SEMR - NYSE

Good morning, and welcome to Semrush Holdings Second Quarter 2023 Earnings Call. [Operator Instructions] I would now like to turn the call over to Brinlea Johnson with the Blueshirt Group. Please go ahead.

Good morning, and welcome to Semrush Holdings Second Quarter 2023 Conference Call. We’ll be discussing the results announced in our press release issued after market close on Thursday, August 3. With me on the call today is our CEO, Oleg Shchegolev; our President, Eugene Levin; and our CFO, Brian Mulroy. 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, but are not limited to, statements concerning our expected future business and financial performance and financial condition, expected growth, adoption and demand for our existing and any new products and features, our App Center expansion, industry and market trends, our competitive position, market opportunities, sales and marketing activities, our leadership position, the sufficiency of our staffing levels, our guidance for the third quarter of 2023 and the full year 2023 and statements about future operating results, including margin improvement, revenue growth and profitability. Forward-looking statements are statements other than statements of fact and can be identified by words such as expect, can, 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 these forward-looking statements. For a discussion of the risks and important factors that could affect our actual results, please refer to our most recent quarterly reports on Form 10-Q and our annual report on Form 10-K filed with the Securities and Exchange Commission as well as our other filings with the SEC. Also, during the course of today’s call, we refer to certain non-GAAP financial measures. There is a reconciliation schedule showing the GAAP versus non-GAAP results currently available in our press release issued yesterday after market close, which can be found at investors.semrush.com. And with that, let me turn the call over to Oleg.

Thank you. And good morning to everyone on the call. Our team performed well during the second quarter with revenue of $74.7 million, up 19% year-over-year. Importantly, we shifted to strong profitability, generating non-GAAP net income of $3.5 million. Our strong performance this quarter has positioned us to raise our overall full year guidance. We are raising our full year revenue guidance as we continue to benefit from our expanded portfolio. We are also raising our full year non-GAAP net income guidance as we continue to drive towards sustained profitability. We have returned to our routes and have a healthy business, focused on growth and profitability. Our impressive results are a testament to the value we provide to our customers and our strategic position. Before talking about the quarter in more detail, I want to take a few moments to talk about why we are excited about the future for Semrush. Over the last 12 years, we have heavily invested in a unique combination of data assets and products to build a new category of software that helps customers improve their online visibility across all major channels, such as search engine optimization, search engine advertising, social media marketing, digital AR, content marketing and Amazon marketing. This forms the basis of our platform. And while we see prudent product competitors, we believe Semrush has become the platform of choice for businesses of all sizes across all industries, all availables. We spent all market segments from solopreneurs all the way up to global agencies and Fortune 100 accounts. Our platform encompassed numerous separate tools and provides our customers with one-stop shopping for all their marketing technologies. We are very differentiated in the markets. We collect data from multiple different sources to build complete online visibility profiles of virtually every domain on the Internet. We can use this data to understand what specific market tactics are best suited for each of our customers in each geography in which we operate. Using these unique data assets we give our customers actionable insights and the steps that we need to take to improve their online visibility. Once these steps are taken, we monitor the outcomes and help our customers report on the ROI of the marketing efforts. We are uniquely positioned to help our clients in ways that others cannot. There are two main differentiators first, our strong data assets; and second, industry dynamics. Let’s take each of them separately. On the topic of our unique data assets, the data in the Semrush system is what we have collected ourselves, some of which is extremely difficult to do. It’s a unique combination of across historical data we have collected our customers in combination with data from several other locations across the Internet and new data that being fed into our algorithms that generates this highly accurate data set with predictive capabilities. This creates a network effect since then our customers share their data with us it makes our audience stronger and even more productive. This is something that would be very difficult for any of our competitors to replicate. From an industry dynamics perspective, with big tech giants with huge data assets terrifically come to mind when you think about companies with a lot of R&D, data and reach. However, these companies make money primarily from advertising. So, we believe their tools are designed to get back clients to optimize their paid advertising on their platform. Because of this, it is not in their best interest to give their clients unbiased advice on optimal use of their marketing efforts, particularly [indiscernible] ROA comes from organic efforts or on a platform other than their own. Semrush on the other hand, provides unbiased advice to its customers and their highest expected ROA marketing activities across all platforms and is able to provide its customers with information how their competitors are doing, something we believe the tech giants are unlikely to do because it would negatively affect their economics of the core advertising business. Before I conclude, I want to take a moment to highlight a couple of recent changes to our Board of Directors. Starting yesterday, Arne Berg, who has been on the Board since March, assumed the role of the Audit Committee Chairperson. Arne has impressed me from day one and has more than 30 years of experience working with Silicon Valley companies to scale teams and enable growth. I am also pleased to announce that Mark Vranesh, who has been on our Board since 2019 and Chaired as an adviser two years prior, has been appointed Chairperson of the Board effective yesterday. Mark is an accomplished CFO and adviser with broad financial and tech experience. He is specialized about building strong teams and partnerships with employees, business partners and shareholders, driving new and innovative business models and organizing businesses for rapid scaling and global expansion. This transition is a result of my desire to focus more on the day-to-day management of the company as our Chief Executive Officer. Mark, very excited to have your guidance and financial expertise to help drive our strategy of balancing revenue growth with focus on profitability. We’re excited about where we see it today and what the future holds for Semrush. I will now turn the call over to Eugene and Brian to discuss the results of our quarter in more details.

Thank you, Oleg. We delivered a strong quarter and are focused on three main pillars of growth and making progress on each front. First, growing number of users. We have over 104,000 same customers with our core platform and we have a long runway of adoption ahead of us. In Q2, we achieved solid net new customer additions and registrations with a more efficient sales and market engine. Second, we are having continued success cross-selling to our existing base through products and applications. Our diverse customer base and extensive digital marketing platform features numerous products, tools and add-ons that enable us to cater to a wide range of customer needs across the digital marketing landscape. We will continue to execute on our strategy to leverage our brand and strong customer loyalty to cross-sell and upsell our base and grow our average ARR per customer. We have over 950,000 free users and are exploring ways to monetize this asset, which we believe presents significant long-term upside for the business. Third, we continue to develop new products, including many with AI capability and to build out the App Center, which will bring more complementary apps from third-party developers into our base. We often get the question of what generative AI is to our business, and I would love to spend a few moments explaining how generative AI presents new opportunities for us. As complexity increases, it will be important for customers to find where they gain traffic. This is where Semrush shows exceptional value. Ad technology drives a lot of utility and new marketing channels to our customers. We are aggressively adapting our products to incorporate new sources of data and improve functionality with a particular focus on AI capabilities. The traction we are seeing right now is very encouraging, especially in terms of usage. So far, over 700,000 users have used our generative AI-powered products. In fact, I’m super excited about generative AI. We are pioneers and have had AI-powered features for a long time. Initially, we positioned them as products for upmarket for more sophisticated users, but now we are implementing AI in many of our products across the board. For example, we have a product called Writing Assistant for people who need to scale content production, which makes it easy for everyone to generate content. We also recently launched the generative AI local product with a reply to review feature. Now our customers who want to reply to reviews can do that more timely and can efficiently communicate their message. We are very pleased with the results that show a 42% growth in the number of posted replies in a matter of weeks after launch. Average reply time has reduced dramatically, and the percentage of unanswered reviews is now close to zero. That, of course, drives a better customer engagement, better review scores and importantly, more business. In summary, I am very pleased with our customer growth, success cross-selling build-out of App Center and launch of new products, including solutions that merge AI with data capabilities. I will now turn the call over to Brian, who will provide a more detailed discussion of our financial performance and guidance. Go ahead, Brian.

Thanks, Eugene. I am 90 days into my tenure, and I could not be more excited about what I have seen so far. The team we have in place and what the future holds for all of our stakeholders. We have a high-margin SaaS software business with a recurring subscription revenue stream. I am impressed by the value that our customers get from our portfolio of products. The combination of our algorithm and unique data set is unmatched in the market. I’ve seen the value firsthand, not only in the customer success stories that witness, but in how we use our tools internally to help grow our own business. The strong ROI of our products gives me great confidence in both my view of our strategic positioning and our financial outlook. Now turning to our second quarter results, we had a very strong quarter across the board. We continue to execute on our revenue growth pillars and maintain the disciplined and balanced approach to improving efficiency and profitability, while also continuing to invest in future growth opportunities that we expect will drive long-term value and growth. Our Q2 revenue was $74.7 million, up 19% from a year ago. Growth was driven by a very strong new customer additions and continued growth in our average revenue per customer. Our dollar-based net revenue retention for the second quarter was 112%. We continue to expect our net revenue retention to remain strong as we increase adoption of our full portfolio of products, tools and add-ons within our installed base. Annual recurring revenue surpassed $300 million, growing 20% to $302.4 million year-over-year. We reported significant improvement in our operating margin, which was up approximately 1,000 points year-over-year and 1,200 basis points sequentially. The significant improvement is a result of a number of factors. First, we reported significant improvement in gross margin, which was up 275 basis points year-over-year to 82.6%. Gross margin benefited from higher revenue and our continued ability to gain scale and leverage from our platform. We continue to expect gross margin above 80% in the near term. Second, we continue to execute on our commitment to drive efficiencies, carefully managing expenses and drive towards sustained profitability. One example of this is in marketing, where we made the strategic decision to slow pay spend and prioritize organic and brand spend, which is delivering impressive results. We saw strong demand for our products across new subscribers, growing our total paid subscriber base by 14% while also lowering our customer acquisition costs. Across the company, we continue to carefully manage expenses and plan to maintain our current headcount in the near term. We believe we are sufficiently staffed to execute on our growth strategy, deliver on our strategic priorities and manage the operations of our business. Within that context, our Q2 operating income also benefited from the timing of some expenses that we originally expected during the second quarter that we now expect will happen in the second half of 2023. Moving down the income statement, non-GAAP net income was positive $3.5 million, surpassing the high end of our guidance range. The outperformance of our non-GAAP net income relative to our guidance was the result of the flow-through of our operating income performance, along with better-than-expected interest income and the timing of an accounting-related tax provision that we now expect to take place in the second half of the year instead of Q2. Turning to the balance sheet, we ended the quarter with cash and cash equivalents and short-term investments of $223.8 million down from $232.3 million in the previous quarter. Our cash flow from operations in the second quarter was negative $6.3 million. Our positive non-GAAP net income was offset by temporary movements in some of our working capital accounts. Going forward and on a yearly basis, we generally expect cash flow from operations to align closely toward non-GAAP net income, but this may fluctuate from quarter-to-quarter. Looking at the second half of the year, I’m confident in the underlying trends in the business and capabilities of our team have continued on the path to deliver strong growth and profitability, and we are therefore raising our guidance accordingly. We expect revenue growth to reaccelerate with our expanding product portfolio and because we are starting to face a more favorable year-over-year comparison. For the third quarter, we expect revenue in the range of $78 million to $79 million, up approximately 19% year-over-year at the midpoint. We expect third quarter non-GAAP net income of $3 million to $4 million. For the full year, we are raising our prior revenue guidance of $306 million to $309 million, up to $307 million to $309 million, which would represent growth at the midpoint of approximately 21% year-over-year. We are also raising our non-GAAP net income expectations to $2 million to $4 million for the full year 2023. This increase takes into account the strong operating profit we delivered in the second quarter but also reflects a few offsetting factors. First, the shift in the timing of our accounting-related tax provision that I mentioned a moment ago; second, the timing of some expenses we had originally planned in the second quarter, but now expect will occur in the second half of the year; and finally, the increase to our assumed euro exchange rate from our prior guidance of 1.06 to now 1.10. As a reminder, approximately 30% of our expenses are denominated in euros. In closing, we are confident in our ability to grow and scale our business and my enthusiasm for what lies ahead has only grown stronger since I started. We remain committed to a disciplined and balanced approach to spending, which will drive improved efficiency and profitability even while we invest in future growth opportunities that we expect will drive long-term value and growth to our shareholders. With that, we are happy to take any of your questions. Operator, please open up the line for questions.

Certainly. [Operator Instructions] Our first question comes from Michael Turits with KeyBanc. Your line is now open.

Hi guys, solid quarter. Two questions, one financial, one at a high level. Very pleased to see some of the thought process around Gen-AI. Where are we in terms of where we think that search will evolve with capabilities being augmented by chat and how you’ll adapt to that? I think that we’ve seen you adapt in many ways a search has changed to things like snippets in the past. Be curious about how you feel that your capabilities and value add will offer will adapt and add more value as we adapt with chat as well. And then the second is just on ARR, which, again, was a little bit below the Street here, but you’re raising the revenue guide for the year. So just doing those two things up for me.

Hi, Mike. So I always enjoy our conversations about generative AI. And in private, I usually can speculate a little bit more then on those calls. But what we’re seeing now is really Google haven’t released their version to general public yet. We are, of course, seeing some interesting things in closed beta. My conclusion right now is that directionally, for a lot of queries, there is not that much improvement or maybe even detriment in user experience. For example, it takes quite a while to generate an answer. Google always was trying to optimize speed of response. So for many queries right now with the state of technology they present, the user experience is actually not that great. For some queries, there is definitely improvement. Those are usually queries that are multi-model, like complex questions where there is no single answer. Let’s put it this way. There is no single piece of content that is a perfect answer for the question. Like, for example, if you’re looking for a perfect dress to go to a particular restaurant in a particular place, during particular season and you incorporate all this information in the question, for those things generative AI does provide user experience improvement. So, that’s what we are seeing now. I think directionally, that’s probably if they release it where they’re going to go. It will be default for some questions, but not default for other questions, depending on the type of query. And then for us, what it means is really we’ve always been building our platform to be expandable and to be able to add additional served features. Google have been adding multiple of those features every year. So, adding this modular approach to how we do our competitive intelligence products for search engine marketing was key. So, for us, it’s really just adding additional search element to track and analyze. I don’t think anything really changes materially for our customers. Of course, there is a debate around click out, but based on what we are seeing, for example, from Bing, they drive tons of traffic outside of Bing to even websites like Wikipedia, and we think that’s really the best example of how chat experience could perform in terms of outbound traffic from search engines. And that financial question, I think Brian will take it.

Yes. Hey Michael, thanks for the question. Just a couple of comments on ARR. We had a really strong quarter. So we grew 20%, that’s the result of our strong capabilities to execute across our growth pillars. And that 20% was a little bit ahead of our revenue growth. So we’re confident in our ability to reaccelerate revenue in the second half. So, what was the specific question just around ARR, it was lower than your expectation?

It’s a little bit below the Street, right? And also, again, try to add another metric to that, just again, where do you see the trajectory on NRR going given where we are in both ARR and revenue?

Yes. So again, ARR was really strong, growing 20%, and then our expectation in the second half is that we’ll continue to reaccelerate that. And of course, that will drive a reacceleration in revenue as well. And then on NRR, I’m glad you asked that, NRR is a really important metric for us, measures our success for a key growth pillar for us. So, we’re not only focused on expanding our customer base and continuing to drive adoption, we are also looking to cross-sell and upsell into our loyal customer base. And our NRR does remain strong. It’s well above 100%. We’re pleased to see that it’s strong, and we’re continuing to be successful in building out and expanding the footprint within our loyal customer base. But you are right, NRR has been ticking down a bit. And there is a couple of things I’d give some color on. First, there’s some macro factors influencing that metric. So while it’s been strong in some periods, we’ve had record new customer adds and demand for our products. We’ve also had a slight uptick in churn. And the churn is a function of the current macro environment as our customers tighten budgets and look to optimize their spend. But the good thing for us is we see a significant portion of our customers’ return. And as the macro improves, we’ll expect that trend to continue. So, historically, we’ve seen 30% of our customers return to us in a short period of time. And I think as the macro environment improves, we’ll actually see that uptick. At the same time, we’re also encouraged by our ability to expand adoption across our full portfolio. So, we have been successful in cross-selling and upselling, and doing that at a rate that’s been increasing beyond levels we saw in 2022. So NRR continues to remain strong. It's a very important metric for us. We expect it will continue to be meaningfully above 100%. And as I said earlier, ARR and revenue will reaccelerate in the second half, and I think we'll see NRR follow closely behind that.

Great. Thanks Brian and Eugene. Thanks very much.

Your next question is from Parker Lane with Stifel. Your line is now open.

Hi guys. Thanks for taking the question here. Brian, I just wanted to pick up on that last point you were talking about on churn. Are you seeing more reductions or customers outright leaving the platform as part of the budget optimization efforts that you talked about there?

No, I think – thanks for the question. I think it's a little different. So for us, churn is a little different. We don't see situations where customers are leaving our platform. What we see in times of tightening macroeconomic factors is they're just pausing their subscription. So we have a group of – a cohort of users that are seasonal users. They use our platform on and off over a period of time. And I think in times of the current macro environment, they may pause those subscriptions for a bit longer; but we're confident they'll come back. As I mentioned before, in times of normal economic circumstances, we see 30% of our customers return, and we think that we're confident that number will be much higher once the current macro headwinds start to abate.

Got it. Understood. And then, Brian, maybe sticking with you, looking at the website, you've clearly done a lot of work to get these apps enter built out. A lot of really interesting tools there with a variety of free plans and different monetization efforts there. Where are we as far as the contribution of App Center? And as you look at the growth algorithm going into 2024, 2025, how much can that actually contribute and lift the growth outlook here?

Hi Parker, this is Eugene. So we're very happy with the growth we are experiencing both in terms of demand and supply. That said, I think it's still early so right now the status I would say is very high growth at a relatively small scale. The whole business is $300 million ARR, App Center was introduced only in 2021 as an experiment. We are very bullish on it, but I think it's very early to start breaking it out as a separate line of revenue.

Understood. Thanks for the color, Eugene.

Your next question is from Adam Hotchkiss with Goldman Sachs. Your line is now open.

Great. Good morning. Thanks for taking my question. When you think about your top of funnel, how proactive are you seeing companies be in terms of getting ahead of some of these GenAI uncertainties that exist? Just should be curious to the extent your customer conversations have changed at all? I'm wondering if you think these uncertainties in the market provide an opportunity for you guys to push free-to-pay conversion or some of your modules that are helpful to folks.

I think, surprisingly from customers, we're not hearing that much about uncertainties. A lot of them focus on opportunities that generate AI provides. For example, tons of people across our user base now scaling content to the extent – the content production to the extent they have never done it before. That's I think one of the bigger trends. We're seeing a lot of people, let's say, using less freelance writers and using more in-house editors, again to scale content production. I think that's been a big narrative across our user base. We had only a couple clients on the agency side whose businesses have been disrupted. But I would say I can count those examples using fingers only one of my hands. So I would say actually, I think, by now a lot of people figured out what AI can do and how it can improve their lives and how it cannot. Of course, their expectation that technology will keep improving. Of course, the expectation is that vendors will keep adding more features, more functionality. And everything we do is to satisfy this demand from our customers. But in terms of uncertainty, I think maybe there have been a little bit of this, what's going on [indiscernible] in February. We don't see that now. I think by now, most of people figured out where this thing is going.

Okay. Great. That's really helpful. And then, Brian, it would be just great to get a download of your view of the current cost structure. I think came in better in the quarter, raised the guide there. But when you look at – you took a step back as CFO, where do you see the most opportunity to create efficiencies from here without sacrificing growth?

That's a good question. Yes, we were actually really pleased with the results this quarter. We did exceed our guidance range and then raised our non-GAAP net income expectation for the year. And that's a function of – we've been saying this and of course we've been committed to being disciplined and balanced in our approach to spending. But in general, we have a really high-margin recurring revenue business and a lot of ability to scale that business going forward and drive increased profitability. So we'll continue to say that our commitment is to drive towards profitability and positive free cash flow. But at the same time, we'll continue to invest in growth opportunities that drive long-term value. And our ability to drive that profitability and sustain it, it's coming from a couple of different things. I think everyone has seen, we have really strong gross margins. They're above 80%, and we expect that we'll be able to continue to gain scale and leverage from that as we advance forward here. We have a really unique data set and platform with the ability to scale and we continue to expect that low 80% gross margin to persist into the future here. And then on the operating expense side, as you know, we've continued to optimize our marketing spend. There's two things just to step back a bit on marketing. Last year, we really invest in a lot in our organic brand and content, and we're really benefiting from that this year and able to improve our customer acquisition costs. And we'll continue to look for efficiencies and scale our marketing and sales engines. And then R&D, we'll continue to invest, but we'll try to maintain our expense to revenue ratio about where it is. I think the areas where we have the most opportunity is in G&A. We're just about two years post IPO. We've been investing a lot in our infrastructure to make sure we can grow and scale our business and be efficient for the broader organization. And we'll really be looking at optimizing that. So I think you'll see G&A come down not only on an expense or revenue basis, but also on an absolute dollar as we start to realize some of the investments that we've been making in the last couple of years.

Okay. Really helpful. Thanks Brian. Thanks Oleg.

Your next question comes from Elizabeth Porter with Morgan Stanley. Your line is open.

Great. Thank you so much. I wanted to ask on the strong customer adds. They've been consistent with about the run rate that you saw in the last two years during 2Q. I know you guys are doing a lot around marketing and churn should come back. So how do we think about the run rate of new adds and does it follow a similar arc that you saw over the last two years? Or could it actually be a little bit better given some of the improvements you guys are making? Thanks.

Thank you, Elizabeth. This is Oleg. Look, first of all, last quarter it was 300 new customers and I would say this quarter we are also very satisfied before we delivered in new customer adds. And as Brian already said, we invested lots in experiments last year in paid marketing experience and organic experience and so on. And right now, we found how to deliver our marketing more efficient. I think we have big where we focused on delivering the same pace of net customer addition and I see a lot of opportunities in our marketing related to organic sales.

Great. And then just as a follow-up, I wanted to hit on the expansion of the product portfolio. And how should we think about the growth algorithm into next year between the existing customer expansion and ability to attract new customers? Thanks.

Thank you. So of course, not guiding next year yet but in general, our Number 1 for yours is always to keep scaling user base as fast as possible. We think there is a huge runway left, and that's Number 1 priority. At the same time, we invest in a lot of resources into product portfolio expansion and upmarket products in existing areas where we already have dominant market position, essentially search engine and optimization, for example. So next year, again, not guiding anything, but directionally, I would like to see more growth driven by user base growth and then the remaining growth driven by expansion and upsell, cross-sell into user base.

Got it. Thank you so much.

Your next question comes from Scott Berg with Needham. Your line is now open.

Hi everyone. Congrats on the nice quarter and thanks for taking my question. I guess I have two. I wanted to start off on your confidence on reacceleration of revenue growth. Looks like in the fourth quarter and likely into early next year, I know Brian mentioned it, I think Eugene kind of touched on it a little bit. I guess what really gives you the confidence there? I haven't heard any kind of clarification specifically, Brian, you mentioned easier comps, but it looks like it's more than just easy comps. So any color there would be helpful?

Yes. Sure. Hey Scott, thanks for the question. There's a couple of things driving that. I think first and foremost, as you mentioned we do have easier compares to the second half of 2022. So the macro environment really started to impact results starting in the second half of last year. So those are baked into the second half and now we've got sort of comparable dynamics occurring in the third quarter and fourth quarter relative to last year. The other part of it though is just building on what Elizabeth was asking about. We're continuing to invest and grow our portfolio and then continuing to gain traction on some of the products that we've launched over the last few years. So just to name a few, we just – we're monetizing our social media platform. We've got a number of free users that are on that, and we're launching a monetized version of it and expecting that to contribute to growth. We're launching our enterprise product in the second half. And then we're just continuing to gain traction with the App Center, our digital PR and our intelligence offerings as they start to advance and cross-sell and just gain new customers across those platforms.

Great. Super helpful. And then when I was in there over the summer, I know you demoed some of your new AI functionality. Felt it was probably the most practical use case of GenAI that I've seen in some of the companies I cover so far, which is great to see. But how do you think about kind of pricing and monetization of that? Do you – as you get into this further? Is it going to be more about additional modules that customers can buy? Or will the pricing be maybe just in some higher tiers and those customers might have to move up tiers to use it?

So first of all, thank you for very kind words, and we keep improving the product. So by now, they look even better and used even more frequently by our customers. I would say it will depend on a functionality. So some features where it's customary to charge money, we will charge money as well. For example, our content writing tools, right in the system, ContentShake all of them are monetized separately. Of course, Generative AI is not the only value proposition for those products, but it's a big chunk of value proposition. So in those tools, you could say that we are monetizing Generative AI features somewhat directly. There are also going to be a lot of products where Generative AI is complementary and big part of value proposition, but not something which are separately for. The good example is implementation in local listings product, where we have a Generative AI powered to apply to review feature, extremely popular, has great traction even though we launched it just less than two months ago, to be honest. So in those cases, we expect the additional Generative AI will increase adoption, will increase conversion, expansion, but we're not monetizing just Generative AI features separately from the rest of the offering. So in those cases, we know there is value. We can measure it directionally, but we wouldn't be able to assign dollar value specifically to Generative AI. So I think if I had to assess, I would say 60%, maybe 70% of implementations are going to be like local listings where Generative AI is complementary and 30%, 40% is going to be more of a direct monetization. Especially I'm bullish on direct monetization when it comes to App Center, where people create kind of more single-use products. A really good example is our Generative AI-powered social media feature that creates content for different social networks. So this is a single purpose application primarily Generative AI-powered, monetized separately. So in App Center, I think is a great opportunity to provide more of this direct AI monetization apps.

Very helpful. Thanks and congrats again.

Thank you.

Your next question comes from Mark Murphy with JP Morgan. Your line is now open.

Hi. This is Arti [ph] on for Mark Murphy. Congrats on the quarter and thanks for taking the question. First, just in terms of manpower on the customer behavior; anything to call out with divergences across the geographies on that front?

Hey Mark. No, I don't think so. We have – as we've always mentioned, we have a very well-diversified customer base that we're in 150 countries. We span across all industries and market segments. Oleg mentioned in his remarks, expanding from solopreneurs all they have the global agencies and Fortune 100 accounts. I don't think it was – I did mention before that we do have some seasonal users. So color users that are subscribing and on subscribing based on project schedules and potential client flow. So if there's any cohort of users where we're seeing anything that's unique just because of the macro environment, I'd say it's there. But I don't think there's any specific pockets geographically or across any industries that's really jumping out and behaving any differently than others.

Yes. The only thing I would add is last year we were saying that Europe is impacted much more by macro than United States. So now I would say compared to really bad year for Europe in 2022, this year seems much better. So that's maybe one thing that I would highlight, like Europe shows certain improvement, but it's an improvement versus sort of bottom that they've reached last year.

Got it. Very helpful. And then turning back to Generative AI and just AI generally; it seems like you guys are having good traction. But are there any kind of pain points or areas where you see some hesitancy from – is there something holding back customers from adopting the new technologies? And kind of how are you guys thinking about those type of situations?

I think the only – the only part that not necessarily holding back, but I think ChatGPT was such a good experience that people had really high expectations, but in reality there are a lot of limitations, there are a lot of things that AI still cannot do or things where you have to orchestrate AI quite a lot. So I think that's maybe the only thing where people would like to do more, but it's not necessarily feasible with the current state of technology, even though I'm not going to argue that technology is not impressive. It's super impressive, super helpful for many tasks. But I think people – after ChatGPT people had some expectations that were kind of from science fiction novels. And technology is not there yet unfortunate. So it's phenomenal technology and like I said we're applying it everywhere we can everywhere it works. But I think that's the only barrier for adoption right now. There are certain things that you just cannot do yet. For example, if you go to ChatGPT and you ask ChatGPT to generate marketing plan for your business, will give you a very generic checklist of action items and this checklist will be more or less the same for almost every business. And it's very hard to train it to give you kind of more actionable, real check was because ChatGPT doesn't know anything about your business specifically, your competitors. It actually doesn't even know what is marketing. So you have to teach all those things to get a use of technology. And I think that's where sometimes people expect one thing, but they don't necessarily get it. And that's, I think, the only real barrier for adoption right now. And super sorry, one more thing. On the enterprise side, of course, there are other considerations like legal restrictions and so on. But our user base primarily SME so. For SMB, I think the only barrier is it has to work and it has to work in line with their expectations.

Thank you.

Your next question comes from Brent Thill with Jefferies. Your line is now open?

Hi guys this is James on for Brent. Thanks for the question. Just on sales and marketing, could you just talk about the reasons for the decrease in marketing spend? Is it just due to lack of returns? Or is it just a tougher macro tape and you've decided to pull back? And how are you thinking about marketing spend just for the rest of the year? Should we expect it to be down? Or do you expect to grow from here? I appreciate the help.

Look, last year in first quarter we experimented with paid marketing and organic marketing a lot. And I agree in first quarter as we found some ways how we can optimize it in because of current environment, because of current setup of channels and so on. And we started to implement this structure in the beginning of second quarter. And right now, we see results. And as you see from our results, we optimized some of the marketing spend and at the same time, we delivered strong results. And for the rest of the year, Brian?

Yes. The other thing just to build on to is last year we were investing heavily in our organic online presence. So we are developing content and channels to reach new customers. That yield results for a really long time, and we're making that investment last year and using our own products to do that, and that's exactly what we promote for our customers. So we're convinced our products are providing returns that yield more cost-effective, sustainable and trustworthy organic results for a longer period of time. We made those investments last year, and we're now getting the benefit from it. So at this point, just based on what Oleg mentioned and the second part around the organic investments, we're expecting our marketing spend basically maintain where it is now. So we'll continue to maintain it on an absolute dollar basis. And then as revenue grows, we'll see some slight increases in our expense to revenue ratio from a marketing perspective.

Okay. That's helpful. And then just one follow-up quickly on the dollar-based net retention rate; is it fair to say that that's more just due to macro and some customers pausing or slowing down? Or is there anything else that's causing that slight drop in dollar-based retention?

First of all, I want to remind everyone that we should think about structure of our churn a little bit different. It's not the same like other companies when our customers leave the company and our software and not returning back later. And on our side, customers leave and it will come back later. Historically, we see a significant flow of customers who will return to us later back to returning agents could just add?

Yes. I mean I think that's exactly it. It's interesting as we've heard on other calls that certain companies are seeing a decrease in demand or an extension of their sales cycle. So NRR, of course is a function of both your ability to retain and an upsell and cross-sell within your base. For us, we're actually seeing really good strong demand. So we had record net new adds last quarter, and we also had record expansion within our existing installed base and it continues to be strong in the second quarter, and we're expecting that to continue to grow and build in the second half. So the upsell, cross-sell component of NRR is really strong. As Oleg and I mentioned though, the one dynamic, which of course is macro is just the increase in seasonal users. But we're confident they'll come back as soon as these macro headwinds start to abate and we start to get a macro tailwinds. Our expectation, as we've seen historically is they'll come back and increase their usage and we'll see that NRR number start to tick back up again.

Great. Thank you.

There are no further questions at this time. With that, I will turn the call back to the management team for closing remarks.

Thanks, everyone, for your questions. Look, in closing, I want to say, look, we delivered a strong first half of 2023. And we believe we are very well positioned to continue our growth ability and with strong profitability there. Look, we have a high margin. It is a SaaS software business with recurring subscription revenue stream. And by the way, today, we celebrate 15 years since we started Semrush, and I want to say thank you to our customers, our employees, our investors and our friends. Thank you for your support, and we look forward to giving you updates on our progress. Thanks everyone.