Marchex Inc Q4 FY2022 Earnings Call

Good afternoon, everyone. Thank you for being part of Marchex’s Fourth Quarter Earnings Conference Call. I’m Tia, your moderator for today. I will now hand the call over to Trevor Caldwell, Senior Vice President of Strategic Initiatives and Investor Relations. Please go ahead.

Thank you, Tia. Thanks for your help. Good afternoon, everyone and welcome to Marchex’s business update and fourth quarter 2022 conference call. Joining us today are Edwin Miller, our CEO; Michael Arends, our Vice Chairman. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements, including references to our financial and operational performance and actual results may differ materially from those contemplated by these forward-looking statements. Risks and uncertainties that could cause these results to differ materially are set forth in today’s earnings press release and in our most recent annual and quarterly report filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements for subsequent events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today’s earnings press release. The earnings press release is available on the Investor Relations section of our website. At this time, I’d like to turn the call over to Edwin.

Thank you, Trevor, and good afternoon, everyone. Thank you for joining us today. This is my first earnings call as the CEO of Marchex. I do have a long history of leading and scaling technology companies, and I'm excited to join Marchex because of its world-class solutions and an exceptionally talented team. I'm eager to build on the work that has been done prior. While I see myself providing the most value through my operational experience of turning strategies into tangible results, I want to lead us in this space and do everything to help us get there. Since I joined Marchex in March, I've been orienting myself with the business, meeting many of our talented people. As you know, Marchex has been at the forefront of an exciting opportunity in the conversation intelligence market. From my vantage point, our shot is clear. Marchex sits at the confluence of conversational data and artificial intelligence at the very moment that our largest commercial customers need to streamline and transform complex and outdated technology ecosystems. We are helping these companies adapt to a data science and AI-driven future. Future sales will require an understanding of your customers or prospects and their needs at the moment the business interacts with them. Sales and training processes will have to be augmented, if not reimagined. The fact is real, and it has the potential to transform the financial characteristics of Marchex. Not only that, conversational intelligence has the power to transform the way businesses function. It will change the way businesses sell and deliver customer service experience. From an operational standpoint, I see this as a tectonic shift, and we're committed to being at the forefront of this endeavor. So far, I've observed how Marchex has built foundational relationships with leaders across many large commercial verticals, including several Fortune 500 customers. These relationships have grown over the last several years, and just as importantly, they have significant potential to grow even more in the future. In fact, we recently signed our longest multiyear agreement with a Fortune 500 customer, which represents an extraordinary commitment to Marchex. This is a pivotal opportunity to transform the bottom line of the enterprise auto manufacturer, a company that needs help transforming how they address the kinds of problems our AI-based solutions solve. We believe that this customer will sell much more by working with Marchex in the future. Our expansion potential here goes hand in hand with Marchex's new auto dealer strategy to secure more dealers getting onto our platform. The company added more than 300 dealers in just the last 12 months through product and channel partner adoption, and that is just the tip of the iceberg. We believe the auto vertical, which is our largest vertical, can hit accelerating double-digit growth as we exit the year. At a high level, here's what you can expect from us this year. In 2023, we're going to focus on accelerating the business through continued innovation with award-winning products. While expanding relationships with many of our industry-leading Fortune 500 customers, we also plan to unlock new channel opportunities through partnerships and deepen existing relationships. And we look forward to going fast. I believe Marchex has the potential to build a $100 million business on an annual revenue basis. The market is right and, most importantly, our existing customer base of Fortune 500 customers can and want to do significantly more with us. There's a lot of opportunity in our existing customer base, and we expect to expand the customers we work with. Plus, Marchex has a large and valuable conversation dataset that will help us leapfrog innovation in data science and AI. I look forward to connecting with all of you and providing further updates in the coming periods. I'll now hand it over to Michael Arends.

Thank you, Edwin. We're very glad to welcome you and to have you on board. We'll talk more about that in a little bit, but first, the financial results for the fourth quarter of 2022. Results were mixed. Revenue was $12.3 million versus $12.8 million for the same quarter last year. We saw continued pressure on conversation volumes due to the macroeconomic environment impacting certain customer types along with the typical seasonal flow of call volumes impacting the sequential and annual comparisons. For instance, there was pressure with portions of our smaller customers, as well as with our small business listing and solution providers that mostly sell marketing services to local businesses as they faced greater customer churn compared to 2021. That trend manifested over the latter part of 2022 and is one that we're watching closely as the new year begins. At the same time, we continue to sign new customers across several verticals and signed our longest multi-year term commitment from a Fortune 500 customer in our history. Looking ahead, we see several expansion opportunities in certain verticals for 2023 and beyond. I'll dive into this more in a moment when I discuss our initial guidance for 2023. But first, turning to the P&L for the fourth quarter. Excluding stock-based compensation, amortization of intangible assets, and acquisition or disposition-related costs, total operating costs for the fourth quarter were $14.6 million compared to $13.1 million in the fourth quarter of 2021. Service costs were $5.6 million for the fourth quarter. Service costs increased on a year-over-year and sequential basis in part due to increased data and labor costs associated with customer migrations onto new product platforms and increased staging investment in our AI technology initiatives as we prepare for new product launches scheduled for the first half of 2023. Several of these investments are of a fixed nature and therefore over time, we believe we will see a positive impact on service costs as a percentage of revenue as we sell through our new conversational intelligence products and advance our new channel initiatives. Sales and marketing costs were approximately $3.1 million. This was largely in line with comparative periods. Product development costs were $3.8 million and were up as a percentage of revenue compared with the fourth quarter of 2021 as we've continued to invest in our future product pipeline, which is staging for several customer pilots beginning in the first part of 2023 and enhancing our AI-driven conversational intelligence capabilities. Moving to profitability measures, adjusted operating loss before amortization for the fourth quarter was $2.3 million. Corresponding adjusted EBITDA was a loss of $1.7 million, reflective of the increased staging investments. GAAP net loss was $3.6 million for the fourth quarter of 2022 or $0.08 per diluted share. This compares to a loss of $2 million or $0.04 per diluted share for the fourth quarter of 2021. Adjusted non-GAAP loss was $0.05 per share for the quarter, compared to a loss of $0.01 per share for the fourth quarter of 2021. Additionally, we ended the fourth quarter with $20.5 million in cash on hand and during the quarter, we were pleased we were able to further reduce our total share equivalents going forward by 1.34 million shares through the settlement of 2023 contractual commitment for $1.5 million in cash and a prospective liability of $335,000. Now turning to our outlook. Certain customer segments continue to face pressure at the start of the year, and therefore, for the first quarter of 2023, we believe revenue should be similar to the fourth quarter of 2022 with the potential for a modest increase. We also believe that with several new and ramping customer relationships, we should see sequential revenue growth from Q1 over the course of 2023. Additionally, once we take into account certain restructuring expenses, we believe we will be near a similar range on an adjusted EBITDA basis for the first quarter of 2023 compared to the fourth quarter of 2022. This contemplates the exclusion of a few restructuring expenditures for operating activity modifications, which we anticipate will be largely weighted to the first half of the year and should enable greater leverage and consequently significant improvement in profitability measures over the course of 2023, potentially reaching at or near breakeven on an adjusted EBITDA basis in the back half of the year. This year, we expect to make further progress with several large customer expansion opportunities as highlighted by our recent announcement regarding a long-term Fortune 500 customer commitment and traction with our auto dealer sales channel. We believe this large enterprise relationship has significant opportunity to grow over time, and we expect to make additional inroads with our auto dealer sales channel this year. This traction, we believe, will lead to accelerating double-digit growth on an annualized run rate year-over-year basis by the end of the year in our auto vertical. These are just two examples of our pipeline of opportunity within our existing customer base, and we see several other opportunities. We are winning mindshare in verticals like auto, auto services, and other industries as the leaders within these verticals look to do more with Marchex and expand our product footprint within their retail bases. We also have the opportunity to drive a more meaningful growth profile over time and deliver significant operating leverage in the business. Our current financial profile achieves enhanced profitability and can support incremental investment as it approaches a $60 million annualized revenue run rate. Some of our new products carry incremental gross margins in excess of 80%. As we execute on our sales and technology infrastructure initiatives, we believe the business will make additional progress toward an enhanced revenue and profit margin profile this year and beyond. Now with that said, I'd like to share some broader commentary on our business. First off, I want to express that I'm excited to welcome Edwin to the team. We believe he has the right combination of technology, operational, and customer experience, as well as the strategic talent to take us to the next level. Marchex has a tremendous opportunity, and we believe now is the time for the company to align to capture the unique opportunities in the conversational intelligence market. While we are in an uncertain economic climate, we continue to believe Marchex is well-positioned to emerge as a leader in conversational intelligence. Our products help businesses solve critical sales and customer experience challenges. Our innovation engine is leveraging data science to help large businesses understand how to better sell and more effectively through their retail networks. Meanwhile, we are investing significantly to move our infrastructure and customers to a common platform that will serve as the basis of our future innovation and enable the company to move faster. This investment gives Marchex the flexibility to add new products and features that we believe will enable us to accelerate growth and potentially add significant operating leverage over time. And once again, I want to thank all of our employees for their dedication and continued efforts. And with that, operator, we will hand the call back to you.

We will now begin the Q&A session. The first question comes from Mike Latimore with Northland Capital Market. Please proceed.

Thank you. Good afternoon and congratulations on the new position, Edwin.

Thank you.

In terms of the auto vertical, can you remind me roughly what percent of revenue auto is today?

This is Mike. The automotive vertical is our largest vertical today and it represents nearly 25% of our total revenues as we operate. We did speak in some of the prepared commentary that the auto vertical is one of the areas we actually see some of the opportunity for meaningful growth. We do think by the end of this year, it has the opportunity for double-digit and accelerating growth profile on a year-over-year basis.

Great. And then, in terms of areas of weakness, you called that smaller customers are those in marketing. Can you just elaborate a little bit more on the vertical there and what you're seeing?

The primary areas we see are small businesses and listing solution providers that work with local businesses. Those resellers or listing providers to local businesses saw more decline, more churn year-over-year than in any of the other areas. So sequentially, we also experienced seasonality impacting the business, as we normally do. Service-based conversations declined generally in the fourth quarter around the holiday timeframe. So that was another reason for some of the sequential decrease from Q3 to Q4.

Okay. And then you talked a little bit about seeing maybe sequential growth throughout the year. Is that largely tied to these new customer ads? Or are you expecting some macro improvement?

So there are multiple parts to it. The first part, I'll answer directly regarding the macro environment. We're not actually anticipating significant updates or improvements in service from the macroeconomic environment; however, that could provide a lift or an opportunity if it does play out. We've been staging and putting different things together from our infrastructure investment, getting some of our existing customers where we believe we have very robust conversations to expand the relationship onto our platforms that allow for access to our new features, as well as the new products that are coming to market. We have several new products slated, particularly in the first half of the year, with pilots scheduled to initiate opportunities for future growth, where we can monetize those new products once we onboard and execute toward getting those customers to sign up. We've made substantial investments with some of the OEM relationships in the auto vertical, not just in expanding existing relationships but also in developing new relationships. We spoke in the prepared commentary about channel relationships in the auto dealer sales initiative. As an example, we recognized just a few years ago the opportunity to take some of our product offerings directly to the dealer versus just the OEM and we started to focus on that a number of years ago. This past year, we made considerable efforts into direct sales initiatives as well as channel partnership opportunities. To that end, we were able during 2022 to deploy over 300 individual dealer relationship engagements through both our direct sales efforts and our channel partnerships. It is these areas that we believe will further our growth opportunity in 2023, and we consider it a significant area of investment, not just for this current year but for how that stages on a go-forward basis. The other thing that Edwin mentioned, which is relevant, is the opportunity to see robust growth for the business over the next few years.

Yes, happy to. Although I've only been here less than 30 days, what I've learned so far about the opportunities in the business is extremely real. I spent close to 75 days before actually joining, learning about the business and getting excited about the talent and the customers. This is the future. All businesses that I see need help with sales and marketing. AI is the future. The amount of conversation intelligence we have as datasets is really strong, so the ability for us to continue to earn trust and grow existing relationships and find new ones based on the size of companies we've already signed is an astonishing opportunity right in front of us.

Great. And then just on the AI topic, generative AI has gotten a lot of attention lately and rightly so. But do you see a way to build on that or leverage that in your business over the next year or so?

Absolutely. I come from a technology background, having been in the field for a little over 30 years, and the ability to build mechanisms around what we currently do and help our clients monetize their relationships is a real path forward. I've had 45 plus conversations with individuals I've met, including the entire product management team, which is an impressive group of real skills in and around AI, math, and machine learning. So I'm very excited about that future.

Great, thanks.

You're welcome.

Thank you. The next question comes from an undetermined line. Please proceed.

Hi, it’s Dillon on for Darren, thanks for taking questions. First, if you look at sort of the volumes that are down overall on a year-over-year basis, but you talk about some emerging verticals being up, can you sort of talk to the split between those? I mean, I'm assuming that's as a percentage of total volume and not revenue. But I guess like, how big of an impact are the smaller verticals having as a drag on the ones where you're seeing growth?

Hi, Dillon, this is Mike. Thanks for the question. A couple of clarifications, some of which may be a reiteration of our prepared comments. If you look at the conversation volumes, the smaller customers as well as the small business listing solution providers working primarily with local accounts had a meaningful decrease on a sequential basis, which was impacted by seasonality, but also on a year-over-year basis. In some cases, especially with the small business listing solution providers for local businesses, they were down well over 20% when we look at those comparative periods. In addition to that, the seasonality and the impact of seasonality in the fourth quarter on service-based businesses is generally muted around the holiday season, particularly when consumer engagement with service-based businesses isn't as robust as other times of the year. Historically, we see this on a Q3 to Q4 basis with an aggregate seen in that 10% to 15% range. Contrasting that, however, some of our volumes in verticals like automotive and home services remained relatively stable despite the seasonal levels. Furthermore, part of the reason for our outlook on sequential revenue growth is due to our expanded long-term pipeline and more discussions about staging for some of our new product pilots. We have more incubation of these test pilots scheduled for the first half of the year compared to the mid-part of 2022.

Thank you. And then with the research and development, you sort of spoke to some of those starting to pay dividends regarding product launches in the first half of this year with AI. Do you think that there's more investment that you need to make to get you back to growth? Or has the majority of it already been done?

In our remarks, we've referred to the fourth quarter and our guidance for the first quarter. Those investments are ongoing. We're working hard. We've migrated some customers over to our primary platforms, which allows for the upside of them getting access and ultimately monetizing when they engage with our new features and products. As mentioned, the large customers have migrated, as we sit in the first quarter. They are positioned to be able to pilot and utilize those new features. The results remain to be seen from an execution perspective, but this is part of the reason we believe there is a revenue opportunity to see sequential growth in the coming year. Additionally, we are onboarding some of the existing auto dealer relationships onto our platform, with over 300 deals engaged in this past year. This opportunity also provides access to new product features and potential upsells within that client base. Regarding investment, I would say we are staged and stable for the time being. We have some operational elements that are fixed in nature. So with our sell-through, we foresee significant operating leverage and gross margin leverage as we progress with revenue growth through '23 and further beyond.

Got it. Thank you. And one, when you talk about adjusted EBITDA, is the potential return to breakeven or maybe better in the second half a reported quarter, or is that just sort of a monthly figure that you're getting back to?

We haven't provided specific details other than we're looking to be at or near breakeven in the latter part of the year. That's our forecast and guidance. We definitely think with increased revenue and monetization, as well as adoption of some of our new products with high gross margin characteristics, it doesn’t take much from a revenue perspective to achieve breakeven leverage. Approaching $60 million in annualized revenue run rate should allow us to reach that position effectively. We do foresee this moving towards that as we progress into the latter half of the year.

Great. Thank you.

I can add one thing to that. Part of what I've learned early on here is that there's a real opportunity to scale both existing relationships and new clients with our go-to-market motion. I'm incredibly encouraged by what I've learned early on, so I believe the second half of the year should be a very good time for us.

Thank you. There are no additional questions at this time. I will now hand it back to the management team for closing remarks.

I wanted to thank you again, everyone joining us today. We really appreciate your time. I wanted to again welcome Edwin, and we'll be providing further updates as we progress throughout the course of the year, and I look forward to that. Thank you.

That concludes today's conference call. Thank you. You may now disconnect your lines.