Good morning. My name is Denis. 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.

[Operator Instructions] I would now like to turn the conference over to Bob Gujavarty, VP, Investor Relations. Please go ahead..

Good morning. I am Bob Gujavarty, VP of Investor Relations, and welcome to Semrush Holdings' third quarter 2022 results conference call. We will be discussing the results announced in our press release issued after market closed on Monday.

With me on the call is our Chairman and CEO, Oleg Shchegolev; our CFO, Evgeny Fetisov; our President, Eugene Levin; and our CMO, Andrew Warden. Before we begin, I would like to highlight our participation in 12th Annual Needham Virtual Software-as-a-Service One-on-One 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 a 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 is a reconciliation schedule showing the GAAP versus non-GAAP results currently available in our press release issued 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. I'm very pleased with our results in the third quarter. Despite a more uncertain demand environment, we experienced solid growth with 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 paying customers, and I would note that we had slightly more customers in the third quarter of 2022 than in the year-ago period.

The strength in new customer adds was partially offset by lower expansion from existing customers, particularly those customers with larger average revenue [per annum] [Ph]. And this team has done a wonderful job leveraging our high marketing expense to the new customer growth.

We continue to fine-tune our go-to-market spending, and I am 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] [Ph] with the leaders in this 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 [agitated] [Ph] social media marketing professionals, demonstrating our ability to expand our total addressable market beyond digital marketing professionals.

As [I mentioned] [Ph], the team remains focused on user growth, however we may introduce [indiscernible] in late 2023. In January of 2022, as we introduced our App Center, which allows our customers to use third-party applications with our [all purpose-built projects] [Ph], a variety of use cases on our platform.

Despite relatively fewer new launches, our App Center continued 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 [indiscernible] App Center in his remarks, but our goal is not simply to set up a [tollbooth aggregation] [Ph] as a mobile platform [aggregators] [Ph] 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 strong revenue growth, and executed a substantial relocation program under budget and ahead of schedule. Semrush has always operated with efficiency [indiscernible] any choice in the matter.

Today, being a successful public company, but we focus their focus on efficiency remains. We will pursue growth but growth underpinned by [solid unit] [Ph] 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 mortgage in professionals.

There are a handful of product categories that are large enough to give birth to successful public companies. For example, Semrush in SEO through our social and social media management, Mailchimp, and email marketing are 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 continued to expand but extremely 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 the fragment market including many niche use cases which seek to offer a wide variety of product capabilities without overwhelming the capacity of our internal development.

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 program 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 Semrush 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 detail 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.

[Indiscernible] product mix largely unchanged 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 [indiscernible] the easy comparisons of the COVID impacted periods and also impacted by lower expansion from existing customers I mentioned previously.

Non-GAAP 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 forecasting 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 high headcount as well as increased compensation expense related to relocating development resources to higher cost geos. G&A 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 cost associated with relocating key personnel to higher cost locations. Investment to support more robust IT systems and a wider geographic footprint also contributed to the increase.

Strong revenue growth and higher cost margins were more than offset 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 not 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 am 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 million to $67.75 million, up approximately 26% year-over-year at the midpoint. For the full-year, expect revenue in the range of $252.8 million to $253.3 million, which would represent growth of 34% the 35% year-over-year.

We expect a fourth quarter non-GAAP loss of $12.5 million to $11.5 million on a non-GAAP loss of $26 million 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 relocated from Russia, and to a lesser extent, the additional hiring at these two 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 are not immune to macroeconomic headwinds, I believe we are 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..

[Operator Instructions] 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 macro. 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 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 that much difference. So, I would say actually, and somewhat surprisingly, our small business segment is holding pretty well, which is -- I think was counterintuitive for many app stores that we talked to.

But yes, right now this is largely limited to larger transactions, mostly existing customers going through the renewal process. Sometimes it takes them little bit longer, sometimes where previously they would buy more, they stayed with their current subscription, 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 small business segment, when we look at total number of expansions, is pretty -- doing pretty well.

Does that answer the question?.

Yes, it did. And then I believe, last quarter, you mentioned some changes and just in the sales leadership, segmenting around customer acquisition versus up-sell 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. This is Oleg. Yes, you're right, all the time changes are being some concerns for people in selling, but I would say sincerely again I don't see a big impact from such changes to what we have right now. I would connect current results more to macro..

[Technical difficulty] Thank you..

Our next question is from the line of James Heaney with Jefferies. Please go ahead..

Great, thanks.

Just another one on the macro, 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 planning on adding any incremental headcount for next year? Thank you..

Related to our 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 years, it was some sort of new seasonality before these COVID things. And it's hard to imagine what we will face in holiday season this year.

As a result of it, we want to be a little bit cautious with our expectations for fourth quarter. And for the second -- related to second question and related to our headcount next year, there are many companies around us who are [doing such] [Ph] layoffs, and we don't expect any kind of such things on our side.

This year, it was relocation process so -- and because of [indiscernible] 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 increase 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 JP Morgan. Please go ahead..

Thank you very much.

Just following up from an earlier question, I'm curious, Evgeny, can you compare the demand environment, it -- what you say back in July and August start in 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 is 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, 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 get -- 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. Then, can I ask you as you look into early next year, and we think about the seasonality of booking, that it had been -- 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 there.

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?.

Yes, so we think there will be somewhat similar seasonality but with -- but I think next year we would expect it to be little bit more kind of flatten because, like you said, previous couple years we had some unique events and plus a lot of our campaigns have been not executed equally during the yea.

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 the additional comment. So 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 we will be, as we're pushing more into the markets, we expect to see demand continue..

Thank you..

Your 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 just have a couple here. I wanted to start with the App Center commentary because I think some of the comments there were new. Wanted help to 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 the long-term revenue opportunity that's possible to generate with your strategy here, because I think the comment was you expect to make a significant amount coming through -- 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 our entry-level products starts at $120 per month. For many people this is a reasonable price to pay for a starting package, for some people 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 [indiscernible], and they just don't want to spend that much. 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, 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.

So, that's the idea around how App Center helps to increase conversions from free active users to paying customers. And then in terms of long-term potential, of course this is very early for us, and so that's very hard to say.

But the way we are thinking about this, it's a fragmented market with a lot of different use cases covered by a lot of different products. 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 companies that inspire us in terms of marketplace models. And, of course, in SaaS world, there are other examples like 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 for my -- a follow-up question, if we look at the cost structure in Q3, most of your relocated Russian employees are likely in their new locations here in Q3. And I'm sure there's a little bit of trickle that fell into 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 that's where it will -- then that's when we will start incurring our full cost in -- of people being in their final locations..

Great, very helpful. Thanks for taking my questions everyone..

Thank you..

Your next question is from the line of Michael Turits with KeyBanc. Please go ahead..

Hey, guys. One on [indiscernible] App Center, so, Oleg, can you talk about the decline in the ARPU growth and decline in the expansion rate? Can you parse that? I am not sure if you commented.

But what did happen with the gross retention rate this quarter? And can you try and just review quickly what were the issues around expansion, and how do you believe you are addressing them?.

Michael, this is Eugene. So, on the gross expansion rate didn't change much versus last quarter. So, what we saw is the I would say higher demand from the new cohorts which start with lower average check and that diluted the overall growth rate. So, that's a big factor there.

So, I would strong demand from the initially lower check customers and that affects the blended rate.

Otherwise, [indiscernible], which may be contrary to this, when we look at blended rates, we have our 10k per year customers growing 12% quarter-over-quarter by number of ways, or more than -- I think it's more than 70% year-over-year, so, a substantial growth in higher priced account.

But at the same time as new cohorts enter the client base that leads to slow growth of average check..

Okay. So, in other words in terms of the ads, the lower prices ads are still coming at a higher rate.

But still diluting more because of that at this point?.

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

[Multiple Speakers] Okay.

And then what about on the expansion side in terms of the lower net expansion rate?.

So, I am happy to provide more details around expansion. So, look, yes, like I said, it's really more about the behavior of existing customers who already buy a lot. And, like I said sometimes deals take more time. So, some of them remain on lower tier subscriptions for longer. Some of them were locked in expense.

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 people -- drop in their subscriptions. But sometimes like I said if people had layoffs, they would buy less. So, that's what contributes to lower expansion.

When it comes to SMB segment where most of the transactions are self service, we don't see that much difference. But, yes, on a higher end, total number like Evgeny said is growing really well. But some of those high subscription tiers, they are 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 the mix [indiscernible] I guess one question I would have is what compels third parties to build on your platform? I mean obviously you are already bundling your brand name so there is commercial logic to it.

[Indiscernible] if there is 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 [market] [Ph] 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 horror 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 have 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 bottom lag is just our technical ability to launch partnerships which we are 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 our data partnerships.

So, that's another big reason for them to partners instead of build on their own..

All right, thanks..

Your next question is from the line of Parker Lane with Stifel. Please go ahead..

Hi, it's [Matt Erasmus] [Ph] 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 plug into the top line?.

It's very minimal, Matt. 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. So, that's it from 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..