Earnings Call Transcript - TTGT Q3 2022

Operator, Operator

Good afternoon, and thank you for joining TechTarget's Third Quarter 2022 Conference Call. My name is Austin, and I will be your moderator today. I would now like to turn the call over to our host, Charles Rennick, with TechTarget. Charles, please proceed.

Charles Rennick, Host

Thank you, Austin, and good afternoon. Joining me here today are Greg Strakosch, our Executive Chairman; Mike Cotoia, our Chief Executive Officer; and Dan Noreck, our Chief Financial Officer. Before turning the call over to Greg, I'd like to remind everyone on the call of our earnings release process. As previously announced, in order to provide you with an update on our business in advance of the call, we've posted our shareholder letter on the Investor Relations section of our website and furnished it on an 8-K. Following Greg's introductory remarks, the management team will be available to answer your questions. Any statements made today by TechTarget that are not factual, including during the Q&A, may be considered forward-looking statements. These forward-looking statements, which are subject to risks and uncertainties, are based on assumptions and are not guarantees of our future performance. Actual results may differ materially from our forecast and these forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, including those discussed in the Risk Factors section of our filings with the SEC. These statements speak only as of the date of this call, and TechTarget undertakes no obligation to revise or update any forward-looking statements in order to reflect events that may arise after this conference call as is required by law. Finally, we may also refer to certain financial measures not prepared in accordance with GAAP. A reconciliation of certain of these non-GAAP financial measures to the most comparable GAAP measures accompanies our shareholder letter. With that, I'll turn the call over to Greg.

Greg Strakosch, Executive Chairman

Great. Thank you, Charlie. For Q3 2022, GAAP revenue grew 11% to approximately $77.4 million. Adjusted revenue grew 8% to approximately $77.4 million. Net income was approximately $14.8 million, an increase of 49%. Adjusted EBITDA grew 15% to $32.4 million. Net income margin was 19%. Adjusted EBITDA margin was 42%. GAAP gross margin was 74%, adjusted gross margin was 77%. Longer-term revenue grew 25% to $33 million, representing 43% of total revenue. Cash flow from operations was $22.5 million, and free cash flow was $18.8 million. And I will now open the call to questions.

Operator, Operator

Our first question is from Justin Patterson at KeyBanc. Justin, you may proceed.

Justin Patterson, Analyst

Great. Perhaps two if I can. First, I was hoping you could elaborate a little bit more on some of the slowdown you saw during the quarter? We've heard a lot of companies talk about longer sales cycles. So just kind of curious about what your observations have been around customer behaviour? And then secondly, really appreciate the 2023 initial outlook. Could you talk a little bit about some of the assumptions that give you confidence in mid-single-digit growth and 40% EBITDA margins?

Mike Cotoia, CEO

Yes, Justin, this is Mike. Regarding the slowdown in Q3, typically, we’ve discussed that this quarter tends to be back-weighted, and after Labor Day, we often see a significant increase in customer spending on sales and marketing to finish Q3 strong and prepare for Q4. However, following the global macro situation after Labor Day, many deals were delayed, and budgets among our customers were on hold as they reassessed their financial plans. This behavior is not unexpected given the current global uncertainties. We’ve witnessed similar budget evaluations in the past, and this process could take a quarter or two. Historically, there has been a trend towards prioritizing quality. Our business model, which includes a robust editorial content strategy, a permission-based audience, and first-party purchase intent data, highlights the resilience of the IT market today compared to a decade ago. Reflecting on the last significant downturn, some customers may adjust their product focus and scale back on brand campaigns, which, fortunately for us, only affects about 10% of our business. However, larger clients might reduce their brand and current campaign investments, favoring more bottom-of-the-funnel leads and qualified sales opportunities through our HQL products. This is the current situation we are facing. Looking ahead to our initial outlook for 2023, we anticipate that this global pullback will extend into Q1 and the first half of the year. Nevertheless, customers need to meet their targets and outcomes. This reset entails carefully reviewing their investments to ensure their sales teams are equipped with the right pipeline and insights on key accounts. We believe they will eventually shift back to quality, and at some point, they will rapidly reinvest to support their sales objectives.

Operator, Operator

Our next question is with Aaron Kessler from Raymond James. Aaron, your line is open.

Aaron Kessler, Analyst

Just maybe just on kind of the slower growth that you're seeing. I think it's kind of across the board, U.S. and international, as well as by company size. And then just also, can you detail any product differences you're seeing? It sounds like Priority Engine is still seeing pretty solid growth of 15%. So does the slowdown stem more from the ad side? Just a little bit more color there would be helpful.

Mike Cotoia, CEO

Yes. I mean we're seeing the slowdown. Again, when we reported Q3 numbers, we reported 11% growth. I think if you look at constant currency, it would be close to 13% growth. The pullback is notable in the U.S. and EMEA, which is facing its own economic challenges right now. I mean, EMEA has a tough situation with the recession, high prices, and the war in Ukraine; there are a lot of challenges occurring. The hardest region right now is probably EMEA. In terms of products, we've seen some solid growth with Priority Engine. As mentioned before, there is a shift in product or budget allocation from branding advertising, which is about 10% of our overall business. Customers spending in that area may quickly pull back, as it's the hardest product to measure and show ROI. They will likely shift their budgets to further down the funnel types of products, focusing on qualified sales opportunities and HQLs. They are trying to drive immediate revenue because closing deals and securing new logos is taking longer. So that's affecting our product mix, but we're monitoring it closely. Customers see the need for good content to communicate their message effectively, and we are navigating this situation based on what we see. The slowdown in EMEA and North America is impacted by these shifts.

Aaron Kessler, Analyst

And then any changes to your expense growth plans for '23? It sounds like you're taking a more careful approach, but any plans regarding hiring, etc.?

Mike Cotoia, CEO

Throughout our 23-year history, part of our DNA is to invest wisely and smartly. We'll continue to invest in the right areas and priorities that will help grow and support our long-term goals. However, we are vigilant when it comes to managing expenses. As you will see, we will finish the year with a 40% EBITDA margin, and we're projecting a 40% EBITDA margin for 2023 as well. We'll manage expenses in line with our revenue projections. We've maintained a strong record of doing that and will continue to do so based on our free cash flow.

Operator, Operator

Our next question is with Bhavin Shah from Deutsche Bank. Bhavin, your line is open.

Bhavin Shah, Analyst

Just kind of focusing back on the guidance for 4Q and 2023. Can you elaborate a bit more on the underlying assumptions regarding the macro environment? Are you expecting the macro to worsen and budgets to tighten? What is embedded in your guidance regarding revenue growth in 4Q and the first half of the year?

Mike Cotoia, CEO

Yes, Bhavin. We analyze customer behavior based on the real-time global macro uncertainty, which is, frankly, not surprising to us and is somewhat predictable. When we got to September, we saw a pullback, and the global markets really dropped. Looking back, we've been booking our growth across the different regions well up until now. When this sudden decline happens, we first observed it coming back from Labor Day when deals got delayed. We're seeing that not all customers are affected, but across small, large, and mid-sized customers, they are being directed by management to reassess and reduce budgets. They conduct a reset to evaluate which investments are must-haves versus nice-to-haves. In essence, they are scrutinizing their spending. This process may take a couple of quarters. We expect to identify the best solutions, data and partners that will help them accelerate and meet targets they have to hit. In the next one or two quarters, we'll see businesses scrutinizing and then reinvesting back to quality, which we anticipate will ultimately benefit our customers and ourselves.

Bhavin Shah, Analyst

Have you seen any notable impact from larger customers? Has there been any significant pullback from those that have affected your business, especially concerning the brand side or anything else?

Mike Cotoia, CEO

In terms of the brand, we definitely saw a decrease in brand business. Customers can easily pull back and cancel that spending, as it's the hardest product to measure. Historically, our brand business used to represent approximately 30% of our business, and right now it's around 10% or even a little less than that. So while it does impact us, it doesn't affect us as comprehensively as a pure advertising business would. It's not simply one customer pulling back; rather, we're witnessing a broader market behavior where companies of all sizes are managing budgets and are scrutinizing every expense before investing. This evaluation process may take time but reminds us that customers still have sales targets to meet. There's always a flight back to quality regarding data and insights for sales and marketing organizations.

Bhavin Shah, Analyst

It's great to see the 40% EBITDA target for next year, despite an uncertain macro environment. But how serious are you about that target? If the macro worsens and revenue continues to be impacted, will you continue to cut expenses to achieve that target, or will you reassess priorities in light of longer-term opportunities?

Mike Cotoia, CEO

The good aspect of our situation is that we have a 23-year history of investing judiciously, without overspending in areas that won't influence the business. This discipline has served us well. We've made significant investments in 2022, including doubling our product development and software teams to enhance our Priority Engine features and roadmap. We do not want to compromise on those areas. Moreover, we are also focused on content enablement services, ensuring our customers have access to high-quality content for effectively engaging with self-service buying teams. We will maintain rigor in expense monitoring, and if we encounter opportunities for growth acceleration, we will evaluate those investments when necessary. Nevertheless, our track record demonstrates responsible cost management. We will maintain our disciplined approach to investing in key business areas while following through on our financial commitments.

Operator, Operator

Our next question is with Jason Kreyer from Craig-Hallum. Jason, your line is open.

Unidentified Analyst, Analyst

Carl here on for Jason. You kind of talked about customer behavior earlier, but could you elaborate on the business metrics surrounding these such as contract duration, sales cycles, and churn? Are you witnessing any macro-related impact on these KPIs?

Mike Cotoia, CEO

Yes. What we're observing is that we've seen some deals we had forecasted for Q3, and as mentioned in our shareholder letter, this is the first time since Q3 of 2010, over 46 quarters, that TechTarget has missed both quarterly revenue and adjusted EBITDA numbers. We've experienced delays in budget approvals, and clients are reporting the freezing of their budgets. If we had something forecasted that we were 70% confident in, we typically know when it will land, and some of those deals are now delayed as customers reassess their spending for quality investments. I cannot stress enough that the flight back to quality is happening, and this is reflected in customer behavior. We've also seen some customers adjust their product strategies from brand or demand generation campaigns to lower-funnel qualified sales opportunities and HQLs, assisting their sales teams to close as many outstanding deals as quickly as possible. Therefore, we see this dynamic reflected in our guidance, and we're investing closely to monitor it.

Unidentified Analyst, Analyst

Perfect. One last question from me. As we navigated through COVID, we noticed a trend where more of TechTarget's products or prospects were inclined towards shorter-duration engagements as opposed to Priority Engine deals. Are we observing any similar patterns during this recession's early stages?

Mike Cotoia, CEO

I think we're noticing some of that shift, where certain customers are hesitant to make long-term commitments, whether it's for one, two, or three years. We are seeing indications of this pattern, so I believe it's a safe assumption for the next quarter or so as businesses navigate through this phase to witness similar behaviors as we did at the beginning of 2020.

Operator, Operator

Our next question is from Joshua Reilly from Needham. Joshua, your line is open.

Joshua Reilly, Analyst

I wanted to hit on the difference in customer base. I think this is an interesting point to highlight with investors. Four or five years ago, we all know you had a very different customer base. Are you surprised that some of these more software-oriented customers are pulling back, perhaps more than we would have expected given their secular growth versus those legacy customers who appear to have more cyclical growth?

Mike Cotoia, CEO

Yes, Joshua. It's a valid observation. Four or five years ago, our customer base predominantly encompassed on-prem hardware customers. When they pull back, their retrenchment tends to last longer. Over the past few years, we have progressed from nearly a thousand customers to over three thousand. Our offerings have expanded, and we now have different capabilities leading to favorable revenue segmentation. Presently, about 42% of our revenue stems from long-term contracts. Nonetheless, macroeconomic uncertainty impacts these customers, and we're observing them pull back their spending. They are unlikely to cancel outright but may pause decisions while putting a greater emphasis on ROI. Although they are more insulated now compared to five years ago, they are not immune, hence the observed pullback.

Joshua Reilly, Analyst

In relation to the 15% growth in Priority Engine, how much of this deceleration can be attributed to weakness in the SMB Express product versus a broader decline in demand?

Mike Cotoia, CEO

I think the slowdown is due to general demand as clients assess their renewals based on current performance, postponing commitments for another month or two. The slowdown affects various segments due to the sudden shifts in the global macro environment. Despite this, we've also seen some Priority Engine clients increase their investment and commitment. Overall, the deceleration is not isolated to any single area at this time.

Joshua Reilly, Analyst

You mentioned in the letter that you're continuing to invest during this downturn. How should we interpret your appetite for M&A versus buybacks, especially given that the stock is down and valuations have been reset? How do you weigh growth and return expectations for acquisitions versus buying back shares?

Mike Cotoia, CEO

That's a smart question. We'll manage our approach to be opportunistic. We announced a $200 million buyback plan. However, we continue to explore potential acquisition opportunities. We believe there will be significant opportunities based on recent valuation resets in companies related to content, intent, audience, and peripheral capabilities, as well as adjacent markets. We will remain opportunistic in pursuing the right organizations that fit TechTarget's needs at appropriate valuations, alongside our buyback strategy.

Daniel Noreck, CFO

Yes, we're fortunate to be in a position to pursue both strategies. We have $384 million in cash and anticipate generating $100 million in cash flow next year. We believe we can aggressively engage in buybacks while simultaneously pursuing valuable acquisition targets. Our history speaks for itself regarding our ability to leverage downturns to take market share, repurchase shares at beneficial rates, and engage in smart acquisition opportunities. This current global pullback can provide strong companies the chance to solidify their positions, and we are eager to capitalize on that.

Operator, Operator

Our next question is with Bryan Bergin from Cowen. Bryan, your line is open.

Unidentified Analyst, Analyst

This is Derek Caseta on for Bryan. I wanted to discuss Priority Engine and get an update on the sales use case version's overall progress as we near the one-year anniversary. How has the performance aligned with your expectations, and where have been the positive surprises, as well as any areas that might have posed challenges?

Mike Cotoia, CEO

Yes, absolutely. In terms of the sales use case, we have monitored its progress closely, and it's coming up on its one-year mark. We've observed strong success in this area. Historically, we sold Priority Engine to marketers for nurturing email strategies. At the beginning of 2022, we launched our sales use case module for Priority Engine, and we've seen substantial adoption on the sales side. The usage trends have been encouraging, with sales representatives utilizing it for customer retention, securing new logos, and managing territories. We intend to build upon this momentum. I'd also like to note, as mentioned in the shareholder letter, that substantial investments were made in 2022, particularly in the latter half, to enhance our development and software teams working on Priority Engine. We focus on data integration through Priority Engine into our customer’s systems, making it easier for clients to leverage our information in a bidirectional manner. We aim to provide insights to support customer campaigns with TechTarget, bridging marketing and sales efforts effectively. There's a lot we are doing on this platform, and we are pleased with the performance of the sales use case but also remain mindful of our market positioning.

Unidentified Analyst, Analyst

If I could just add one more here. I know you've mentioned clients pushing back their budgets and reevaluating, but are you also seeing any pushback from clients regarding pricing, and how do you navigate a more cautious consumer?

Mike Cotoia, CEO

We haven't seen significant pushback concerning our pricing. Customers appreciate that we offer high value relative to the pricing we offer, given our data's quality at both the account and individual prospect levels. Occasionally, we encounter situations where clients request lower costs, but we adhere to our strategy of ensuring our pricing reflects the value we provide. While we want customers to benefit from our offerings, we won't engage in pricing that compromises our value proposition. As our customers navigate through these challenges, they will need accurate and transparent paths to reach their target audiences, which further emphasizes the quality we bring to the table.

Operator, Operator

Our next question is with Max Michaelis from Lake Street Capital. Max, your line is open.

Max Michaelis, Analyst

Just one for me. Given the guidance for Q4 and the outlook into 2023, what are your expectations for gross margin? Should we also anticipate any wage inflation impacting operating expenses next year?

Mike Cotoia, CEO

Yes, I think our gross margin will stay consistent with what it is today, and we've projected a 40% EBITDA margin for next year. These factors are factored into our model, so I don't anticipate significant changes.

Max Michaelis, Analyst

And regarding OpEx, should we expect any wage inflation in 2023?

Mike Cotoia, CEO

I wouldn't anticipate much alteration in that regard. Additionally, we are observing market trends as many companies are trying to manage expenses across the board, including their workforce. Therefore, we do not foresee substantial changes to our operating expenses.

Operator, Operator

Our next question is with Greg Burns from Sidoti & Co. Greg, your line is open.

Greg Burns, Analyst

Looking at your revenue guidance for 2023, does it assume growth in Priority Engine?

Mike Cotoia, CEO

We do not break it down by product, but we provided preliminary guidance on how we anticipate performance will run quarter-to-quarter and throughout the year, targeting mid-single-digit growth overall.

Greg Burns, Analyst

Of your 3,200 customers, what percentage is currently utilizing the sales use case?

Daniel Noreck, CFO

It's a very small percentage since we're still within the first year, but it's growing nicely, albeit still a small base.

Operator, Operator

That concludes our Q&A. Thank you for your participation. You may now disconnect your lines.