Similarweb Ltd. Q1 FY2023 Earnings Call

Greetings and welcome to the Similarweb First Quarter Fiscal 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder this conference is being recorded. It is now my pleasure to introduce your host RJ Jones, Vice President Investor Relations. Thank you. You may begin.

Thank you, RJ, and welcome everyone joining the call today. We reported a solid result in the fourth quarter. Despite the challenging macroeconomic environment, we grew our revenue by 19% over Q1 last year to $52.8 million. Our global customer base consisting of SMB enterprise and strategic accounts grew 14% year-over-year to nearly 4,200 customers. And our average customer spends about $51,000 with us annually, up 4% over the last year. We have much to be proud of this quarter when looking at our path to profitability. First, our gross margin was nearly 80%, a new record. Next, our investment in marketing and R&D is showing strong returns. In marketing, metrics at the top of the funnel are very positive and show increasing trends. Our R&D team made significant strides with our data and solutions, which will provide more value to our existing and prospective customers. Lastly, our operating margin showed an impressive improvement of 31 percentage points compared to last year. Earlier this year, we announced our goal to achieve sustained positive free cash flow by Q4. Our Q1 results show we are making great progress. We are focused on deploying resources carefully on the core activities that generate revenue and improve profitability. With this in mind, we are reducing our headcount by 6% in Q2. We're excited to see all the progress happening in the world of AI. With all the new capabilities AI will bring, we see many opportunities for our company on a few fronts. The first is to improve our data analysis at scale using AI to excel in speed, accuracy, and quality. Next, it will enhance our product development by utilizing AI's capabilities to find and analyze insights in our unique data, which is extremely powerful. What will be different for us is when those AI systems meet our unique data assets. We are one of the only companies that possess this comprehensive data on activity in the digital world, covering more than 10 years. Once AI is trained on all the coverage that Similarweb's digital data provides, we will be able to develop new capabilities to conduct extensive analyses for companies from simple queries regarding their specific needs and provide predictions of what will come next. We are uniquely positioned to benefit from the AI revolution and how it will utilize our data to help companies succeed in the digital world. We believe that Similarweb's digital data is the best of its kind available anywhere our customers generate revenue and enhance monetization in the digital realm. Our customers tell us that they make better decisions navigating this uncertain environment because of Similarweb. We remain committed to helping our customers overcome challenges to thrive in this unpredictable economy and beyond. Jason, I will turn the call over to you.

Thank you, Or, and thank you to everyone joining us on the call today to discuss our first quarter results. I will briefly address our financial performance, and then we will open up the call to questions. Our results in the first quarter demonstrate our continued focus on disciplined execution towards achieving our strategic objectives. Revenue was $52.8 million for the quarter and in line with our guidance range. Our overall dollar-based Net Retention Rate or NRR was 105%, as compared to 115% in the first quarter of 2022. For our $100,000 ARR customer segment, NRR was 114%, as compared to 127% in Q1 last year and now represents 55% of our total ARR. While customer retention was good in the first quarter, we saw a more challenging environment to drive upsells within our customer base, as businesses struggled with budget cuts in the current macroeconomic environment. Despite tight budgets, we are encouraged that 40% of our ARR is generated from customers with multi-year contracts, which has continued to grow steadily and sequentially, demonstrating the durability of those customer relationships and the value that our data delivers to our customers. While our results on the top line were in line with our plans, we exceeded expectations on our bottom line. Our first quarter GAAP operating loss was $13.1 million while our non-GAAP operating loss was $7.2 million, significantly below the low end of our guidance range. Notably, our non-GAAP operating margin improved 31 percentage points versus the prior year. And as Or mentioned, our gross margin improved to nearly 80%. These results reflect the ongoing impact of the broad-based operating efficiency measures we've implemented across the business. Turning now to Q2 2023, we expect total revenue in the range of $53.3 million to $53.8 million. For the full year, we continue to expect total revenue in the range of $221 million to $222 million, representing approximately 15% growth year-over-year at the midpoint of the range. Non-GAAP operating loss for the second quarter is expected to be in the range of $6.5 million to $7 million and for the full year between $21 million and $22 million. Importantly, we intend to achieve sustained positive free cash flow by the fourth quarter of 2023. Please note that our free cash flow may fluctuate seasonally as we progress through the year. In particular, we anticipate significant improvement in Q2 2023 as compared to Q2 2022. With our reorganization announced today, we expect savings to be realized in the back half of this year. Ultimately, we expect our quarterly free cash flow cadence to be positive when we finish 2023. Our updated growth projection for 2023 reflects our assessment of the impact of continuing macroeconomic pressures on our business that will persist for an indeterminable amount of time. We continue to balance our expectations for moderating growth with accelerating our path to profitability. The decisions we are making and the actions we are taking align with our intent to become free cash flow positive by the end of this year. We believe that our team, our business model, and our balance sheet remain resilient as we navigate this challenging environment. And with that, Or and I are ready to answer your questions.

Hey, guys. Thanks for taking the question. Can we start with the headcount reductions that you announced? I would love a little bit more detail on where you're cutting heads and how should we think about what that means for top line growth for the remainder of the year? Is there a potential for that to be disruptive, or are these non-revenue-generating roles that are being cut?

Thank you for the question. So the guidance stays. We are still heading to plan. When we did the reduction, we looked across the company to see where we can optimize. A significant part was around SML and another department like operations where we decided to streamline. So this is where we had a 6% reduction. As I mentioned, it's not going to change the guidance; it's still on track.

Okay. Got it. That's helpful. And then you're making some good progress on the margin front getting to free cash flow breakeven. One of the things that stuck out this quarter was the gross margins, which continue to increase for a couple of quarters now. But as you think about this 80% range, do you think that's sustainable, or should we expect some fluctuation as we progress through this year?

Well, first, we feel this was excellent progress. We're very proud of the numbers we have achieved in that front. Yes, in the long term we hope that it will be even above 80%. There may be some fluctuation in the next quarter or two, but down the road, for sure, 80% and above.

Hey, guys. Thanks for taking the question. I couldn't see the continued progression on the profitability front and raising your full-year operating income guidance despite some uncertainty on the macro side just with those economic headwinds. Jason, maybe any commentary on how macro impacted you guys, like as you expected or any worse in the quarter? Did it get incrementally more difficult following March like the Silicon Valley Bank and into April?

Yeah, Ryan, it's good to hear from you. As we shared in the shareholder letter, we're seeing the extension of sales cycles. They're taking longer and impacting upsells due to the slimmer budgets that businesses have. We are seeing similar trends, and demand at the top of the line is actually increasing throughout the quarter and going into Q2.

Excellent. And then Or, I was thinking about the total activity around AI and large language models. I'm curious about the interesting insights that can come from the combination of your dataset and things like ChatGPT. So I'm sure despite the macro, you're really excited given all the technology investment. Could you help us again just remind investors why your dataset is unique? And what insights or near-term use cases do you think some of that can help customers with large language models?

Regarding our uniqueness, in market competition, we are very unique in our data quality, providing full visibility to the digital world. Very few companies have this unique data, and when combined with digital trends from the past 10 years, it allows us to train AI models effectively. We recently conducted a week-long hackathon, experimenting with ChatGPT and our capabilities, which yielded some incredible results. AI helps discover insights and translate those insights into actionable steps. Most companies providing analytics and insights require significant effort to unearth these insights, but AI accelerates this process, providing a strong push for our sector.

Hi. This is Steve Hromin on for Jason. Given that billings continue to slow and customers are growing faster than billings, when do you see kind of an inflection occurring? What indicators are you looking for?

Yes. We have a significant benefit in our business; 40% of our renewals are on multi-year commitments. This gives us good visibility. Recently, some customers have requested semiannual or quarterly payments, which will affect the billing number but not overall cash flow. The drive towards profitability is more tangible than ever.

Hi. This is John Byun for Brent Thill. I think in the past, you mentioned some changes in product bundling, packaging, and pricing. Can you provide an update on that regarding a lower entry point and a higher price enterprise tier?

Yes, that's a great question. We started rolling out a new package for the enterprise that contains many features. Our average order value increased by 4% in the first quarter, which is a good indicator. This is just part of a larger project to improve our overall approach and better leverage our offerings throughout the second half of the year.

Great. Thank you. And then maybe for Jason, the NRR has declined due to macro trends, but how do you expect it to trend for the rest of the year? Is there a time when you think it could bottom and grow from there?

We saw strong overall retention evidenced by logo retention. For our $100,000 accounts, lower retention is around 98%, which is very high. The upsells we historically saw are simply taking longer, affecting the near-term NRR numbers, but the durability and health of our customer relationships remain strong.

Hey, guys. Thanks for taking the questions and congrats on the quarter. Can you give us some sense of how much you're generating from people using your datasets to train AI models? And what are you baking into your full-year guidance given the 6% headcount reduction?

Hi, Noah. The guidance reflects improvements in the back half of the year from those reductions. We are already seeing a few million dollars of improvement on that front, and more is expected in 2024.

Hi, guys. Thanks for taking my questions. Was the headcount reduction needed for you to reach positive cash flow in the fourth quarter?

It was on plan irrespective of this. The optimization we have done in our headcount is just a further focus on disciplined execution and driving efficiency.

Can you discuss the additional revenue guide for the second quarter? What influenced that?

Two factors: first, sales cycles are lengthening; we've seen that in our payback periods. Secondly, the linearity during the quarter means customers take longer to finalize deals. Thus, current quarter's contributions may be lower, but this will trend upward moving forward.

What can you share about NRR trends? Do you see the potential for it to decline below 105%?

Long sales cycles on upsells are a challenge; however, we are seeing strong logo retention. About 55% of our revenue comes from large accounts, which tend to have significantly strong retention. There can be some churn on the lower end, but overall, our customer base is healthy.

I have three questions related to Similarweb's digital data: how much are you generating from those using your datasets to train AI models? Is there a real market? And if so, how do you drive monetization?

Patrick, that's a very interesting question. We believe leveraging our unique data to train AI models will be significant. However, there is not yet a market for that. Our focus is on delivering insights and answering critical questions for our customers regarding how to win in the digital world.

Is there anything you need to do to drive more of that today than you're already doing?

No, we just need to start implementing this across various levels of our offerings.

Thanks. Jason, regarding strong logo retention, how are the overall seats tracking given the layoffs and pressure on the seat-based model?

In terms of solutions, we are taking to the market five products. Four of them don't correlate growth with seats. If our champions remain in place, we are not concerned about losing accounts. Only one product is somewhat seat-based, but it's minimal. So that is aligned with account growth.

With the guide, it looks like you're holding the full year unchanged, implicitly expecting a revenue step-up in Q3 and Q4. Can you discuss your confidence level in the second-half pipeline, given the current conditions?

We have a strong belief in maintaining our guidance. We are seeing positive signs with increased traffic to our website, registrations, and overall demand. If the market rebounds in the second half, we anticipate even stronger movement, so we are confident in our current guidance.

Thank you. We will now conduct a question-and-answer session. Our first question comes from Arjun Bhatia with William Blair. Please proceed. The next question comes from Ryan MacWilliams with Barclays. Please proceed. Next question comes from Jason Helfstein with Oppenheimer. Please proceed. The next question comes from Brent Thill with Jefferies. Please proceed. The next question comes from Patrick Walravens with JMP Securities. Please proceed. There are no further questions in the queue at this time. So this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.