Company Participants
Bob Gujavarty – Vice President, Investor Relations
Oleg Shchegolev – Chairman and Chief Executive Officer
Eugene Levin – President
Evgeny Fetisov – Chief Financial Officer
Andrew Warden – Chief Marketing Officer
Conference Call Participants
Elizabeth Porter – Morgan Stanley
Parker Lane – Stifel
Scott Berg – Needham & Company
Michael Turits – KeyBanc Capital Markets
Operator
Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Semrush Holdings Fourth Quarter 2022 Results Conference Call. Today’s conference is being recorded. All lines have been placed on mute, to prevent any background noise. After the speakers’ remarks there’ll be a question-and-answer session [Operator Instructions]. A transcript of the prepared remarks will be available at investors.semrush.com after the call.
At this time, I would like to turn the conference over to Bob Gujavarty, Vice President of Investor Relations. Please go ahead.
Bob Gujavarty
Good morning. I’m Bob Gujavarty, VP of Investor Relations, and welcome to Semrush Holdings fourth quarter 2022 results conference call. We’ll be discussing the results announced in our press release issued after market close on Monday. With me on the call is our CEO, Oleg Shchegolev; our CFO, Evgeny Fetisov; our President, Eugene Levin; and our CMO, Andrew Warden.
Today’s call will contain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements concerning our expected future business and financial performance and financial condition, expected growth, adoption and demand for our existing and any new products and features, investments and acquisitions and their anticipated benefits, industry and market trends, our competitive position, our market strategies, market opportunities, our guidance for the first quarter of 2023 and the full year 2023 and statements about future operating results, including margin improvements, profitability and free cash flow goals can be identified by words such as expect, anticipate, intend, plan, believe, seek or will. These statements reflect our views as of today only and should not be relied upon as representing our views at any subsequent date, and we do not undertake any duty to update these statements.
Forward-looking statements address matters that are subject to risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. For a discussion of the risks and important factors that could affect our actual results, please refer to our most recent quarterly report on Form 10-Q and our annual report on Form 10-K filed with the Securities and Exchange Commission as well as our other filings with the SEC.
Also during the course of today’s call, we will refer to certain non-GAAP financial measures. There is a reconciliation schedule showing the GAAP versus non-GAAP results currently available on our press release issued yesterday after market close, which can be found at investors.semrush.com.
And with that, let me turn the call over to Oleg.
Oleg Shchegolev
Thank you, and good morning to everyone on the call. Fourth quarter revenue of $69 million was up 28% year-over-year and up 5% from the previous quarter. Despite a more challenging market economic environment, revenue came in above our expectations.
We reported a strong year, a full year revenue of $254 million, up 35% year-over-year as we beaten range estimates throughout 2022. We have a well-positioned business with a growing market, and we are excited who we are as a business.
I wanted to provide a few highlights on 2022, and then Eugene will talk about our future strategic initiatives in 2023. In 2022, we launched our first brand marketing campaign, where we conducted a wide variety of experiments across different channels to determine which would drive the best results. We had a number of successful brand marketing campaigns, with the fact that net new audiences and users to Semrush beyond our core customer growth, which is particularly promising.
These results were largely positive as we delivered record new customer additions in 2022 despite a more challenging environment. Because we have with over 95,000 paid customers, however, net customer additions were slightly lower than the year ago period. We continue to see record new customer additions, which were partially offset by churn of existing customers.
I wanted to share some data about churn and propensity of customers to return to Semrush. For example, on average, more than 30% of customers who chose Semrush returned to the platform. For the customers return, which are at onset of COVID-19 lockdowns in April 2020, the return rate was more than 40%. We believe this level of customer conduct demonstrates the value of our product and its necessity to thousands of marketing professionals for organizations of all sizes.
We are implementing targeted personalized promotions to help address churn and are already seeing improvements thus far in the first quarter. We are optimistic about the future growth based on the record new customer, the history of customer returns post-pandemic. In fact, we experienced a strong start to 2023 with record new customer additions in January and February.
Other important leading indicators, registrations and trials have hit new peak levels as much as 79% year-over-year for trials in February 2023, which is significant. Looking ahead to 2023 guidance, we expect it will be a year of balanced growth and significant margin improvement starting in the third quarter, and we expect to return to a non-GAAP breakeven run rate in Q3 time through our growth and efficiency initiatives.
For the first quarter, we expect revenue in the range of $70.3 to $70.7 million, up approximately 23% year-over-year. We expect first quarter non-GAAP net loss of $8 million to $7 million. For the full year, I expect revenue in the range of $306 million to $309 million, which would represent growth at the midpoint of approximately 21% year-over-year. We expect non-GAAP net income equivalent to $3 million for the full year 2023, including approximately $1.3 million of exit costs.
I would remind investors that post our relocation program, roughly 30% of our costs are now incurred in euro and euro related currencies. My guidance for 2023 non-GAAP net income assumes a year fixed rate of approximately $1.08 to $1 for the remainder of the year.
I remain very encouraged by underlying trends in the business and have been efficient in deploying capital. And we are focused on achieving non-GAAP profitability in Q3 2023. We are uniquely positioned and are diversified across geographies, industries and customer size with no consolidations. Our price points and go-to-market strategies target the widest possible customer base and we offer our customers a high degree of flexibility. I believe these qualities will provide to be even more competing in 2023.
In closing, I want to thank all our employees, customers and partners for helping us deliver strong growth, while navigating through a challenging year. We remain focused on shareholder value and execution on our strategy to drive growth and future profitability.
Before I turn it over to Eugene, I wanted to highlight the recent announcement we made appointing Brian Mulroy as Chief Financial Officer, effective April 10, 2023. Brian brings an exceptional background to Semrush, with over 23 years of experience in finance and technology. He has very strong leadership skills, most recently holding SAP finance roles at Microsoft and Nuance Communications.
I also want to thank Evgeny for his key contributions to Semrush over the last four years. His expertise was instrumental in building our financial foundation, and we wish Evgeny success in his future endeavors.
And now I pass it to Eugene.
Eugene Levin
Thank you, Oleg. I’m pleased with our results in 2022 and even more excited about the future. During 2023, we will be focused on expanding our product portfolio, while leveraging new technologies and search landscape changes, driving operational efficiency and managing expenses across the organization and delivering positive free cash flow.
Let me cover each area in more detail. First, we plan to continue updating and adapting the product as we have every year to incorporate new sources of data and improved functionality. We will further develop our platform by one, adding new apps to App Center; two, increasing our capacity to onboard new apps, making the onboarding process more automated; and three, allowing bundles to be bought outside of main subscription plans.
As the leading online visibility management software vendor, Semrush is uniquely positioned to benefit from two strong tailwinds to our business: generative AI and changes in the search engine industry landscape. Generative AI is not a product by itself, but rather technology that can be used across an entire portfolio of our products. We already have implemented generative AI in several of our products, including our writing system and position tracking. This year, we are planning to keep expanding our portfolio of products to use this technology, both within our core products and in the App Center.
As the search and web landscape changes, digital marketers rely more heavily on digital landscape data. And as the reliance on this data builds, we will see spike in demand for data and insights. For example, Bing becoming bigger, more meaningful player and is gaining market share will benefit us as we can sell products for Bing optimization on top of those we offer for Google to date.
Additionally, optimization for combined chat and search interfaces or answer engines is more complex than the regular search engine optimization and require sophisticated products that we can provide. We can address online visibility questions and as search engines introduce new interfaces, we can help our customers to navigate in an ever-changing environment.
Second, we will be focused on operating more efficiently. We expect to launch more efficient marketing campaigns, drive increased productivity of sales with focus on expansion and reduction of G&A spend as a percentage of revenue. With respect to marketing, we will fine-tune our go-to-market strategy to focus on territories and channels, which result in the best return on investment. We expect to focus more of our budget on those channels and campaigns with the highest return on investment.
We expect changes in our go-to-market with a heightened focus on automation and more balanced marketing spend between organic and paid channels. We made an investment in our organic search team in 2022 that are starting to deliver. Currently, our organic search non-brand channel is performing above plan. Our emphasis on optimizing our paid channel is paying off with better-than-expected ROI in the first quarter year-to-date. As a result, we expect marketing spend as a percentage of revenue to decline throughout 2023.
In our sales teams, especially in expansion and retention, we are testing automated ways to grow and retain customer accounts at scale. Sales efforts will focus on expansion and increased sales team productivity to drive improved average check growth. Our view right now is we’ll invest in efficiency in 2023 to yield even better performance in 2024. Combined, these actions should deliver better sales efficiency and enable us to grow our reach.
We will continue to manage expenses as this is the most prudent way for us to run the business in the current environment. We believe we are staffed appropriately for the current demand environment and expect headcount growth for the remainder of 2023 to be modest and lower than in 2022.
And finally, we are focused on delivering positive free cash flow. Efficiency and agility are the core of how Semrush operates. We have historically been very good stewards of capital, and we’ll continue to pursue a growth strategy with a set path to profitability.
I will now turn the call over to Evgeny for a more detailed discussion of our financial performance.
Evgeny Fetisov
Thank you, Eugene. And many thanks to Oleg and the Semrush team. I have certainly enjoyed my time working together. It has been an incredible journey in preparing our company to go public, and we see tremendous results together towards ideal and on our path to growth.
Now turning to our Q4 and full year 2022 results. Q4 revenue of $68.8 million was up 28% year-over-year and up 5% sequentially. Turning to full year revenue of $254.3 million was up 35% year-over-year. Growth was driven by higher average revenue per customer and growth in paying customers. Compared to a year ago, we have seen an increase in revenue from the higher priced core customers in place of lower paying customers.
Our dollar-based net revenue retention for the fourth quarter was 118%, down from 126% in the year ago period, consistent with our prior expectations. We continue to believe the net revenue retention will settle at mid-teens over the long term.
ARR was $275 million as of December 31, 2022, up 28% from the previous year. As a reminder, December is seasonally soft, given the timing of holidays and I fully expect sequential acceleration in ARR in the first quarter. In 2022, margins reflected brand marketing campaigns, and higher personnel costs in new locations as our operating expenses grew faster than revenue, largely due to our education program, which cost approximately $11.3 million.
Fourth quarter gross margin of 82.6% was up over 400 basis points from a year ago. Gross margin benefited from higher revenue and lower cost for hosting and third-party services. This lower cost should persist, and as a result, I expect gross margin will remain above 80% throughout 2023.
Operating expenses, excluding equity costs, were $70.2 million in the quarter, up 53% year-over-year and up 22% from the previous quarter. The year-over-year increase was driven by growth in headcount as we ended the year with 1,503 employees, including 214 contractors, which is up 25% from a year ago as well as with the cost associated with operating in high-cost locations.
Sales and marketing expense was $39.6 million in the fourth quarter, up 54% year-over-year and up 30% from the previous quarter. The increase largely reflects higher headcount as well as increased spending on brand and performance marketing programs.
I would also note that the sequential and year-over-year increase was partly a function of a pre-classification of costs from G&A into sales and marketing as previous to the fourth quarter, sales and marketing leadership expenses were recognized in G&A.
We expect sales and marketing expense as a percentage of revenue to be lower in 2023 as we drive great efficiency in our spend. Research and development expense was $13.3 million in the fourth quarter, up 94% year-over-year and 31% from the previous quarter. The year-over-year and sequential increase reflects higher headcount as well as an increased compensation expense related to operating in higher-cost geographies.
I expect R&D spending to be relatively in line with the fourth quarter as a percent of revenue as we continue to build our platform and deliver new products and functionality. G&A expense of $17.4 million was approximately 31% year-over-year, but essentially flat from the previous quarter.
The year-over-year increase reflects higher public company costs, costs related to new locations and investments in systems and people. The sequential comparison benefited from allocating executive costs to separate functions as they referenced it earlier. In 2023, expense G&A will grow on an absolute basis, but below the pace of revenue growth.
During the quarter, solid revenue growth and higher gross margins were more than offset by higher expenses, including nearly $2 million of exit costs and contributed to a non-GAAP net loss of $11.6 million compared to a non-GAAP net loss of $2.9 million a year ago. Also to note, we have relatively low shareholder dilution as a result of stock-based compensation due in part to a large portion of our workforce being located outside of the U.S., where stock-based compensation is less prevalent.
Turning to the balance sheet. We ended the quarter with cash and cash equivalents and short-term investments of $237.5 million, down from $246.6 million in the previous quarter. Our cash flow from operations in the current fiscal year was negative $9.6 million, and we incurred approximately $4.2 million of capital expenditures and capitalized $1.7 million of software development costs.
In summary, we continue to execute well despite a more uncertain economic environment. We’re looking ahead to 2023, I believe we have solid visibility to deliver another year of growth, while also improving margins.
With that, we’re happy to take any of your questions. Operator, please open the line for questions.
Question-and-Answer Session
Operator
[Operator Instructions] We’ll go first to Elizabeth Porter at Morgan Stanley.
Elizabeth Porter
Great. Thank you for the question. I wanted to ask on the demand environment. Net adds softened in Q4 after being fairly robust for the last couple of quarters. And I recognized you called out some higher churn. So were the softer adds in Q4 fully attributable to churn? Or were there any changes in the new demand environment that started to emerge in Q4 versus what you saw in Q3? And then any sort of color on — if so, what the changes were and kind of when those occurred? And any customer segments would be very helpful. Thank you.
Andrew Warden
Thank you very much for the question. This is Andrew. So I would say that the net customer adds have been well within our guidance. Like everyone else, we are seeing an impact from the macroeconomic environment on our overall customer base. But I want to make sure to mention that we’ve added a record number of customer additions in Q4, and this growth continues through Q1 of this year so far. We’re seeing the outcome of the brand marketing campaigns we ran in 2022, carrying us into 2023.
Elizabeth Porter
Great. And then on the — you guys highlighted there was an increased sales focus and just growing average check size going forward. And just given the NRR [ph] softness, which you’ve seen across many other companies, how should we think about the growth in ARR per customer into 2023? And can that sustain double-digit growth?
Evgeny Fetisov
Elizabeth, this is Evgeny. I think we should be expecting the average check to grow, I would say, in line with what we saw in Q3, Q4. I mean there will be an impact from the macro, I guess. But as we get back to the more normal environment, we expect this — the average to slight — average growth to slightly accelerate.
Elizabeth Porter
Great. Thank you so much.
Operator
We’ll move next to Parker Lane at Stifel.
Parker Lane
Hi, guys. Thanks for taking the questions. You alluded to supporting being on top of Google use case that many of your customers are embracing today. Have you already started to see the benefits of that, either through new customer acquisition or expansion? Or are you viewing that as more of a long-term benefit to the business?
Eugene Levin
Thank you for the question. This is Eugene. To be honest, right now, we’re actually not seeing a lot of demand for this feature. Our reference was about potential of being gaining market share and how that would be beneficial for our business, not necessarily something that customers are asking today.
Also on top of this, we have competitive intelligence products that show us how much actual usage of these new features have been gained. And while we saw initial spike, we’re actually not seeing a lot of growth right now. It’s sort of stabilized. So we’re monitoring situation.
I just wanted to highlight that Eve Bing becomes a real player in search engine space, we absolutely would be delighted to provide features — new features to our customers.
Parker Lane
Understood. Thanks for clarifying on that. And then on the generative AI front, I was just curious, did you develop those solutions in-house for writing assistance and tracking? Or were those some tools that you contracted a third party for?
Evgeny Fetisov
So of course, we’re using GPT a lot. But on top of that, we also use our own models. First of all, the trick is that you need to give GPT algorithm right input. So our algorithms define what is this right input, what will make content perform well. And then, of course, we use pure generative capabilities of GPT.
Parker Lane
Great. Thanks for the feedback. Appreciated.
Operator
We’ll go next to Scott Berg at Needham.
Scott Berg
Hi, everyone. Thanks for taking the questions. I guess I have a couple here. I wanted to start on the churn comment. I appreciate that 30% of your customers that churn returned to the platform. But how should we think about the elevated churn in the quarter? Are you able to maybe isolate small customers versus large customers? Any particular region or vertical that maybe you saw some higher churn in particular?
Eugene Levin
Yes. So in Q4, actually, I think there is no particular region or segment that did stand out. I would highlight that a lot of customers who were on the larger end in churn in Q4 actually getting back right now in January and February. That was really more of a long renewal rather than real churn. Even though in December, they were telling us that they’re not sure.
But a lot of them actually got back, so we’re already seeing them. And I think that’s in line with commentary that Oleg have provided. On the lower end, unfortunately, we don’t see that yet. But we’re optimistic based on what we’ve seen historically.
Scott Berg
Got it. Helpful. And then from the profitability comments, trying to help understand where the leverage in the model comes from this year, not the GAAP net loss in Q1 has been led fairly significantly in the back half of the year to drive your guided profitability for the year.
Does most of that come from — that leverage come from G&A? Or is there something in cost of goods? You made some comments on the sales and marketing expense, maybe just trying to understand where that leverage will come from in the second half? Thank you.
Evgeny Fetisov
Scott, this is Evgeny. So the flexibility will be driven by, I would say, three main factors: One, the gross margin will be, I would say, like solidly above 80%; second, marketing spend will go down substantially as a percentage of revenue. And then the rest of the cost will, I would say, will also go down as a percentage revenue as well. So G&A will be lower and then in will be lower and sales costs will be lower as a percentage of revenue.
The only I would say I would we will probably be R&D, which will go up slightly and then stay there, I would say, up slightly above 20%.
Scott Berg
Got it, very helpful. Thanks for taking my questions.
Operator
[Operator Instructions] We’ll go next to Michael Turits at KeyBanc.
Michael Turits
Good morning. A couple of questions. First of all, just in terms of relocation costs, where are we in terms of having an apples-to-apples comparison in the sense that you had the relocation costs this year? But you were fully operating this year in the higher expense region.
So how much of a headwind do we have this year? And then obviously, as we go into ’24, that seems to be completely apples to apples, but — and therefore, no longer a headwind. So how much of an incremental headwind this year, how much of that goes away in the following year?
Evgeny Fetisov
Michael, thank you for the question. I guess I would split it in two parts. There are onetime costs, which we clearly like separate and talk about $11.3 million — $11-plus million in 2022. And we expect about $1.3 million in 2023, majority of that in Q1. So — and then we expect that will be over.
Now — and then there will be the higher cost plan in the business since we are relocated to more expensive locations. We believe that Q4 is a very solid base of which you can model our business going forward. And as I mentioned, we plan on improving profitability every quarter as we go through 2023, improving margins and again, I probably won’t be repeating myself, but I guess the efficiency. We expect efficiency to be following through every quarter.
Michael Turits
And then — thanks very much for that. And then congratulations having made this transition of the operations of the business. On generative AI, I guess the simple question is, as a company in search engine optimization to the extent that use — that search broadly put shifts over to a chat functionality as opposed to a listed search functionality. How does your ability to add value and optimize people’s moves to certain websites change when that is a chat function versus a listed search function?
Eugene Levin
Thank you. And this is definitely something we’re spending a lot of time discussing internally. I think from — at this point, we don’t know what the final implementation is going to be. We have only seen a couple of examples being implemented their approach to this, which is, I think, very user-friendly.
We don’t know what Google is going to do. But I think from what we’ve seen so far, the outputs of this model are actually very similar to what happens if you try to produce feature snippet based on a couple of top articles. So it’s really more of answer that takes more real estate and provides combination from several sources. And in most examples, we’ve seen so far provide expectation to those sources.
So from a technical point of view, optimizing for this is very similar to optimizing for future snippet, which we help people to do for a very long time. And actually, we’ve seen a lot of demand for those features and support of our tracking feature snippet, as well as proactive recommendations about how people can rent and be mentioned in those features snippets.
So from a technical point of view, if things go the way that we are seeing them now, this is very similar to what we already have. With minor fine-tuning, we should be able to help our customers to get mentioned in those answers. But like I said, it’s a little bit hard to tell until we see the actual implementation. But we are very positive about our ability to serve our customers when they have those needs.
Michael Turits
Eugene, thanks very much. Evgeny of course good luck. [Indiscernible].
Operator
And that does conclude the question-and-answer session and today’s conference call. We thank you for your participation. You may now disconnect.