Earnings Call Transcript - MCHX Q2 2022

Operator, Operator

Good afternoon. Thank you for joining Marchex's Second Quarter Earnings Conference Call. My name is Tamia, and I will be your moderator today. It is now my pleasure to hand over the call to our host, Trevor Caldwell, Senior Vice President of Investor Relations and Strategic Initiatives. Please proceed.

Trevor Caldwell, Senior Vice President of Investor Relations and Strategic Initiatives

Thank you, Tamia. Good afternoon, everyone, and welcome to Marchex' Business Update and Second Quarter 2022 Conference Call. Joining us today are Michael Arends and Russell Horowitz, our co-CEOs. 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 or 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 also available on the Investor Relations section of our website. At this time, I'd like to turn the call over to Mike Arends.

Michael Arends, Co-CEO

Thank you, Trevor, and good afternoon, everyone. Thank you for joining us today. Despite the fluid macroeconomic environment in the second quarter of 2022, we continue to see growth in existing customer relationships and validation of our focus on building products that address critical needs for our customers. Right now, businesses are seeking to navigate and ultimately thrive in a climate with economic challenges and uncertainty. And we know how to help them. Our customers' ongoing commitment to us, along with our growing suite of conversation intelligence capabilities, created an opportunity in the second quarter to expand some of our largest relationships. We consistently hear feedback from our customers that our dedication to innovation is what differentiates Marchex from others in the market, and we are seeing that reflected in our sales progress. We are expanding relationships with Fortune 500 customers as they uncover what Marchex' conversational intelligence product suite can do to help them understand and react to the needs of their customers and prospects from the brand level, all the way to hundreds of thousands of customer touch points at thousands of store or franchise locations. Even though inflationary pressures, inventory issues, and other factors continue to impact our customers' businesses, I am pleased to share that we were able to grow our customer base across multiple verticals. We are now engaged in active dialogues to expand relationships with some of our largest Fortune 500 customers, including in the auto, home services, and health verticals. Having said that, challenges with inventory availability remain persistent last quarter in some of our largest verticals such as auto. Inventory was down on a year-over-year basis for many of our customers, and as a result, there were fewer cars available to sell, which impacts conversation volumes. I want to take a moment here and say that Marchex has navigated through turbulent macroeconomic times in the past. Our executive team has experience navigating such circumstances and focusing on the long game. We understand that as long as we keep listening to and innovating for our customers, we will remain highly competitive and well-positioned no matter the environment. This commitment and progress were recently recognized when we won Product of the Year for our conversation intelligence platform from the Business Intelligence Group, which is a significant honor. The Marchex’ Conversation Intelligence Platform was built upon powerful artificial intelligence technology that we have spent years cultivating and developing. It enables businesses to take critical actions, deliver better customer experiences, and grow their revenue. Our technology unlocks key insights from voice and text conversations at scale. This transforms how marketing, sales, and customer engagement teams can win more business and achieve their goals. In many ways, we are bringing critical insights at the location level to national brands that enable both the brand and the locations to engage with consumers when there is an opportunity to close or save more sales. Our conversation intelligence technology also won the award for Best AI-Based Analytics Innovation from the 2022 AI Breakthrough Awards program. This program recognizes standout AI and machine learning solutions. These acknowledgments and recognition continue to reinforce our path forward. We see firsthand how we empower businesses with strategic insights that can increase brand effectiveness and drive sales growth. This inspires us to keep pushing and innovating. I'm proud of our team's effort to build a company that helps businesses create better sales processes and customer experiences. And with that, let me hand the call to Russ.

Russell Horowitz, Co-CEO

Thank you, Mike. Today, we see significant long-term opportunity in Marchex' ability to disrupt the siloed sales and marketing funnels for enterprises to create better buying and also customer service experiences. Over the past two years, we methodically focused on building a suite of software products that have fundamentally altered the way businesses can reach and interact with consumers. And as Mike mentioned, we aim to transform marketing, sales, and customer engagement. We have seen the impacts in our customers' businesses, and it's what motivates us to keep building the product capabilities needed. While we're pleased with the progress we're making in our overall market opportunity, as a management team, we're mindful of the changing economic dynamics of the world in certain industries. We've been through economic cycles before and managed our business prudently for many years. Today, our business is diversified and has a strong balance sheet with a financial profile that enables us to invest aggressively as a market leader in conversational intelligence. Our base of large enterprise customers, including some of the largest Fortune 500 brands, are leaning into Marchex to solve their critical business challenges. Marchex solutions can be both cost-cutting and revenue growth drivers for enterprises as they seek to leverage the benefits of our conversational intelligence products. Based on our expanding customer relationships and points of impact and opportunity, we believe Marchex is well positioned for the future in a variety of scenarios. We feel good about how Marchex is situated to take advantage of this market, and we can continue pursuing this while also maintaining our financial discipline. And with that, I will hand the call back to Mike.

Michael Arends, Co-CEO

Thank you, Russ. Our second quarter of 2022 results saw modest growth from the first quarter of 2022. This was a slight decline from the second quarter of 2021 as overall, we continue to face influences from macroeconomic factors caused by the pandemic and global events, which are suppressing overall conversation volumes. More specifically, on a year-over-year basis, our volumes in several verticals continue to be impacted by pandemic and geopolitical-related shifts, which are suppressing inventory levels causing continued supply chain disruptions, limiting parts availability, and creating inflationary pricing pressures. As we have previously communicated, these factors may take time to unwind even as we grow, add new customers, and scale a number of our existing relationships in some of our largest verticals. On a sequential basis, we did see some modest increases, largely due to the expansion of relationships with some of our largest Fortune 500 customers, and we did see some progress in adding new customer relationships across multiple verticals. We believe that over the remainder of this year, we will continue to make progress through our momentum and sales wins with new customers in verticals such as health care, home services, and an ongoing relationship expansion with several big customers. Looking more closely at the second quarter of 2022, we saw a modest uptick from January 2022 levels. But due to the factors outlined, we did not see the robust conversation volume growth that we experienced last year during the second quarter when the economy rapidly expanded coming out of the first pandemic wave. However, looking at the more favorable takeaways from the quarter, we continue to see consistent traction with new product sell-through to new and existing customers. Our long-term customer and prospect pipeline is growing, and we believe it has an opportunity to drive a more meaningful growth profile. Furthermore, to the extent that we get an unwinding of the supply chain disruption, particularly in verticals like auto, we believe the conversational volume headwinds that have been present in our business can shift to a tailwind and contribute to growth potentially meaningfully so as we expand the footprint of customers in those verticals. While that may take some time in certain verticals, we expect we will have a larger base of customers to leverage in a normalized environment as volumes return, and that will have a very positive impact on our growth trajectory. On the operating cost side, our continued progress on technology infrastructure initiatives enabled us to achieve positive adjusted EBITDA, which positions us well in the future for discretionary operational leverage with growth acceleration. For today's commentary, I will focus on our financial results from continuing operations. On that basis, revenue for the second quarter of 2022 was $13.5 million versus $14 million for the same quarter last year when we saw an uptick in overall economic and consumer activity coming out of the first pandemic wave. We did see some modest growth from the first quarter of 2022, due largely to the expansion of some of our largest customer relationships, as previously mentioned. As noted earlier, we continue to see our sales channel expand with several new opportunities emerging with some of our largest customers and the onboarding of a few significant new relationships. We believe as we continue to expand our product pipeline and channel opportunities over the course of this year, this should favorably impact our opportunities with current customers as well as open new customer opportunities. Now let's shift to the P&L for the second quarter. Excluding stock-based compensation, amortization of intangible assets, and acquisition or disposition-related costs, total operating costs from continuing operations for the second quarter were $13.7 million compared to $14.8 million in the second quarter of 2021. Service costs were $4.8 million for the second quarter. Service costs showed some leverage year-over-year largely due to our progress with our technology infrastructure initiatives. Over time, as we continue to see successful sell-through from the launch of our new conversational intelligence products and channel initiatives, we believe we will see a positive impact on service costs as a percentage of revenue. Sales and marketing costs were approximately $3.4 million. This increased from the year-ago period due to additional investment in personnel costs compared to the year-ago period. Product development costs were $3.5 million and were down as a percentage of revenue compared with the second quarter of 2021, reflective in part of continued efficiencies gained from our cloud-based initiatives and our technology platform progress. Moving to profitability measures, the adjusted operating loss before amortization for the second quarter was $240,000. The corresponding adjusted EBITDA was a positive $167,000, improving modestly from the first quarter of 2021. GAAP net loss was $1.5 million for the second quarter of 2022 or $0.03 per diluted share. This compares to a net loss of $300,000 or $0.01 per diluted share for the second quarter of 2021. Adjusted non-GAAP loss was $0.01 per share for the quarter compared to an adjusted non-GAAP loss of $0.02 per share for the second quarter of 2021. Additionally, we ended the second quarter with approximately $25 million in cash on hand, a modest uptick from the first quarter. Now turning to our outlook. For the third quarter of 2022, we have seen conversation volumes remain relatively stable with the June period. As stated, inventory remains down on a year-over-year basis in some of our largest verticals, and we expect it may take some time to recover. Additionally, macro events like supply chain disruptions and inflationary pressures continue to impact some of our large verticals. Despite this, we anticipate that sales traction will lead to similar revenue levels in the third quarter compared to the most recent quarters. Additionally, based on our current momentum, we believe we will be at or near adjusted EBITDA breakeven for the third quarter. With that said, as we move through the rest of 2022 and into 2023, we believe there are positive fundamental long-term trends in our business. We continue to have strong engagement with a number of our Fortune 500 customers about expanding our relationships meaningfully over time. In addition, we are seeing potential opportunities with some of these relationships to expand into growing multiyear frameworks. We are also making progress winning new business as our new product suite continues to resonate with customers looking to leverage conversational intelligence to create better customer experiences and grow their business. This is further reinforced by our ongoing efforts to leverage our cloud-based architecture and large proprietary data set to open new opportunities to explore channel partnerships to reach thousands of additional businesses over time. These factors are why we remain fundamentally optimistic about our future. The trend toward businesses taking advantage of conversational intelligence to create better customer experiences and drive increased sales is meaningful and expanding. We are being recognized for our innovation and believe we are well positioned to take advantage of this trend. We continue to solve mission-critical problems for Fortune 500 and world-class brands. Furthermore, we fundamentally believe that some of the economic headwinds created by the pandemic over the last two years at some point will abate. Factors like inventory disruptions will begin to ebb and recover from current levels, and we believe that can be an incremental driver of growth for Marchex. I want to thank again all of our employees for their dedication and continued efforts. With that, operator, we will hand the call back to you.

Operator, Operator

The first question comes from Mike Latimore with Northland Securities.

Logan Hannan, Analyst

This is Logan Hannan speaking for Mike Latimore. We have three questions for you guys on this call today. The first one is how has the auto sector begun to improve from low related supply chain near the end of Q2 and the beginning of Q3?

Russell Horowitz, Co-CEO

Thanks, Logan, it's Russ. Yes. On the auto front, what we've seen is these inventory issues or lack of available inventory has impacted conversation volumes. The inventory is just not there to fully support the consumer demand. And so that has been a factor. We talked about it as part of kind of the broader macroeconomic headwinds. Auto for us is our biggest vertical when you've got auto OEMs and auto services. Where we're really optimistic is kind of beyond the moment. We continue to see a successful expansion of relationships with our existing customers, and we've also continued to add new ones, both on the OEM side and on the dealer side, and get deeper adoption of a variety of our products. And so that's been a positive trend. But the inventory issues are suppressing conversation volumes. However, when we look at the customer product progress beyond your question relative to kind of Q2 and the Q3, we truly think these are good pulse metrics of ultimately what's possible when things normalize. So we think we've done much of the work that sets the stage for us to see growth and opportunity when the environment normalizes, and some of these supply chain issues start to thaw.

Logan Hannan, Analyst

Perfect. And then should gross margins, should we expect them to be stable for the rest of the year?

Michael Arends, Co-CEO

Thanks, Logan. This is Mike. At this point, yes, we think that our service costs or cost of sales from that perspective have improved in the last year, in the last two years, largely because of our technology infrastructure efforts. We see that condition or the benefit that we've been able to obtain from that during the very recent months continuing throughout the rest of the calendar year in 2022. Additionally, if we see room for opportunity for growth, particularly if we look out into 2023 and beyond, the way our technology infrastructure has been set up now with a cloud-based environment, we should actually look forward to some operating leverage and margin expansion in that arena.

Logan Hannan, Analyst

Okay, perfect. What is the current headcount, and where do you expect that to be by the end of the year?

Michael Arends, Co-CEO

Thanks, Logan. It's been fairly consistent with how we've been operating over the course of the last year. It's just a little over 200 FTEs, full-time equivalents. We do use some key members in some jurisdictions from a contracting perspective here across the U.S. and Canada. Those team members from an FTE perspective would round you up to a little north of 250 total.

Operator, Operator

The next question comes from Darren Aftahi with ROTH Capital Partners.

Austin Vetterick, Analyst

This is Austin on for Darren. I just have a few for you. First, I mean, you guys already touched on kind of the auto industry, and it sounds like that may be a bit of a laggard at least for a couple more quarters until we can start seeing some inventory upswing. But aside from that, I'm more curious on what level of resiliency you kind of see, given the economic backdrop with some of the other verticals you operate in, like health care and home services and so forth.

Russell Horowitz, Co-CEO

Thanks, Austin. It's Russ. I mean you really hit on our core largest verticals. Obviously, we've got a variety of verticals that we see as significant opportunities. But if you had to pick auto, home services, and health care, those are clearly three of them. You do see some supply chain challenges also with home services, just given the nature of the seasonality and what's going on. However, when you look beyond the moment and you look at our customer footprint, similar to auto and expansion opportunities, we do view it as a catalyst for growth acceleration going forward. Health care. We've had some key relationships where we've also seen some expansion. So similar to what I said before regarding our observations on auto, we feel like we've done the work to develop the right products to solve key pain points for customers. We feel like they've recognized that, and they have been leaning in to adopt those. The key element behind that is whether they have the inventory and availability and capacity to support the consumer demand. As that improves, we think we're well positioned to see that last step be growth and flow-through.

Austin Vetterick, Analyst

Got it. I appreciate that. Second question. You guys have done a very good job at implementing some of these cost controls. I'm just curious how that kind of plays into launching new products and whether there are any major expenditures associated with launching these new products that could deviate from kind of expected OpEx levels.

Michael Arends, Co-CEO

Thanks, Austin. This is Mike. We have invested significantly over the course of the last two and a half years, even during the COVID environment in development and research initiatives. A lot of this is stemmed off of some of the customer feedback, which we have been routing into our product roadmap that has translated into various new initiatives leading to some of the accolades we have recently received. Those innovations are ongoing, and with any development endeavor, you're always ripe for potential setbacks. However, the program that we've developed, the technology infrastructure, and our move to cloud-based systems give us confidence in our ability to manage productively and still produce favorable results in the product and update it as needed with these innovations. We believe we can bring to market new developments in a fiscally responsible manner in the near and intermediate term. Long-term, obviously, development presents inherent risks, which is part of the opportunity. However, in the near and intermediate term, we feel optimistic about the discipline surrounding our product roadmap and the financial perspective on expenditures.

Austin Vetterick, Analyst

Got it. I appreciate that. And then just one last question for me. I'm curious besides the major verticals of health care, home services, and auto, are there any other verticals you guys are tapping into that you're starting to see traction with that could be pretty notable moving forward?

Russell Horowitz, Co-CEO

Yes. Real estate is a vertical that continues to be important for us. Beyond that, texting continues to be a catalyst across multiple verticals when you look at the combination of voice and text. So those are just a couple of trends we're following. Health care, as mentioned, is a significant focus. We talk a lot about the OEMs in the auto vertical, but auto services represent significant opportunities as well.

Austin Vetterick, Analyst

Got it. Great. Well, I appreciate that. Congrats again on the quarter.

Russell Horowitz, Co-CEO

Thank you.

Operator, Operator

There are no further questions in the queue. So I will pass it back to the management team for closing remarks.

Russell Horowitz, Co-CEO

Great. This is Russ. Just to give you some closing thoughts. To put emphasis, the trend toward conversational intelligence is real, meaningful, and recurring among our largest customers. Businesses want to use technology to improve the consumer path to purchase, and this will be a major theme when we look out over the next several years. We think we've really got the proof points around that. Marchex is well positioned by virtue of the investment we made in the strategic aspects of our business. We've touched on many of those details today, and those are recurring themes from our new cloud-based technology platform to expanding the product suite to help businesses leverage conversational intelligent software to drive growth and also save costs. Given the customer progress we've made through relationship expansion and adding new customers, we believe Marchex can be successful as we look to the future, regardless of economic outlook. Our products continue to be recognized as best-in-class, and we believe that with normalization in any of our key verticals like auto, this could be a further catalyst for growth acceleration in our business. We genuinely look forward to when this happens as well. So we want to thank you all for participating in the call and continuing to be involved with us. We look forward to updating you as we go forward as well. Thank you.

Michael Arends, Co-CEO

Thank you, everyone.

Operator, Operator

This concludes the Marchex' Second Quarter Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.