed in May 2013. A lot has changed in nearly a year, both with the company and the Ad Tech industry in general.

I recently laid out the bull case for Tremor, based on 5 key catalysts:

  • Company in midst of epic transformation to programmatic advertising solution, which will drive future margin expansion and revenues.
  • After a recent IPO at $10, Tremor has an impeccable balance sheet with nearly $2 per share cash, no debt and positive net operating cash flow in 2013.
  • High growth story in booming niche industry with analyst projections of a 25% increase in sales from 2014-2015 driven by exclusive publisher deals.
  • Multiple accounts of insider buying and zero instances of selling since August 2013 IPO which is very unusual for an IPO.
  • Likely takeover target due to proprietary software and patents and same CEO and CFO combination that found and sold to Primedia.

Following the release of the 10-K filing, I was interested in confirming, strengthening or weakening my buy thesis. I read this 59-page report with an open mind. As with all annual reports, the majority consists of standard disclosures and somewhat boilerplate discussion on company overview. However, the first report from a public company normally has a few hidden gems in it. I will review 3 key takeaways from the 10-K that have strengthen my Tremor Video bull case, so much so that it has become my Top Pick of 2014.

1) Tremor Video has seen near 100% YOY growth in their high-margin VideoHub analytics licensing program.

From the 10-K:

In 2012, we also began licensing VideoHub analytics to advertisers and agencies through an intuitive, customizable user interface. This license solution affords advertisers transparency and analytical tools to measure the effectiveness of video ad campaigns across all of their video ad buys, whether or not those campaigns are run through the Tremor Video Network. Recently, we also began to license VideoHub analytics to publishers who can use the platform to gain insights into what is driving the performance of ad campaigns running on their sites. In 2013 and 2012, we generated $3.2 million and $1.7 million, respectively, of revenue from licensed analytics-solutions. Our gross margin on this licensing revenue is generally higher than that for the Tremor Video Network

While they discussed this licensing initiative on earnings calls, investors haven't been given much details other than it is a small but high-margin business segment. Granted it is only $3.2 million in 2013 and just under 2.5% of their $131.8 million revenue total for the year. However, it is a very desirable high-margin licensing business, which is increasing at a much faster rate than the core in-stream video advertising business.

More importantly, this strengthens my own findings that the proprietary VideoHub platform is based on industry-leading technology. It is so strong that companies not even running campaigns with Tremor are willing to pay to license VideoHub for its advanced analytics capabilities. That is quite an impressive feat considering all the analytics tools that exist in this highly competitive market, many of which are low-cost or free solutions.

2) Fear of heavy client concentration in a few key accounts is outright dismissed.

From the 10-K:

We do not believe our business is substantially dependent upon any individual advertiser as no individual advertiser represented more than 10% of our revenue in 2013...

One of the concerns I keep hearing when talking to investors about Tremor is the perception that revenues are not very diversified. I think this stems from the competition, where heavy key client concentration is a major concern. Of course, when a company derives a substantial part of their sales from a single customer, that is a negative risk factor.

For instance, YuMe (NYSE:YUME) just released their first 10-K report on Thursday and disclosed that they have a single advertising agency customer that represents 19% of their 2013 sales. I recently wrote about YuMe and am very bullish on their prospects, but a definite nod goes to Tremor in the revenue risk profile category.

3) Aggressive expansion of patent portfolio consisting of proprietary advertising technologies.

From the 10-K:

We currently own two issued U.S. patents that expire in 2028 and 2031, respectively, and one granted European patent, which we registered in France, Germany and Great Britain, that expires in 2029. Additionally, we currently own seven pending U.S. patent applications that we are currently prosecuting with the U.S. Patent and Trademark Office...

In their S-1 from May 2013, Tremor did not own any registered US patents, and now, they have 2 of them. The first one registered in November 2013 is for the "Method and apparatus for tracing users of online video sites". And most recently, Tremor received a patent for "Methods and apparatus for optimizing advertisement location". This particular patent seems quite significant, as they issued a press release about it that stated:

This patent relates to the process that is continuously learning and optimizing the delivery of ads to maximize campaign performance for brand objectives. Tremor Video's technology is unique because it balances performance with reach goals of advertisers while ensuring delivery of an ad to the right person, at the right time, in a brand-safe environment. Such technology allows Tremor Video's clients to optimize towards brand performance in ways they never could before.

What is important to note about this patent is that it covers Artificial Intelligence (AI), which is a big buzzword right now in the Ad Tech industry. This is the technology that Tremor is using to drive margin expansion in 2014 through their performance-based pricing model. Rapid adoption of this solution by Tremor's clients is what will drive this growth story.

Currently, Tremor is trading at less than 0.7 times FY2014 sales, once you back out their significant cash holdings. In an industry where companies like Rocket Fuel (NASDAQ:FUEL) trade at 4 times, plenty of upside exists in shares of Tremor. It is worth noting that while Tremor trades at about $4 per share, they have cash on the books of nearly $2 per share and zero debt, leaving little downside risk.

I believe that Tremor has a unique opportunity in their market of in-stream video brand advertising to really capitalize on this fundamental shift to AI technology-driven performance-based pricing. They are rapidly ramping up their deployment of this model. This involves educating their big brand advertising clients, who up until now favor the standard TV-style lower-margin demographic advertising buying. These clients include all of the top 10 auto makers and 9 of the top 10 consumer packaged goods companies.

As it stands, Tremor derived over 29% of their revenues in 2013 from high-margin performance-based pricing, compared to only 7% in 2011. I expect this number to be as high as 50% in 2014. A sharp increase in this key metric will drive both revenues and margins, and of course, the price-to-sales multiple on the Tremor stock itself as the company starts to be considered by investors to be more high-tech.

Perception is everything when it comes to the value that the market places on a stock, and right now, Tremor is being valued like an old school pen-and-paper ad agency, when in fact, they are on the forefront of technological and systematic innovation in a market that few truly understand.

Disclosure: I am long TRMR, YUME. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.