SEMrush Holdings, Inc.

Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the SEMrush Holdings Third Quarter 2022 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. To withdraw your question, press star 1 again. I would now like to turn the conference over to Bob Gugivardi, VP, Investor Relations. Please go ahead.

Good morning. I'm Bob Gugivardi, VP of Investor Relations, and welcome to Semrush Holdings' third quarter 2022 results conference call. We will be discussing the results announced in our purpose release issued after market close on Monday. With me on the call is our Chairman and CEO, Oleg Shagalov, our CFO, Evgeny Fetisov, our President, Eugene Levin, and our CMO, Andrew Ward. Before we begin, I'd like to highlight our participation in the 12th Annual Needham Virtual Software as a Service 101 Conference and the Southwest Ideas Conference in Dallas, both this week. Today's call will contain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements concerning our expected future business, and financial performance and financial condition, expected growth, adoption and demand for new and existing products and features, industry and market trends, our competitive position, our market strategies, market opportunities, our guidance for the fourth quarter of 2022 and the full year 2022, and our ability to successfully relocate employees outside Russia, including executing our relocation plans on the timeline we expect and at the anticipated cost. These forward-looking statements can be identified by words such as expect, anticipate, intend, plan, believe, seek, or will. These statements reflect our views as of today only and should not be relied upon as representing our views at any subsequent date, and we do not undertake any duty to update these statements. Forward-looking statements address matters that are subject to risks and uncertainties that could cause actual results to differ materially from those forward-looking statements. For discussion of the risks and important factors that could affect our actual results, please refer to our annual report on Form 10-K filed with the Securities and Exchange Commission, our quarterly reports on Form 10-Q, as well as our other filings with the SEC. Also, during the course of today's call, we'll refer to certain non-GAAP financial measures. There's a reconciliation schedule showing the GAAP versus non-GAAP results currently available on our press release issued after market close. which can be found at investors.femrush.com. And with that, let me turn the call over to Oleg.

Thank you and good morning to everyone on the call. I'm very pleased with our results in the third quarter. Despite a more uncertain demand environment, we experienced solid growth with a revenue of $65.8 million, up 34% year-over-year and up 5% from the previous quarter. As of the end of September, we had approximately 94,000 paid customers, and I would note that we had slightly more customers in the first quarter of 2022 than in the year-over-year period. The strength in new customer ads was partially upset by low expansion from existing customers, particularly those customers with larger average revenue per user. And this team has done a wonderful job. leveraging our high marketing spend to drive new customer growth. We continue to fine-tune our go-to-market spending, and I'm hopeful that we will continue to see solid new customer growth in the fourth quarter. On the product front, we rolled out a major update to our social media management toolkit, and I believe this update brings us closer to future paychecks with the leaders in the space. We ended the quarter with over 50,000 monthly active users of our SMM toolkit. And we estimate more than half of these users are dedicated social media marketing professionals, demonstrating our ability to expand our total addressable market beyond digital marketing professionals. At the moment, the team remains focused on user growth However, we may introduce a paid offering in late 2023. In January 2022, we introduced our App Center, which allows our customers to use third-party applications with our purpose built to address a variety of use cases on our platform. Despite relatively few new launches, our App Center continued to see strong growth in the quarter. We have a great lineup of apps set to launch in the near future, and this should boost App Center growth in the fourth quarter. Eugene will expand on our studies around App Center in his remarks, but our goal is not simply to set up a total operation as the mobile platform operators have done. We see the App Center as central to extending the reach of SEMrush platform. It's clear We face a more uncertain demand environment compared to a year ago. However, I believe SEMrush is uniquely positioned to continue to sustain our strong growth. Customers are looking for products that are easy to purchase, easy to use, and deliver quick return on investment. And our product checks all these boxes. This year has been full of challenges, but despite these challenges, We delivered a strong craving for growth and executed a substantial relocation program on the budget and ahead of schedule. SEMrush has always operated with efficiency as high priority, and as a boot-set startup, we hardly had any choice in the matter. Today, we are a successful public company, but the focus on efficiency remains. We will pursue growth, but growth underpinned by solid unit economics. I will now turn the call over to Eugene for a more detailed discussion of our App Center strategy.

Thanks, Oleg. Looking at the marketing technology space, what is immediately clear is that the market is highly fragmented, and therefore consolidation has been very slow. The fragmentation of the technology stack is a direct result of the varied preferences and use cases of marketing professionals. There are a handful of product categories that are large enough to give birth to successful public companies. For example, SEMrush in SEO, Sprout Social in social media management, MailChimp in email marketing are a few such examples, but most market vendors are small and remain focused on niche use cases. We leverage success in SEO to expand into new categories such as competitive intelligence, digital PR, content creation and other areas primarily through internal R&D. As we look ahead, the use cases continue to expand but it's simply not feasible or practical for SEMrush to build solutions for all the different use cases internally as our R&D resources would need to expand exponentially and thereby limit our ability to invest elsewhere. This is the crux of our App Center strategy. To address a fragmented market, including many niche use cases, we seek to offer a wide variety of product capabilities without overwhelming the capacity of our internal development team. To solve this, we intend to offer third-party applications that address customer needs in instances where the third-party solution has a wide adoption and we have decided not to build internally. Over the long term, we believe a substantial portion of SEMrush revenue will be driven by products created by partners, but are only made possible by the SEMrush platform. Another promising feature of the App Center model is the potential to monetize free active users. As many of you know, we have a large and growing cohort of free active users on the platform. These users may have very modest requirements, and the full functionality of the entry-level pro plan may be overkill for their needs. They may be interested in limited functionality offered by a lower-priced app with the possibility to trade up to a SEMRA subscription in the future as their use cases expand. As we continue to grow the SEMrush platform, I believe partners, whether they be third-party developers or leading companies like Wix, will increasingly see value in collaborating with SEMrush. The App Center is central to our wide platform strategy, a strategy that I believe will lay the foundation for our growth well into the future. Evgeny will now provide detailed discussion of our financial performance.

Thank you, Eugene. Third quarter revenue of $65.8 million was up 34% year-over-year and up 5% from the previous quarter. Customer growth of more than 17% was consistent with the previous quarter, but average revenue per user growth moderated due to lower expansion from existing customers. I would note product miscarriage and change in the quarter, with growth only slightly favoring our entry-level pro plan. As expected, our dollar-based net revenue retention for the third quarter was down to 122%, as we love the easy comparisons of the COVID-impacted periods, and also impacted by lower expansion from existing customers I mentioned previously. No gap gross margin of 81.2% was up over 400 basis points from a year ago, and up 160 basis points from the previous quarter. We are achieving strong leverage in our cost for hosting services. However, I expect gross margin will decline slightly in the fourth quarter. Total non-GAAP operating expenses, including exit costs, were $55.8 million in the quarter, up 48% year-over-year, and up 6% for the previous quarter, with the majority of growth coming from investment in sales and marketing. Sales and marketing was $31 million in the third quarter, up 48% from the previous year, but essentially flat from the prior quarter. The growth year-over-year was primarily due to increased investment in brand marketing and headcount. Research and development expense was $9.8 million in the third quarter, up 61% year-over-year, and up 5% from the previous quarter. The year-over-year and sequential increase reflects higher headcount as well as increased compensation expense related to relocating development resources to higher-cost GEOs. GNA spending of $15.6 million was up approximately 43% year-over-year and up 23% from the previous quarter. The growth is primarily related to higher headcount, and the costs associated with relocating key personnel to high-cost locations. Investment to support more robust IT systems and a wider geographic footprint also contributed to the increase. Strong gradient growth and higher cost margins were more than upset by higher expenses and contributed to a non-GAAP net loss of $7.1 million compared to a non-GAAP net income of $12,000 a year ago and non-GAAP net loss of $6.1 million in the second quarter. I would note that exit costs represent more than 80% of our non-GAAP net loss in the quarter. Turning to the balance sheet, we entered the quarter with 247 million of cash, down only slightly from 249 million in the second quarter. Our cash flow from operations was negative $500,000, and we incurred approximately 500,000 of net capital expenditures. I'm pleased with our ability to minimize our use of cash in the quarter and expect our cash generation will continue to outperform our non-GAAP operating income in the fourth quarter. Looking ahead to guidance. Although the fourth quarter is typically a strong quarter for SEMrush, we believe it is prudent to be slightly more cautious given the more challenging economic environment which we believe impacts the demand for our products. We expect fourth quarter revenue in the range of 67.25 to 67.75 million dollars up approximately 26% year-over-year at the midpoint. For the full year, I expect revenue in the range of $252.8 to $253.3 million, which would represent growth of 34% to 35% year-over-year. We expect a fourth quarter non-GAAP loss of $12.5 to $11.5 million on a non-GAAP loss of $26 to $25 million for the full year of 2022. The incremental spending in the fourth quarter is primarily due to the full quarter impact of the employees we allocated from Russia, and to a lesser extent, additional hiring in these new locations. We expect to incur higher payroll and benefits expenses, as well as increases related to supporting multiple new office locations. We continue to execute well, and although we're not immune to macroeconomic headwinds, I believe we're well positioned to deliver another year of solid growth. With that, we're happy to take any of your questions. Operator, please open the line for questions.

At this time, I would like to remind everyone in order to ask a question, simply press star, then the number one on your telephone keypad.

We'll pause for a moment to compile the Q&A roster. And your first question comes from the line of Elizabeth Porter with Morgan Stanley.

Please go ahead.

Great. Thank you so much. I just wanted to touch again on the MAC realm. We've heard from a lot of companies about customers scrutinizing spend more, but it seems like SEMrush is a little bit more insulated from the dynamic, just given the small deal cycle sizes and short deal cycles. So what exactly are the changes you're seeing and when did they start to occur? I believe August was an improvement from July. So did they start to happen at the end of the quarter?

Thank you. So, hi, this is Eugene.

So, in terms of macro, we see impact in larger accounts, but in terms of performance of our core base, we don't see, you know, that much difference. So, I would say actually, you know, and somewhat surprisingly, small business segment is holding pretty well, which is, you know, I think was counterintuitive for many experts that we talked to. But yeah, right now this is largely limited to larger transactions, mostly existing customers going through a renewal process. You know, sometimes it takes them a little bit longer. Sometimes, you know, where previously they would buy more, they stay with their current subscription. You know, sometimes they experience layoffs, so they have to downsize their subscriptions. So that's what we are referring to when we talk about macro situations, but, you know, small, business segment when we look at total number of expansions is doing pretty well.

Does that answer the question?

Yes, it did. And then I believe last quarter you mentioned some changes just in the sales leadership segmenting around customer acquisition versus upsell versus retention. So I wanted to ask if there were any disruptions from those sales leadership changes Or alternatively, what are some of the improvements that you've seen since you've reoriented sales? Thank you.

Good morning. Yes, you're right. All the time changes bring some concerns for people and so on. But I would say it's insignificant. I don't see a big impact from such changes to what we have right now. I would connect current results more to MACRA.

Thank you. Our next question is from the line of James Heaney with Jefferies.

Please go ahead.

Great. Thanks. Just another one on the MACRA. Curious what you're assuming just for Q4 in terms of the guidance. Do you assume it gets worse or things are relatively stable? And then my second question is just around headcount, how you're thinking about that for next year. You talked about, obviously, the relocations, but are you planning on adding any incremental headcount for next year? Thank you.

Related to fourth quarter, look, from one side, we feel some positive signals from demand, and we are very, very optimistic on our long-term future. At the same time, last couple of years, it was some sort of new seasonality with all these COVID things. And it's hard to imagine what we will face in COVID season this year. As a result of it, we want to be a little bit cautious with our expectations for quarter. And for the second quarter, related to second question related to our account next year. There are many companies around us who are playing with such layoffs and we don't expect any kind of such things on our side. This year it was a relocation process because of editing from Russia and at that moment our hiring was almost freezed. And because of that, I think right now it's not needed to put our hiring on stop. It's not needed to reduce our headcount right now.

I think right now we are in a very good shape. Thank you. Your next question is from the line of Mark Murphy with J.P. Morgan. Please go ahead.

Oh, thank you very much. Following up from an earlier question, I'm curious, Evgeny, can you compare the demand environment, what you saw back in July and August, starting Q3, and if you compare that to what you saw in September and October, is it safe to assume it's getting a bit tougher out there demand-wise as you head into the winter, or does it feel like that the environment had maybe stepped down a bit kind of back in the summer and just remaining at that level?

So this is Andrew Warden, CMO here at SEMrush. I would say just commenting on the demand environment. So pointing to the summertime, actually August was one of our record years in terms of August is typically one of our lowest months in terms of demand. But we saw, we were surprised by and saw that pivot. The second piece is as we go into September and October, Demand continues to be very strong. But I will say, again, in this environment, you know, one week we see a little bit of pressure, then another week when we launch another experiment, we see an upswing in demand. So right now, that's why we point to be cautious, but we're optimistic.

Okay. So cautious but optimistic. Demand was better, but sometimes it's worse, and sometimes it's better. I'm just trying to kind of listen through that. I don't really understand which way the environment is changing. I mean, do you feel that the environment is degrading as time passes?

I don't see at this point any sign that anything is degrading. Okay. For us.

Okay, understood. Can I ask you, as you look into early next year and we think about the seasonality of booking, it's been pretty first half weighted in 2021 and 2022. And I think you've had various reasons there. We have the COVID environment. There was some pricing and packaging changes in some of those years. Do you expect that type of trend to continue into 2023, where you're booking a little more business in the first half? Or do you think it's going to revert back to something more normal, perhaps with higher bookings in the second half?

Yeah, so we think there will be somewhat similar seasonality.

I think next year we would expect it to be a little bit more kind of flattened because like you said, previous couple of years we had some unique events and plus a lot of our campaigns have been not executed equally during the year and there have been some spikes in our spend, especially when it comes to brand campaigns. I'm sure Andrew can provide more details around that if you would like.

I would be happy to provide additional comments. I think that especially when we look at 2022, we were delayed in launching some of our larger campaigns until the first week of March, which were planned earlier in the quarter. We are now in a different position and already set up for Q1 for campaigns to launch very, very early in the season or early in the quarter. So, again, we are optimistic that as we're pushing more noise into the markets, we expect to see demand continue.

Thank you. Our next question is from the line of Scott Berg with Needham. Please go ahead. Hi, everyone. Congrats on the good quarter.

Thanks for taking my questions. I guess I have a couple here. I wanted to start with the App Center commentary because I think some of the comments there were new. I wanted to help better understand how you ultimately monetize some of the free users on the platform. And if we think about the functionality that those partners will bring, what's the kind of long-term revenue opportunity that's possible to generate with your strategy here? Because I think the comment was, Do you expect to make a significant amount coming off that product?

So, first of all, thank you for the question because that's one of the topics that I like to talk about. In terms of monetization of free users, the way we think about this is that, you know, our entry-level product starts at $120 per month. For many people, this is a, you know, reasonable price to pay for a starting package. For some people it is, it is not, maybe they're very early in their marketing journey. They don't expect to invest that much money. Maybe their business is struggling. Maybe they're solopreneurs and you know, they, they just don't want to spend that much. Uh, and also a lot of them don't need all the functionality that we provide, even on our entry level plan, which is quite robust. So with app center, they could start with something smaller, you know, let's say for $20 or $50. And we think that would increase percentage of free active users who start paying something. And then over time as they learn more, as their businesses grow, they will probably buy more. Um, so that's the idea around how app center helps to increase conversions from free active users to paying customers. Uh, and then in terms of longterm potential, Of course, this is very early for us, and that's very hard to say, but the way we are thinking about this, you know, it's a fragmented market with a lot of different use cases covered by a lot of different products. You know, we find a lot of inspiration in business models executed by companies like Amazon, or if you're familiar with gaming market, there is Steam Marketplace for gaming. So those are you know, companies that inspire us in terms of marketplace models. And of course, in SaaS world, there are other examples like, you know, Shopify, for example, has really good ecosystem of apps within SaaS space. So I think looking at those examples, you can see what percentage of revenue is feasible for app centers like ours. But of course, so my point is we are very optimistic. But it's too early to say.

Fair enough. And then a follow-up question. If we look at the cost structure in Q3, most of your relocated Russian employees are likely in, you know, in their new locations here in Q3. I'm sure there's a little bit of trickle that's still in the Q4. But if we look at the cost structure in Q3 and what's effectively $65 million worth of operating expenses, excluding the exit costs, is that the right way we should start thinking about the model into next year, or are there some other puts and takes to consider? Thank you. So, Scott, this is Evgeny.

So Q4 will be the quarter to be using as a baseline for next year because in Q3 people were still moving, right? Some of them were in transit or in buffer locations. So Q4 will be the proper base to start modeling next year. That's when we'll start incurring our full cost of people being in their final locations.

Great. Very helpful. Thanks for taking the questions, everyone. Your next question is from the line of Michael Turretts with KeyBank.

Please go ahead.

Hey, guys. One on App Center. So on finance, can you talk about the decline in the ARPA growth and the decline in the expansion rate? Can you parse that? I'm not sure if you commented, but what did happen with the gross retention rate this quarter? And can you try to just review quickly what were the issues around that? expansion, and how do you believe you're addressing them?

Michael, this is Steve Guinea. So on the growth retention rate, so it didn't change much versus last quarter. So what we saw is a higher demand from the new cohorts, which started with a lower average check, and that diluted the overall growth rate. So that's the effect of that. So I would say stronger demand from the initially lower check customers, and that affects the blended rate. Otherwise, I can point to another, which may be counterintuitive when you look at the blended rates. We have our 10K per year customers growing 12% quarter-over-quarter, number-wise, or I think it's more than 70% year-over-year. So it's substantial growth in the higher-priced accounts, but at the same time, as new cohorts enter the client base, that leads to the slow growth of the average check.

Okay, so in other words, in terms of the ads, the lower price ads are still coming in at a higher rate, but still diluting more because of that point?

I think that's the right way to look at this.

Okay, and then what about on the expansion side in terms of the lower net expansion rate? Oh, yeah. So I'm having to provide more details around expansion.

So, yeah, like I said, it's really more about, you know, the behavior of existing customers who already buy a lot. And like I said, you know, sometimes deals take more time. So some of them remain on lower tiered subscriptions for longer. Some of them reluctant to expand. Some of them have different procurement requirements compared to what they had a year ago. So it's more of a softer environment. We don't see, you know, people dropping their subscriptions. You know, sometimes, like I said, if people had layoffs, they would buy less. So that's what contributes to lower expansion. You know, when it comes to SMB segment where most of transactions are self-service, we don't see that much difference. But yeah, on a higher end, total number, like Evgeny said, is growing really well. But some of those highest, you know, subscription tiers, they're a little bit reluctant to buy more where previously they would be much more eager to do that.

Okay, thanks. And then on the App Center side, I guess, I mean, it makes a ton of sense. I guess one question I would have is what compels third parties to build on your platform? I mean, obviously, you're already bundling in your brand name, so there's a commercial logic to it. Trying to figure out if there's a real product or technical logic to them running on your platform that would make it sticky and keep them loyal to running on your platform versus alternative channels for them?

So I would start that in general, like I said, MarTech is very fragmented.

So what fragmentation means for software developers is that it's much harder for them to get access to audience. It's much more expensive for them to advertise. It's harder for them to explain the value of their product. And it's almost impossible to gain wide brand recognition and earn trust upfront. So I think that's where partnering with SEMrush provides enormous value to all new app developers. We have over 94,000 paying customers, over 750,000 free active users, and that's a huge asset that attracts app developers. And I've been saying for a couple of quarters that we have a queue. We have a lot of people who want to integrate with us. Right now, the bottleneck is just our technical ability to launch those partnerships. which we're working on. But in general, demand to partner with us is very high among developers. And like I said, of course, audience is a big asset, but also we have some data assets. SEMrush data powers a lot of third-party applications, but sometimes buying data from us is expensive, and a lot of people would rather partner with us and build app for our app center where we have more favorable terms for data partnerships. So that's another...

a big reason for them to partner instead of build on their own. Great, thanks. Your next question is from the line of Parker Lane with Stifel. Please go ahead.

Hi, it's Max Osner. It's on for Parker Lane. Thinking about kind of the top line for this year so far, can you give us a sense of any contribution from acquisitions that's floating in the top line?

Oh, it's very minimal, Matt. So I would say less than 1 percentage point.

So most of our growth is organic. Okay, great. And then going back to one of the first questions, did you say that lower expansion activity was more in the larger customer base and the smaller customers have been consistently growing, or did I hear that wrong?

Yes, that's correct. Okay. Got it. Thanks. That's it for me. And at this time, there are no further questions.

And this will conclude today's conference call. Thank you all for joining today. You may now disconnect.