Semrush Holdings, Inc. (SEMR) Earnings Call Transcript & Summary

[Audio Gap] Morgan Stanley TMT Conference. My name is Elizabeth Porter. I'm an analyst on the U.S. Software team. And I am really pleased to have with us today Semrush's President, Eugene Levin; and CFO, Brian Mulroy. We're going to take audience questions, so if there's any towards the end we will have mics going around. And for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And with that, thanks again for joining us today.

No problem. Thanks for having us.

Of course. So I think it would be helpful to start off, for those that might be less familiar with Semrush, to get just the background of the business. You guys sit in a really unique area within online visibility management. But can you just talk to us about the different offerings that kind of create that portfolio and the type of customer you're serving?

Yes, I can give just a brief overview of the company in general. So we're a high gross margin SaaS recurring revenue business. Our main product focus areas is search engine optimization, marketing, digital PR, competitive intelligence, social media and in local marketing. Basically, what that means is there's companies all over the world and marketers who are looking to be present where their consumers are, and to be able to bring those consumers into their world to drive traffic to their sites and their businesses, and ultimately, convert them to paying customers. What we're seeing happening is consumers can't spend any more time online. I think doctors are saying, we're all spending way too much time, 8 hours a day or so on average. And the number of consumers who are coming online is starting to slow. So businesses are realizing that to be present and to generate that traffic is increasingly becoming more complicated. There's a lot more competition, and they're looking for companies like Semrush who can serve almost like a GPS to tell them how to get places, how to do it in the most efficient way, and to make sure that they can make their brands known and driving traffic and ultimately, revenue to their businesses. Just from a financial perspective, I'll spend a second on that. We're very high margin -- gross margin company. So we're at 83.6% gross margin in the fourth quarter. That's up 100 basis points. And we've been really focusing on driving efficient growth. So we delivered 21% growth in 2021, and did that while expanding our net income by over $40 million. So in the fourth quarter, operating margins were up 2,500 basis points. Looking forward into 2024, we see an extensive market opportunity. We spent many years investing in our data and assets and now have 108,000 paying customers, over 1 million free users. And we're really pleased with the traction and success that we've been able to accomplish to date and excited about the opportunities ahead of us. Our main focus areas in terms of growth are we want to continue to expand our net ads. So we have nearly 108,000 today, but there's millions of marketers and business owners who will benefit from our platform. We focus also on cross-sell and upsell. So we have an extensive portfolio and platform where our existing customers and new customers continue to adopt more and more of what we do. And then because of that high gross margin, 83.6% in the fourth quarter, we have the benefit, a structural advantage and competitive advantage to be able to reinvest that back into the business and just keep the flywheel of bringing new customers and bringing new products to the market going.

Great. And you mentioned a lot of different areas you're playing in, whether it's SEO, a digital PR, social. So when I think about that landscape, there tends to be a lot of point solutions that could be pretty fragmented. So why is Semrush positioned to win? And why is it hard for the competition to build or recreate what you guys have built?

There are several parts to this question. So in terms of how -- like what is the moat, right? We have really unique data assets that we've been collecting and improving for more than a decade. And there is a bit of a network effect in this. And it works in a way that we have really good data and people come for us to get answers to their questions and explore our data. And because our data is so good, we attract a lot of customers. Now as those customers use our research products, they also start using our reporting products or optimization products. And to use them, they have to connect their own data sources such as Google Analytics. And then we can use those connected data sources, the source of true data, to continue calibrating our machine learning algorithms so our research data becomes even more accurate. And as a result, as our research data gets even more accurate, it attracts even more customers who use them in more products, who share even more data that we use to improve machine learning algorithms and create even better products and improve quality of data. So that becomes a really good moat where, without this network effect, other vendors really struggle to build research data of high quality. The second big differentiator is in a fragmented market, platforms have just overall advantage versus point solutions. They have brands that people trust. They have user experience benefits. So you use one log in, same payment method for all the products that you buy from this vendor. So there's a lot of convenience. It's great in terms of cross team, cross-functional collaboration. If you have social media team using one tool, and then you have SEO team using a different tool, they don't have a lot of opportunities to interact if they use one product or one platform, then there is a higher probability that they will talk to each other and coordinate their marketing activities. And finally, all the metrics are apples-to-apples, very comparable, and it's easy to track visibility and performance across the board, which really creates better alignment across organizations. So if you look at MarTech in general, biggest companies, there -- all of them are platforms.

Great. And so you mentioned data as being the moat. You also hook into other sources like the Google Analytics to make your own data better. And the question we often get is, well, large companies like Google often have similar data. So what is it about Semrush that you're able to deliver something that's different than what Google data may have?

Yes. So Google in terms of data, it's hard to compete with them, and that's not something we're doing. They know everything about like almost everyone. That said, they make money by selling ads. So that's their primary revenue stream. And what it means is that you're -- if you're a Google customer, they will tell you how to spend more money on Google. They're not going to tell you how to spend more money in other places where -- they will not tell you when you need to pull money from Google and spend it in Facebook or maybe spend it in organic marketing or spend it on brand marketing or create content or do PR. That's not how they make money, so they will not tell you anything about these activities. And Semrush, on the other hand, is a unique place where we have visibility about what's going on across the market, what works, what doesn't work. And we can give people unbiased advice because we are not selling them ads or anything else. We are representing them in their relationships with those bigger platforms, and we help them to make capital allocation decisions when it comes to marketing.

So it's this kind of Switzerland, neutral approach to give this unbiased opinion.

Yes. I like that.

So I wanted to switch a little bit to the go-to-market. You guys have amassed that's huge, 1 billion plus base of free users. There are a couple of different layers on how you guys think about this free user base. So I'd love to understand better, like what was the strategy to accumulate such a large group and presence? And what levers do you have to convert those free customers into paying customers? And then I guess, just lastly, as the macro seems to be getting a little bit easier in budgets, even wallets open up potentially, does that give you some room to accelerate that conversion?

Yes. I don't know if we've seen the wallets opening up yet, but we're looking forward to it. Yes, so we have 1,041,000 free users. That's up 30% year-over-year. And our free users is a long game for us. So we have 3 cohorts of users in that. We're in 60 universities and part of the core curriculum for marketers. The idea is when they graduate and they start to build their careers in marketing, that they think of Semrush first. We're continuing to expand our platform, become more and more part of the day of a marketer. Our key thing is we have our core competencies, but we keep focusing on that next adjacency and delivering a broader and broader platform for marketers. So we want to be training them in college, in universities and masters programs to be thinking of Semrush. There's also an opportunity for us to test new features and products. So we often put features and products into the market for free, build up a subscriber base, get feedback, understand usage patterns, and then we'll look to either move that into the core paying offering and increase its value or to monetize it separately. Most recently, we did that with a social media offering. We were able to build up a really strong group of free users and then convert it in the third quarter that to a monetized offering, which we're now generating revenue from. So you'll see products go in and out with that strategy. And then because our offering is democratized for the masses, we go really deep into the market. Our customers start out with really small business owners, solopreneurs, but we also have customers in the Fortune 500. So we have 5,000 enterprise accounts that have more than 500 employees. So we have such a broad reach, but there is a cohort of users that are just starting out in their journey and just learning about online search, social media, PR, intelligence, local marketing, all the different tactics that you need to grow and scale your business, and we want to make sure that they're thinking of Semrush and using us as they start that journey. So there's those 3 cohorts and it's more of a long-term play for us.

In your opening remarks, you noted cross-sell and upsell as a major focus for the business. When you land with a customer or your average ARR, I should say, per customer is around -- is 3,000. And you can look kind of sequentially and see that overall, it has been a pretty durable kind of tick up from a sequential basis. So once you guys land with a customer, what are some of the key paths you have to expanding spend?

So it really depends on the type of the customer and what they're looking for. We have such a broad portfolio that we cannot just go and start randomly offering them, do we try -- do you want to try this or do you want to try that. So we monitor what they do in product and what kind of business they have and how mature is their presence in different vertical -- sorry, in different channels. And then we start suggesting them different additional products that might help them on their journey. And there are several parts where we do in-product marketing. So sometimes it's a banner, sometimes it's an interstitial, sometimes it's just a tool tip. In one tool that says, well, maybe you want to also try this additional tool. It works in a very natural way where people solve one problem and then we say, well, great. Now you may look at this one as well. And good examples are if we have someone who is local business, we would even try to suggest them to buy our local products first, even though it's a cheaper product, we have a much higher conversion rate when we pitch this product to local businesses. And then we upsell our core SEO product, for example. [ More ] in the -- started with core SEO, but we know they're a local business. We'll first, for example, tell them to set up, let's say, rank tracking for their location. Then we'll tell them, well, in this additional local product, we can also track your visibility in Google Maps. And we also have features that allow you to manage your reviews, that allow you to manage your listings in different directories. Maybe you want to try that. So we get them to a point where they have this sort of success. And then we kind of say, okay, now when you're a success, here is the next thing you may want to do. But then if it's a big business and not local business, then we are not going to offer them local product, we're going to offer them research product if we see that people are focused on kind of more high-level strategy and market share and those kind of things. And we have many, I would say, at least 7 key personas. And for each of those personas, recommendations will be different. And then I said we have those banners. So those are almost like banners that you see on Google, where they're either 100% personalized based on who you are and what you do. And then we have the same recommendation algorithms working behind the scenes to figure out who is the best fit for what particular product.

Great. And on your last conference call, one of the things that stood out to me was, as you're addressing some of these larger customers, they can have a 10 to 15x ARR size as your average customer. And so I wanted to get a view on how you're planning to accelerate that move to the larger customer base. What are some of the technology and go-to-market investment that you've made to better serve this cohort?

Yes. So that's exactly right. We launched an enterprise version of our products. We've been really successful in getting enterprises. So as I mentioned before, we have 5,000 with more than 500 employees, but they've been asking us for more. So they love our platform, really good loyal paying customers that have been around for years that are just looking for that next level for search engine optimization, intelligence, PR, local marketing and social. And they're looking to Semrush to be able to deliver that. So we soft launched it in October. We'll make it general availability the first half of this year. We're already getting some really good traction and interest. And as Elizabeth said, we believe, it will generate 10 to 15x our average ARR per paying customer. So about 30,000 to 50,000 price point to start. From a go-to-market perspective, so what's common with an enterprise play is you do need a caliber of rep that knows how to build relationships and develop a strategic partnership with senior level executives in an account versus facilitating a transaction. So over the last 2 years, we've been investing in our sales organization and developing that talent to bring us to the next level and make sure we're structurally ready for that to be able to scale in the enterprise. The second part is you need to -- an SMB business is all about standard terms of service and just clicking accepts, whereas enterprise is about negotiating and being able to facilitate a deal from a lead all the way through to negotiate and close. So there's a process and a need to be able to navigate through procurements and negotiating those terms and conditions that are important to larger enterprises. So we've built out a deal desk. Again, that's something we've been building out over time. And we'll continue to scale it as we gain success. And then finally, there's a CRM component where you do need a demand generation engine and a means to be able to track and facilitate through a selling cycle to be able to prospect and quantify the opportunity, make sure you're getting support internally from all resources to be able to negotiate and close the deal. So we've been investing heavily in our CRM system and our internal processes to be able to make sure that that's a smooth process. From a financial perspective, you're not going to see an increase in our expense to revenue ratio for sales. And the reason for that is we've been able to find efficiencies in our SMB selling motion, where we're now able to do that in a more cost-effective, frictionless e-commerce-driven sales way. One example is we're leveraging AI to facilitate a lot of the SMB customer inquiries, and now automating more than 40% of those. So we're getting efficiencies and savings in SMB. We're reinvesting that in enterprise, and building the foundation to grow and scale our enterprise business.

Great. Keeping with that AI thread, how is Generative AI impacting kind of the core SEO business just as like the nature of search evolves? Is that a headwind or a tailwind for Semrush?

It's a great question. I think for me, searching for information is just such a fundamental part of human nature that I think it's a constant that stays probably forever. One of the first structures that people have been building when they had civilizations were libraries. So they wanted to preserve knowledge in a certain structured way so other people can search and find information and information can go to new generations. And I think, from this point of view, people will keep searching for information. The only thing that changes is really interface. So information is presented to people in different interface and AI and conversational AI and Generative AI really just a way to present information a bit differently. And if you look at all the changes and all the implementations of AI or machine learning that have happened with Google in the past, and you look at Google's interface and how they present information, let's say, 14 years ago in 2010, and then you look at how they presented information in 2022 right before ChatGPT. And then you look at what they're testing now with their own version of Generative AI in the interface, you will probably come to a conclusion that changes between 2010 and 2022 are way more dramatic than changes they're testing between 2022 and today. So for me, that tells that as interfaces evolve and these new technologies get introduced, it's actually getting much harder for marketers to figure out how to optimize for those new interfaces, new experiences, and they start looking for answers in systems like Semrush, where we can monitor a very large volume of those search interactions and say, okay, for this interaction, if you want to be mentioned here or you want to rank here, you need to do this and this and this. For that interaction, you need to do something different. And 2 years ago, we would generate a lot of interest by helping people to identify searches with a lot of clicks or searches where they have a high chance of being in the sort of feature snippet. So I think the next step of evolution is explaining to people how to get mentioned in one of those 3 results that Google summarizes in their new AI snippet, if it goes live anytime soon because they've been testing for a while, it's still not live. But another thing that we've done recently, we have introduced Bing tracking because Bing has been experimenting with Generate AI for a while, so we support Bing. If our customers want to optimize and track their visibility in Bing, they can do that now for a variety of different search queries. So for me, it's like as things get more and more complicated, there's really more demand for the sort of, like Brian said, GPS that tells people where to go when it comes to their marketing activities. And like I said, there have been tons of changes already in terms of how information is presented, and Semrush experienced phenomenal growth during this period as well as many, many other companies in marketing kind of universe.

Great. And you guys have also been leaning into AI and some of the other kind of core marketing parts of the portfolio. So what are some of the examples of different AI functionality you're currently embedding in the portfolio? And what are you seeing thus far in terms of adoption from customers?

Surprisingly, we are still at the stage where customers need to learn what AI can do for them and how to use it well. So in our case, for example, we used to have, for several years, a writing assistant product that helps people to create content that ranks well, resonates well with the audience. But a lot of people still don't know technologies like this exist. So what we're doing right now, we're actually going up the funnel, and we are creating free versions like of certain features that are available in this kind of bigger premium product that people can try even without registration. For example, if you google rephraser, Semrush will be somewhere very high, and you can go to the page and try Rephraser, and you can copy-paste something, and then it creates an output that is substantially the same but uses different words. So it can pass any kind of plagiarism checks. And with those pages, those kind of small applications that educate the market about what AI can do for them, attract millions of visitors for us. And then some of those visitors not ready to buy a premium product, but some of them are and we're moving them through the funnel. But for me, surprisingly, a lot of people still don't understand the full potential of those technologies, and we're spending a lot of time educating them and explaining to them how what we do is, say, different from what they can get from ChatGPT. At the same time, we have also a lot of commercial success with certain AI applications. The best example is probably how we use AI to help local businesses reply to reviews in our local product. That has been a feature that gained very, very high adoption rate in a very short period of time. Small business owners, they don't have a lot of time to deal with reviews. And often, they don't necessarily know what is the appropriate thing to say because they didn't have online reputation management course, something -- they usually care about the business more than the communications. And we use best practices. We use their existing replies as well as what other people reply in same situations. We train machine learning algorithms. And then they can just put it on autopilot, and whether it's a new review, system can just reply on behalf of the business. Or if they want to have more choice, system can give them 3 different options, and they can choose from one of the 3 options. And that's been extremely popular feature that a lot of people use and a lot of people have tried. And it's also a premium feature, so it also drives revenue. So we're -- like I said, we're doing a lot in terms of integrating. Actually, just today, we've launched in beta, our summarizer. So a lot of you have been dealing with different graphs and charts and marketers have probably even more different graphs and charts, and sometimes, it's hard to make sense, like what is exactly the punchline here. And how to filter it to get to the substance. And what we've done, we've started feeding all those marketing reports into AI system in a certain way where it can give you short summary about the key things that have happened during the period. So you don't have to filter anything. You don't have to go through all the charts. You just get a summary of most important things. And it's almost like having real human assistant who have seen it all and just gave you the output. It saves tons of time for marketers. So again, we're doing a lot of work, implementing a lot of things. Great traction. But I think we're still at the part where people still don't realize how much this technology can do for them.

Yes. That's really surprising because clearly, as you're sitting at this conference, you usually don't get more than 5 minutes into one of these presentations before everyone talking about AI. But it sounds like there's a lot of education that still needs to be done in terms of the day to day, how you're implementing these businesses. We are going to do some audience Q&A. But before turning over the mic, I wanted to ask a couple of financial questions.

Sure.

So first, on the cost structure, you guys guided to operating margins of 10% to 11% in 2024, which is well ahead of where Street was at around 5%. It's also really impressive that you're guiding to an expansion of about 8 points after delivering close to 14 points last year. You mentioned some things about utilizing your technology and internally driving some efficiencies. But just help us unpack from investors, what are some of the more specific lines you're able to drive this big improvement in leverage from? And what we should think about in terms of a go-forward model?

Yes, it's a great question. All of that is coming from efficiencies in the business. So we are very heavily investing in our business. We have such an extensive market opportunity ahead of us and a really good foundation. As I mentioned, with 108,000 paying customers and 1 million free users. And then our ability to scale and extend our platform because of our strong profitability. So we're investing in the business. We're going to continue to focus on upselling and cross-selling with our existing portfolio, but also building new features and capabilities that extend beyond our core competencies to those close adjacencies, and creates an even larger platform for our customers and others that will be new to Semrush. The profitability expansion, as I mentioned, it's more about efficiency. So we have 83.6% gross margin. It's a structural advantage for us where we've been able to scale our data and technology assets across a very large population of users. And we've just built the platform in a really efficient way. We also continue to leverage -- as I mentioned before, leverage AI to automate some of the customer support interactions. So we've been able to continually improve our gross margin. In the most recent quarter, it's up 100 basis points year-over-year. and that will continue to be strong. From a sales and marketing perspective, we're fortunate that we have access to a significant amount of data. So we have data assets all over the web that are educating marketers and business owners about the power of our platform and what marketing and sales techniques they'll get the most value out of. And we're able to see that traffic, see how it crosses over into the Semrush world, ultimately becomes a paying customer. And then once they're there, see how they're using, upgrading and adopting new products. So we're able to fine-tune our sales and marketing engine constantly to see what's working, what's not working, and where we can put our dollars best to work. So we're able to do sales and marketing in a very efficient way. And then on G&A, you'll see a really substantial change in that. We're actually going to be reducing it on an absolute dollar basis in '24. And the reason for that is we spent the last few years post IPO, investing in our quote-to-cash CRM workforce management and other systems that were now launched, and we're able to grow and scale our business from that strong foundation. So a lot of that investment will be driven back into building the business and driving growth in the long run. So these margins, again, are a function of efficiency in our ability to grow and scale the business.

Great. And then on the -- one more question before I turn it over to the audience. In Q4, NRR downticked to 107 from around 109. And I recognize this is a trailing 12-month metric, so it can be a lagging indicator. But would it be helpful to understand what you're seeing intra-quarter and does your willingness to signal a bottom in the trailing 12-month metric, hitting bottom in the next quarter or 2, is what you suggested. Does that mean that you're seeing that intra-quarter NRR already start to improve? And where would you point investors to in terms of thinking about kind of the longer-term NRR, especially as the story with kind of multiple products, upsell, cross-sell is really taking hold?

Yes, great question. So our net retention rate is a function of our gross retention and our ability to upsell and cross-sell within our base and then, of course, get pricing leverage. And we've been really successful in retaining -- having a very high retention rate and then being able to expand and continually to expand our footprint within the accounts that we have. So there's 2 very important things. One is that NRR calculation is a 2-year measure. So we're actually measuring our '23 performance relative to '22 and our ability to grow and expand that cohort. So 2 years is a long time. There are certain dynamics that are still working their way through, so that's why it ticks down a little bit, but it'll trough in the next couple of quarters in the same way that revenue did. So now it's sustaining revenue at about 20% growth, and we'll see NRR follow the same pattern. The other important dynamic I mentioned before is we scale across a very wide population of users. So we're in over 150 countries. We're in every segment of the market, every vertical and industry, and we have a very broad reach. But we do go deep into the market where we do have a lot of small businesses that use our platform. They tend to be more price-sensitive. So going forward, to help investors, we're actually going to segment those metrics to show you that we've got a really strong population of sophisticated, even enterprise accounts that are very strong and growing net retention rate, very high gross retention, a high propensity to adopt multiple products, and on average, have about 3 to 4x as much ARR per customer, which will inflect upwards as we launch this enterprise product we mentioned before. So there's just a couple of different cohorts that behave differently, and we'll share more insights into that population later.

Great. Do we have any audience questions?

I guess, I'm curious, like the enterprise motion, what -- how do you judge success 3, 4, 5 years out? Is it $50 million of revenue, $100 million revenue, $300 million revenue? What is it, I guess?

Yes. I think this is one of those where you either go big or go home. For me, it's our market, really, that we've been leader in search engine marketing space for many years. We're #1 brand. We have more large company logos than anyone else. So we have 4,000 or 5,000 existing customers who love our product, who are also big corporations. Nobody else in this space has it. So of course, the aspiration is to quickly capture this market. Of course, a lot of things need to be done on our side. We're 3 months in. We're not even in general availability yet, but the feedback is extremely positive. So for me, that means we have something unique, something that customers like. We just need to execute. And that's -- for that companies like Semrush have people like me and Brian. So we'll do our best.

I think you're in the ballpark, though, for the 5,000 accounts that we already have and our capabilities to upsell. But the market is larger. There are competitors in this space that we believe we'll be able to displace. And there's -- like it's common in the early days of new technology, like CRM 20 years ago, a lot of companies had proprietary solutions that were tailored for their needs. We've now been able to capture the data sets and the technology that will serve a broad cohort of industries and companies and believe we can go further beyond just expanding our existing accounts and actually start to get new enterprise accounts. So our aspirations are much larger.

And Brian, I want to go back to one of the comments you made about having a broad base of customers that you're serving, including some that are price sensitive. You guys recently did a price increase on new cohorts and some existing customers as well. So what was the reaction that you saw from customers due to this price increase? And how do you think kind of more philosophically about price as a lever going forward as you just -- you start to align the pricing with the value you guys are delivering?

Yes, and pricing is a big asset for us. So that second growth vector about cross-selling and upsell, pricing is part of that. We did do about an 8% price increase on new customers in the third quarter. And then we tested it out on a small cohort of existing. We're really pleased with the results. There are some price-sensitive customers. But in the aggregate, when you evaluate the impact of the price increase, we were very pleased with the increase in our average ARR, the incremental ARR, and ultimate revenue that we generated from that. We're going to continue to explore the performance over multiple months for the existing customers and evaluate opportunities for further pricing changes, but we believe it's a very strong asset for us. We continue to deliver a significant amount of value, which is resonating with more and more companies. So we believe we have some pricing leverage to take advantage of.

Great. And then about a minute that we have left, I want to get one more question in. On just the revenue guidance. You guided to 19% growth this year, which is reflected in the durability from the 21% that you just did last year. So unpack kind of that guidance. What do investors need to underwrite in terms of what goes well, whether it's kind of the upmarket motion? And what are you guys not including that could be upside drivers?

It's a great question. First of all, we're very pleased with our revenue growth. We achieved 20% in the third quarter, 21% in the fourth, and then guiding about 19% for the full year. This is my first full year as CFO, so this is my guidance versus inheriting it in 2023. And my philosophy on guidance is to basically set up Semrush for success. We want to be consistently delivering on our commitments. We take it very seriously. So what we've been saying is look at this guidance as a starting point and a prudent starting point, and something that we'll keep everybody updated on as we advance through the year. The key component of my philosophy on guidance is there's decisions and actions that we need to take throughout the year. Some of those relate to launching this enterprise products and going GA. It was launched in October, but going GA in the first half of this year. Some of the pricing dynamics and other things that we're doing that I'm not going to bake in the guidance until we get closer to the actual date, and can give investors confidence about our abilities to drive revenue from those actions. So consider this as a starting point.

Great. Awesome. With that, we are out of time. So thank you so much for joining us.

All right. Thanks, Elizabeth.