Marchex, Inc. (NASDAQ:MCHX) Q3 2022 Earnings Conference Call November 3, 2022 5:00 PM ET
Company Participants
Trevor Caldwell – Investor Relations
Michael Arends – Co-Chief Executive Officer
Russell Horowitz – Co-Chief Executive Officer
Conference Call Participants
Dillon Heslin – ROTH Capital Partners
Vivek Palani – JMN Research
Operator
Good afternoon, everyone, and welcome to the Marchex’s Third Quarter Conference Call. My name is Emily and I will be your conference call operator today. [Operator Instructions] I will now turn the call over to our host, Trevor Caldwell, Senior Vice President of Strategic Initiatives and Investor Relations. Please go ahead, Trevor.
Trevor Caldwell
Thank you, Emily. Good afternoon, everyone and welcome to Marchex’s business update and third 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 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 for the Investor Relations section of our website.
At this time, I’d like to turn the call over to Mike Arends.
Michael Arends
Thank you, Trevor, and good afternoon, everyone. Thank you for joining us today. The third quarter was mixed for Marchex. The ongoing supply chain challenges and rising inflation continued to impact conversation volumes on a year-over-year basis for certain customers and business segments. At the same time, demand for our conversational intelligence software is growing among many of our largest customers as well as other large businesses with distributed retail footprints.
We are seeing healthy development in our pipeline, which is a positive indicator for our overall growth as we look into next year. There still are certain macroeconomic factors present such as inventory shortages, which have impacted prices in certain verticals. That, along with the pullback in consumer spending to a degree, has had a corresponding effect on conversation volumes at the retail level. That story is fluid on a vertical-by-vertical basis, but it is still a present factor, especially when looking at it on a year-over-year comparison basis.
At the other end of the spectrum are customers who, despite the challenging economic outlook, are seeking to increase their utilization of our products and resulting spending with us. We are engaged with some of our largest Fortune 500 customers, who want to expand their relationship with us because they want to fundamentally change how they operate their businesses. They see our suite of conversational intelligence software solutions as a means to understand critical insights into the retail operations and customer interactions, like how to deliver a best-in-class customer experience and close the loop to capture more of the opportunities and to sell more effectively. We can solve big problems for these types of businesses, and we believe this will drive our growth.
For the auto industry, the time to change has never been more urgent. The global supply chain situation has transformed how U.S. consumers buy vehicles. And hundreds of millions of dollars in sales are being lost every year because dealers and manufacturers have an ingrained outdated way of operating. Marchex recently released an in-depth data analysis of 60,000 consumer-to-dealer conversations and found that dealers and manufacturers have significant opportunity to capitalize on these lost sales by bridging a big communication gap between both dealers and consumers and between manufacturers and dealers.
We surfaced vital and detailed insights showing that dealerships and manufacturers consistently struggle in their communication over the phone, answering questions about car availability and how the vehicle ordering process works, particularly as the auto industry is in the midst of one of the largest changes in its history. This is being defined by the shift to build to order directly from manufacturer websites and the rise of electronic vehicle sales.
In our study, current gaps in customer communications left the majority of potential customers frustrated and distressful, particularly at a time when inventory is tight, and order and financing processes are confusing, equally as alarming is that many of these bad experiences convince customers to defect from a particular brand. The good news is that dealers and manufacturers are telling us they are motivated to fix these problems so they can evolve their practices now because the moment demands it, and they are turning to us because we have the platform and intelligence to show them exactly how to do it. Marchex is increasingly becoming the conversational intelligence software platform for the auto industry.
Our customers’ success is at the heart of what we do. Our commitment to that mission was recognized last month when we won the APPEALIE SaaS award for customer success for helping businesses recover lost opportunities. The award came from a case study, which highlighted a national computer repair and support services company that saved $50,000 in a single month by using our sales rescue feature of our conversational intelligence platform. This success was possible through our continued investments in cloud-based solutions and Marchex Anywhere, our integrations and applications hub that makes our suite of industry leading conversational intelligence services available through third-party communications platforms.
The world is changing and we are changing with it to serve our customers, whether it’s the auto industry, home services or healthcare, the need for conversational intelligence software is present and growing. The scope of these challenges underlies our move to the cloud to reach more customers and prospects and our ongoing investments and innovations to solve an increasing array of customer experience pain points at the retail level, particularly for large businesses.
And with that, I will hand the call over to Russ.
Russell Horowitz
Thanks Mike. What Mike just described about the auto industry shows how the trend toward conversational intelligence is a very meaningful opportunity for Marchex. Our products sit at the juncture of revealing critical actionable business insights to help companies transform their customer experience and to strategically plan and invest for the future growth of their businesses.
Marchex’s ongoing investments are driving the innovations that are enabling us to achieve a pivotal role for large Fortune 500 companies with distributed retail footprints. Conversational intelligence software can be a defining solution to optimize costs while creating better customer experiences and increase sales. We are seeing our largest customers embrace our solutions in ways that can be differential for Marchex and drive higher volumes as the macro environment normalizes.
While the near-term economic circumstances have been somewhat cloudy, we have seen Marchex manage through these periods before, and we believe that we can emerge from this even stronger and with more momentum. That’s because Marchex has the right technology and solutions for businesses that need to streamline a complex ecosystem of retail operations technologies. Our unique offerings help companies improve their customer experience so they can continue to grow both now and well into the future. We’re energized by the opportunity it presents for our business. Meanwhile, we’ll continue to invest and capitalizing on this opportunity and be mindful to stay focused on our financial profile as these dynamics play out.
And with that, I will hand the call back to Mike.
Michael Arends
Thank you, Russ. Revenue for the third quarter of 2022 was $13.2 million versus $13.7 million for the same quarter last year. As I mentioned earlier, the third quarter was mixed. On the one hand, conversation volumes came under pressure as macroeconomic events and persistent inflationary pressures weighed heavily on certain customer conversation volumes and led to an overall volume decrease compared to the year ago and sequential periods. For example, pressure in the tail of our business and in small business listing and solution providers that mostly sell marketing services to local businesses faced pressure in conversation volumes compared to the year ago period. While we are watching that trend closely, we are seeing some traction with sales of our new products helping the overall mix.
Looking at the intermediate and long-term view, we are making progress with onboarding several new customers and also further in dialogue with several of our largest Fortune 500 customers where there are growth opportunities and potential for new multiyear commitments. We believe that over the remainder of this year, we will continue to make progress through our momentum with several large customer expansions and with new sales wins in verticals such as healthcare, home services and auto that will set the stage for sequential progress as we go into 2023.
Our new cloud-based suite of products continues to resonate with businesses, and as a result, we are adding to our long-term customer and prospect pipeline, and we believe it has an opportunity to drive a more meaningful growth profile over time. On the operating cost side, our focus 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.
Now let’s shift to the P&L for the third quarter. Excluding stock-based compensation, amortization of intangible assets and acquisition or disposition-related costs, total operating costs for the third quarter were $13.6 million compared to $13.9 million in the third quarter of 2021. Service costs were $4.9 million for the third quarter. Service costs showed some leverage year-over-year, largely due to our progress with our technology infrastructure and cloud-based initiatives. Over time, we believe we will see a positive impact on service costs as a percentage of revenue as we continue to see successful sell-through from the launch of our new conversational intelligence products and channel initiatives.
Sales and marketing costs were approximately $3.2 million. This decreased from the year ago period due to continued optimization of sales and marketing initiatives. Product development costs were $3.5 million and were up as a percentage of revenue compared with the third quarter of 2021, as we’ve continued to invest in our future product pipeline and enhancing our AI-driven conversational intelligence capabilities.
Now moving to profitability measures. Adjusted operating loss before amortization for the third quarter was $430,000. Corresponding adjusted EBITDA was a positive $10,000, staying relatively consistent with the third quarter of 2021. GAAP net loss was $1.6 million for the third quarter of 2022 or $0.03 per diluted share. This compares to a gain of $3.3 million or $0.07 per diluted share for the third quarter of 2021. Adjusted non-GAAP loss was $0.01 per share for the quarter, which was consistent with the third quarter of 2021. Additionally, we ended the third quarter with a little more than $23 million in cash on hand.
Now turning to our outlook. For the fourth quarter of 2022, similar to past years, we expect a seasonal decline in revenue compared to the third quarter, as this period typically represents lower sales volumes for many of our customers as call volumes decline during the holidays. In addition, as previously mentioned, there are certain macroeconomic factors that are weighing down conversation volumes in parts of our business. Despite this, we anticipate that sales traction will lead to similar revenue levels in the fourth quarter as compared to the year ago period. Additionally, we believe we will be at or near adjusted EBITDA breakeven for 2022, which implies a loss on an adjusted EBITDA basis for the fourth quarter. I would like to note that given the traction of our sales pipeline, timing of onboarding new customers, and technology infrastructure initiatives, we believe we will make sequential progress in both revenue and adjusted EBITDA in the first quarter of 2023.
With that said, I’d like to share some broader commentary on our business. While we are in an uncertain economic climate we believe Marchex is well-positioned to emerge as a leader in conversational intelligence. Our products can help businesses both grow and save costs as they look to consolidate a complex ecosystem of sales operations technologies. At the same time, we are seeing strong customer engagement as businesses embrace the trend towards utilizing conversational AI to improve the customer buying experience and increase sales. Meanwhile, our significant investment in moving our infrastructure to the cloud over the last 2 years will serve as the basis of our future innovation. This also gives Marchex the flexibility to add new products and features that will enable us to take advantage of this trend and accelerate growth, which can lead to potentially significant operating leverage.
Our long-term sales pipeline remains healthy. As we move through the rest of 2022 and into 2023, we continue to have a number of opportunities with our Fortune 500 customers regarding expanding our relationships meaningfully over time, including multiyear relationships. At the same time, we will be onboarding some of our recent new customers while also taking our new products to market and securing new customer wins. These trends, coupled with a new suite of cloud-based products, lead us to believe Marchex has the potential to accelerate growth with considerable potential to expand margins. And these factors are why we remain fundamentally optimistic about our future.
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.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question today comes from Darren Aftahi from ROTH Capital Partners. Please go ahead.
Dillon Heslin
Hi. This is Dillon on for Darren. Thanks for taking my questions. If I could start, you mentioned some of the puts and takes of the verticals where you saw better traction in expanding your relationships in certain verticals where others were under pressure. Like how does the revenue mix shake out between those clients, like the ones you mentioned, home services, healthcare and auto versus the smaller customers that were still under pressure?
Michael Arends
Thanks for the question, Dillon. This is Mike. So, we are looking on a vertical basis. Automotive was actually relatively stable in the third quarter on a sequential and a year-over-year basis. From a volume perspective, home services usually has a seasonal uptick in the third quarter. It didn’t have as strong an uptick as it does or as it has in the last number of years. Those two verticals are relatively sizable for our overall mix. The pieces of the equation that saw some decrement and in particular, if you look at small business listing providers. So, arrangers in the digital as well as the advertising space that work with small businesses and large cases, they saw some more significant impact on a year-over-year basis from just decreasing conversational volumes. In addition, there were some longer tail or smaller customer bases that saw – they just seemed to have lower conversational volumes than they have on a year-over-year basis as well. And so there was some decrement there. But the small business listing providers was probably the most noteworthy one in the overall equation that we would call out as being impacted.
Dillon Heslin
Got it. And another question, when you talk about the pipeline building and expansion potentially with the Fortune 500 companies in new products, like what is your visibility in terms of actually rolling out and monetizing those products? Like said another way, are they live right now and you are seeing some revenue starting to generate there, or do they still have to get rolled out and sort of tested throughout 2023?
Michael Arends
So, in one facet, we have secured some new customers in terms of paperwork as well as piloting. And so it’s more a matter of actually rolling it out. And I will give you a few cases. We have actually got some relationships in auto services with some existing customers that are expanding in a potential significant way. Home services, we have had some recent customer acquisition wins. Auto is another area. And healthcare, we have got some relationships existing that are expanding as well as some new customers. The ones where there are existing relationships, those relationships are more able to be scheduled, and it’s part of why we gave some of the visibility into 2023 today, where we see us making sequential progress in both the top and the bottom line. It’s because we actually feel like there is some solidification of the traction coming from those existing customers. With the new customers, we not only think that some of these new customers that we have won and secured the relationship with, but the piloting and the onboarding process as part of that we think is going to play out well for us in the first half of 2023. The other piece, Dillon, that we are seeing is, in the pipeline, we have actually got more opportunities. They are not secured. They are not signed. We haven’t piloted them yet. But we do have more opportunities that are building, which gives us pause for some of the interest from the customer base as we look ahead and feel like 2023 can actually be a tracking year for progress, not just from the product perspective and the customer perspective, but also from the financial perspective.
Dillon Heslin
Thanks. And one more, if I may. When you talk about some of the operating leverage, how should we think about sort of the flexibility you mentioned in terms of what line items you are able to sort of taper back or increase, say, like sales or marketing if you are seeing good traction. Is sort of the breakeven or better adjusted EBITDA the goal to spend to, or is it sort of where it shakes out on the top line first?
Michael Arends
So, the number one place that we see the operating leverage is with the gross margin, just the cost of service, the cost of sales lines. We think there is more opportunity for expansion with added revenues and economics from that standpoint. As we have talked in the past, we think that at the current scale, we have got quite a bit of room for leverage also just with keeping a few places fixed. And so G&A would be an area that we think is a relatively fixed cost, even with fairly robust significant scale from where we are. I think sales and marketing, there is more of a piece that’s variable with that. And if we see some traction with customer acquisition, that may be an area that actually grows, but it would be more commensurate with revenue opportunity and the revenue growth in that arena. So, hopefully, that gives you some indications. In the relatively near-term, I think our focus is on progress, especially on the top line and trying to make sure that we see traction there with the new customers as well as expanding some of the relationships. And so revenue would be more of the focus than necessarily trying to optimize for the near-term profitability.
Dillon Heslin
Got it. Thank you. I will pass it on.
Operator
Our next question comes from Vivek Palani with JMN Research. Please go ahead Vivek.
Vivek Palani
Hi. Good afternoon. I am Vivek on from Mike Latimore of Northland Capital. I have a few questions with me. The first one is, what percent of sales now into text messaging?
Michael Arends
So, Vivek, this is Mike. I think the question you asked was about messaging or SMS and text messaging. If that’s the case, it still remains a minority piece of the equation, but it’s a growing piece. It’s a single-digit percentage in terms of the direct traction, but one of the things that we are doing in 2023 has this on the path. It will become a more integrated component across our suite of products. It’s not integrated across all of our products today, and that’s one of the things from a strategic roadmap perspective that we want to enable on a go-forward basis. And so as part of that, we do expect SMS and messaging to become just more of a focal point of the value proposition that all of our customers get to see, not just the ones that are accessing or acquiring the relationship simply because of our text messaging capabilities.
Vivek Palani
Great. My second question is, does bookings grew year-on-year in the quarter?
Michael Arends
So, when you are talking about bookings, I presume that you are referring to pipeline. And so from a pipeline perspective, there is two parts. There is actually secured new arrangements, so customer acquisition arrangements. And those, we have got some good news in the last quarter where there is growth. There is more activity in that arena, both in terms of number as well as dollar volume. But in terms of the pipeline and what the backlog is with growing opportunities that haven’t been secured and signed, I think that’s where we are seeing some refreshing activity. And it’s across a variety of verticals. It’s not just in auto. It’s not just in auto services. It’s coming across in home services. It’s coming across in healthcare.
Vivek Palani
Okay. The last question is, how do you see the gross margin trends? And what are the main levers there?
Michael Arends
So, on the gross margin, we think that it can be relatively stable in the near-term with consistent revenue levels. What I think we see with revenue growth is for every incremental dollar of revenue growth, we think the gross margin is going to be expensive. And especially when you look at our new suite of products, if that becomes the predominant piece of the mix of additive revenue or new revenue that’s added, then the gross margin can move more significantly. We think there is $0.70 plus for each incremental dollar of revenue that comes onboard that can drop to the contribution line, the gross margin line. And with some of the suite of the products, it could be even more than that. Given the cost of sale it’s a relatively nominal part of the actual service component.
Vivek Palani
That’s it. Thanks.
Operator
We have no further questions. I will now hand back to the management team for concluding remarks.
End of Q&A
Russell Horowitz
Thank you. This is Russ. Just to wrap up, I want to thank everyone for participation in the call today and the very good questions. The main thing I think we can close on is, we really feel like we are increasingly getting clear and clear line of sight on our opportunities and growth catalysts. The environment, obviously, as we have referenced, has been clouding and there has been various macro factors at play. But despite that, we have been getting closer with our customers, deeper in our understanding with our vertical opportunities, that’s helped to inform a lot of our product priorities and strategic differentiators. And so it’s put us in a place where with clear understanding and clarity around where those growth opportunities are, it’s really just being executionally focused. And so in the spirit of what Mike talked about as well, the catalysts are there with expansion with existing customers. We have had new wins that validate a lot of these new products that we believe will contribute sequentially. And we continue to focus on our channel expansion, which we think will just put more momentum behind all of those initiatives. And so we are eager to share progress with you and appreciate your ongoing support and involvement. Thank you very, very much.
Operator
Thank you everyone for joining us today. This concludes our call and you may now disconnect your lines.
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