Q3 2023 Edgio Inc Earnings Call

Participants

Robert A. Lyons; President, CEO & Director; Edgio, Inc.

Sameet Sinha; VP of IR & Corporate Development; Edgio, Inc.

Stephen Cumming; Senior VP, CFO & Treasurer; Edgio, Inc.

Daniel Hibshman

Eric Martinuzzi; Senior Research Analyst; Lake Street Capital Markets, LLC, Research Division

Frank Garrett Louthan; MD of Equity Research; Raymond James & Associates, Inc., Research Division

Presentation

Operator

Ladies and gentlemen, thank you for standing by. My name is Desiree, and I will be your conference operator today. At this time, I would like to welcome everyone to the Edgio Third Quarter 2023 Earnings Call. (Operator Instructions)
I would now like to turn the conference over to Sameet Sinha, Vice President of Investor Relations. Please go ahead.

Sameet Sinha

Good afternoon. Thank you for joining the Edgio third quarter 2020 financial results conference call. This call is being recorded today, November 15, 2023, and will be archived on our website for approximately 10 days. A copy of our Form 10-Q for the third quarter, along with the earnings press release can be found in the Investor Relations section of our website.
Please note that today's comments include forward-looking statements regarding future events and financial performance, including statements regarding guidance for the 2023 fiscal year. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. The factors include any impact from macroeconomic trends, the integration of any acquisitions and any impact from geopolitical development.
Please see the forward-looking statement disclaimer on the company's earnings press release as well as the sections entitled Risk Factors included in Edgio's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. Undue reliance should not be placed on forward-looking statements, which speak only as of the date they are made. Edgio disclaims any obligation to update these statements to reflect any new information, future events or circumstances, except as required by law.
During the course of today's call, we will be referring to certain non-GAAP financial measures. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed and a reconciliation of the differences between such measures are provided in the earnings press release in our Investor Relations section of our website. These non-GAAP financial measures are not intended to be a substitute for our GAAP financial results.
I will now turn the call over to Bob Lyons, President and CEO. Bob, the floor is yours.

Robert A. Lyons

Thank you, Sameet. Good afternoon, and welcome to our earnings call for the third quarter of 2023. In the fall of 2021, Edgio embarked on a transformational journey. Transformations like these are never easy and require relentlessly working through challenges to unlock the opportunity. This past year has offered us several challenges to navigate, but as expected, in the recent 2 quarters, we have also begun to realize the opportunity.
One of our previously stated strategic objectives was to better align our capital structure with our strategic plans. Specifically, we had 3 goals. First, we wanted to ensure adequate liquidity to continue building on the recent momentum. Second, we wanted to exchange our converts due in 2025 for new 2027 converts to avoid near-term headwinds. And third, we wanted to remove any uncertainty around our NASDAQ listing status without putting more pressure on our stock.
Over the past 2 quarters, the Board and management team undertook a thorough process to ascertain the best way to accomplish these objectives, including an outreach to over 40 capital providers. That work was accelerated following the transfer of our listing to the NASDAQ capital market, but our overall objectives remained unchanged. As outlined in our 8-K filing yesterday, we have been able to successfully address each of these 3 objectives. Our existing investor Lynrock Lake Master Fund LP exchanged its existing unsecured convertible notes due in 2025 for secured convertible notes due in 2027. Additionally, Lynrock has provided the company with $66 million of new financing. Importantly, these transactions provide us with a strengthened balance sheet and put us in a stronger financial position to continue building on the momentum established in Q2 and Q3. As part of these transactions, we will appoint 2 new independent Board members and reduce the overall board size from 9 to 5. Last, we believe that we have taken the necessary first steps to return us to compliance with NASDAQ.
In short, based on our thorough process, we are confident that these steps taken are the best and most complete option to preserve and protect value for our shareholders and drive the company's growth strategies. With these transactions, we look forward to moving forward with a full focus on improving the profitability and growth of the business.
We continue to make progress improving overall profitability toward achieving an adjusted EBITDA margin of at least 15%. We will achieve this by continuing to implement a more efficient company-wide operating model, improving network unit economics and by pivoting to an asset-light capacity strategy.
We remain committed to our plans of reducing run rate costs by $85 million to $90 million by year-end. Approximately 70% of those savings are driven from improved operating efficiency. We have reduced annualized operating expenses by more than $60 million, implying a 28% reduction in total company operating expense year-to-date. Approximately 30% of savings resulted from improved unit economics by reducing our hosting bandwidth and peering costs. Cash gross margins expanded by 130 basis points sequentially.
Our asset-light strategy has resulted in reducing capital intensity to just 1.7% of revenue year-to-date. We continue to execute on our savings road map in the current quarter and well into 2024. With this backdrop, we are on track to deliver adjusted EBITDA breakeven in the fourth quarter. The introduction of new growth-oriented application and security solutions has resulted in the achievement of several industry awards and recognition. We are proud of the progress we made here as we believe these awards reinforce our focus on fully integrated solutions. Edgio now boasts differentiated application, security and streaming solutions powered by our globally scaled edge network natively secured and delivered with deep expertise.
In the third quarter, we broadened our security offering with the release of our API security solution. Consistent with our other security modules, this solution leverages our machine learning capabilities, to inspect both application traffic patterns and content to ensure API endpoints are discovered, managed and secured. This is one of many security product enhancements this year that continue to position us well in this high-growth industry.
Adding to the multiple security awards during this year, we recently were named the overall Web Security Solution of the Year Award in the Seventh Annual CyberSecurity Breakthrough Awards. Our security solution is also a finalist in the InfoWorld's Technology of the Year Awards for DevSecOps.
A key element of our value proposition has always been to simplify the buyer experience. We recently announced the availability of our enterprise-level Protect and Perform Applications Bundle to do just that. This bundle combines Tier 1 web performance capabilities, our full web security suite and enterprise-level security operations support services, all in a single comprehensive package with a simple and predictable price model.
Applications Version 7 released in April of this year continues to be rolled out as an upgrade to existing customers. Upon adoption, customers have one quick access to the full breadth of our solution suite along with the new simplified bundled pricing model.
In our media business, we recently announced a strategic partnership with leading streaming technology vendors to provide a simplified, cost-effective and comprehensive linear, live or on-demand OTT solution led by Edgio's managed services offering. Our partnership with Wurl announced last week will enable fast syndication via our Uplynk service.
During our last quarterly call, we outlined the many steps we have taken to support stabilization and expansion of our revenue. These steps include implementation of a client success team, the overhaul of our go-to-market capabilities, improved enablement of our commercial teams and channel program that expands our [routes] to market.
In the third quarter, bookings for our application suite improved by more than 150% from the previous quarter and more than 400% from the first quarter. The improved momentum was balanced across both new customer acquisition and existing customer expansion with new customer bookings growing almost 400% and expansion bookings growing almost 300% sequentially.
Churn has also meaningfully declined with revenue churn declining more than 35% sequentially. In the third quarter, expansion revenue outpaced churn for the first time. We expect this trend to continue in the fourth quarter and well into 2024.
Our qualified pipeline continues to grow and the conversion rate of that pipeline has more than doubled since the first quarter. Equally important, sales productivity measured by cost of acquisition to bookings also improved by 40% in the same period.
Highlights from the third quarter bookings include a competitive takeout of a $250 billion automotive group in Europe, a large North American pet supply retailer with more than 1,600 retail stores and Cebu Pacific Airlines, where we improved their web response time by 41%. We also upsold security solutions to a large hardware company in Asia, a leading health food company in the U.S., a unicorn e-commerce platform in Brazil and a media company in India.
The diversity and scope of these commercial wins are directly attributable to the breadth of our capabilities and our ability to demonstrably improve performance, operating efficiency and security. All of this is directly attributable to the release of Applications Version 7 in April. We have also seen ongoing industry consolidation in our legacy CDM business with Lumen and StackPath, both shuttering their CDN offerings. This trend speaks to the challenges in the CDN industry, but also offers validation of the strategic steps that we have taken to reposition the company.
We continue to see opportunity in the delivery business through our Open Edge supported asset-light strategy. This approach will improve profitability and return on invested capital while continually providing quality and performance at a fair price to our customers.
In summary, the foundation required to support our strategic pivot is now in place. We continue to move the company toward our vision of profitability and growth, supported by our differentiated edge-enabled solutions.
Now I will turn the call over to Stephen to discuss second quarter results. Stephen?

Stephen Cumming

Thank you, Bob. As expected, second quarter revenue was the bottom for the year. Revenues for the third quarter of 2023 were $97 million, sequentially increasing by 1.3%, driven by improved seasonality, our successful efforts in reducing churn and high conversion of bookings to revenue.
Moving to gross margin. Cash gross margin, which excludes the impact from stock-based compensation, acquisition-related expenses and depreciation and amortization was 32.1%, up 130 basis points sequentially. The sequential improvement was due to higher revenue and our continued cost-saving initiatives, partially offset by higher switching costs related to a cloud platform services provider impacting gross margin by approximately 300 basis points. We expect most of this incremental cost to be nonrecurring going forward.
Turning to operating expenses. Cash operating expenses, excluding share-based compensation, restructuring charges, acquisition and legal-related charges, depreciation and amortization were $40.7 million or 41.9% of revenue, down from $42.9 million or 44.8% in the second quarter of 2023.
We continue to make significant progress in our cost reduction initiatives. We are executing well on our planned acquisition synergies and operational efficiency programs while investing in new product introductions and our revitalized sales and marketing motions.
Cash R&D expense decreased by $2.8 million sequentially to $13.9 million, approximately 14.3% of revenues from $16.7 million or 17.4% of revenues as we saw a full quarter benefit from previously announced organizational restructuring.
Cash, sales and marketing expense decreased $750,000 sequentially to $15 million or 15.5% of revenue from $15.7 million or 16.4% of revenues as we saw the remaining benefit from transitioning the commercial team to a more productive territory-based go-to-market model.
Cash G&A expense increased by $1.3 million sequentially to $11.8 million or 12.2% of revenue from $10.5 million or 10.9% of revenue. Previously announced cost containment efforts were partially offset by onetime accounting and legal fees.
Share-based compensation included in operating expenses was $3.3 million versus the second quarter at $3 million. Restructuring charges were $72,000 compared to $3.3 million for the second quarter of 2023.
Acquisition and legal-related charges included in COGS and operating expenses in connection with the EdgeCast acquisition were approximately $0.5 million compared to approximately $1 million for the second quarter.
Adjusted EBITDA for the third quarter of 2023 was a loss of $9.5 million compared to a loss of $13.4 million in the second quarter of 2023 due to higher revenues and continued execution on cost saving initiatives, which have resulted in sequential decline in our cost structure.
Moving to the balance sheet and cash flow. Cash and cash equivalents and marketable securities totaled $27.6 million, a decrease of approximately $8.6 million from the second quarter of 2023. Third quarter 2023 capital expenditure was $2.3 million or 2.4% of revenues.
Over the last 9 months, we have initiated tighter CapEx spending goals, which have resulted in CapEx significantly below historical levels. DSO for the second quarter was 63 days, up slightly from the second quarter.
Now moving to guidance. Strong product execution and improved go-to-market motions helped overcome the continued softness in the macro environment. Our broad product portfolio and the value proposition of our solutions are resonating with customers and we're seeing improvements in our leading indicators, which Bob outlined earlier. We remain focused on executing on cost-saving opportunities and are on track to deliver the $85 million to $90 million of run rate savings by year-end.
Our guidance for the fourth quarter and the full year are, for the fourth quarter of 2023, we expect revenue in the range of $96 million to $98 million. This implies full year revenue range of $391 million to $393 million or a growth of 15.5% to 16% year-over-year.
For the fourth quarter of 2023, we expect adjusted EBITDA in the range of between negative $1 million and positive $1 million. For the year, we expect adjusted EBITDA in the range of negative $38 million to negative $36 million. And for the fourth quarter of 2023, we expect capital expenditure in the range of $3 million to $6 million. For the full year 2023 we expect CapEx in the range of $10 million to $13 million. This implies CapEx as a percent of revenue of about 2.6% to 3.3%.
Now let me provide you more context around our guidance. We are accelerating our focus on revenue quality and unit economics. As a result, we are guiding a flat revenue sequentially in the fourth quarter at the midpoint. We expect cash gross margin to expand by approximately 400 basis points sequentially due to continued cost-saving initiatives, reduction in cloud platform services provider and margin improvements as we focus on revenue quality.
As previously communicated, we expect breakeven adjusted EBITDA in the fourth quarter. To put it in perspective, at the midpoint of fourth quarter guidance we've reduced cash expenses by almost $90 million on an annualized basis.
As Bob mentioned, we've made significant progress transforming the cost structure of Edgio by driving synergies and efficiencies in our operating costs and expenses.
Our operational expenses declined since the beginning of the year by 28%, and we expect further reduction in the fourth quarter, which will set us up for further adjusted EBITDA margin expansion in 2024.
With that, I'll turn the call back to Bob for some closing remarks.

Robert A. Lyons

Thank you, Stephen. I want to wrap up by reiterating that our transformation from a first-generation CDN platform into a third-generation edge solutions platform continues to progress. We now have the foundation in place to continue to move the company toward our vision of profitability and growth supported by differentiated edge-enabled solutions.
With that, operator, please open up the lines for the question-and-answer session.

Question and Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Frank Louthan with Raymond James.

Frank Garrett Louthan

I wanted to get a little -- appreciate the color on the outlook for the fourth quarter. Looking forward, how should we think about EBITDA next year? Is this kind of the low and we should expect sort of a cross over next quarter or Q1 to [permanent] EBITDA positive going forward. And then can you give us an idea of when we can expect breakeven and positive free cash flow. That's the first question -- first set of question or so. And then second one, how is the exit of StackPath or Lumen done for your delivery business? Has that changed anything?

Stephen Cumming

Yes, Frank, this is Stephen here. Yes. I mean as you can see, we've made great progress with regards to our EBITDA progression. If you take the first half of this year, we had an EBITDA loss of $28 million. I think based on the midpoint of our guidance, we're going to be somewhere a loss of $10 million in the second half of this year, and that's getting us to a breakeven EBITDA in Q4.
So you should expect as we go into 2024 with all the cost-saving initiatives that we're going to see continued expansion of EBITDA. Obviously, I don't want to put numbers on that -- around that. But we've taken a lot of cost take out. A lot of that was primarily in the OpEx, I would say, in the first half of this year. And now you can see we're transitioning to more COGS reduction, our gross margin lift. So expect a continual expansion of EBITDA as we go into next year. There will be a little bit of seasonality certainly in the first half, but we should see continued progression.
With regards to free cash flow, we're going to be working through some of the net working capital true-up. So again, as EBITDA expansion throughout the year and certainly into the second half, we should be turning free cash flow positive. Bob, I don't know, if you want to comment on the StackPath?

Robert A. Lyons

Yes, I'll do that. Look, I think the way to think about the dynamics that you saw with StackPath and Lumen is really 2 things for us. I think one, I think it underpins the challenges in the traditional way of running the CDN business. And when 2 companies walk away from that business, literally, it kind of speaks volumes as to the challenges. So -- and that's certainly not new to any of us. I think it also underpins the importance of why we have repositioned the company over the last 2 years as a edge-enabled solutions company focused on app security and moving up stack and video and why those moves are so important.
So I think strategically, it just validates all the moves we've making over the last 2 years.
I think operationally, we've seen some inbound opportunities from that. I think the way we think about it is it's an opportunity for us to become one of the less number of parties in the space. But we've got to make sure that we can actually generate the positive return on invested capital that we need to. And that's why that asset-light strategy is so important.
So the way we think about that business, it is a challenging business in the industry right now. We think that the asset-light strategy that we're pursuing will allow us to navigate that industry much more effectively and do it in a way that we can actually generate EBITDA and return on invested capital for our shareholders, which is why we're really pushing that strategy hard. And no doubt as the industry consolidates, just provides more opportunity for us as long as we can do that.

Operator

Next question comes from the line of Eric Martinuzzi with Lake Street.

Eric Martinuzzi

Yes. I wanted to get a little bit deeper into the refinancing transaction, and congrats on getting that buttoned up here. We finished out the September quarter with $28 million in cash, and we had at the time on 9/30, we had the $125 million of convertible notes. And then obviously, with yesterday's financing, we pick up $66 million in cash. It looks like we paid out $6 million to clear around 5% of the $125 million convertible notes but we've got the remaining $119 million. So I just wanted to know, with all those puts and takes, can you give us kind of a November 15 pro forma cash and pro forma debt?

Stephen Cumming

Yes. Proforma debt is going to be somewhere around $183 million and I think with all the puts and takes, cash is going to be about $88 million.

Eric Martinuzzi

Okay. All right. And then the business, as it is today, and the business as it is a year from now, I'm not looking for 2024 specifics on the revenue, but you've historically characterized your business is about 50% CDN, 25%, apps, and 25% streaming. How does that look a year from now?

Stephen Cumming

Yes. I mean, Eric, this is Stephen again. I would say just the sort of growth trajectories of the business, you're going to continue to see the nondelivery piece growing faster than delivery. And so you should expect, as we exit '24 and move into '25 that the apps and Uplynk business are becoming a larger portion of the overall company revenues. We're about, as you said, about 50% delivery stay and then 25% split between the other 2 businesses. But they are going to grow disproportionately faster than delivery. So there will be a higher portion of the mix as we go out in the subsequent years.

Operator

Next question comes from the line of Daniel Hibshman with Craig-Hallum Capital Group.

Daniel Hibshman

This is Daniel on for Jeff Van Rhee. Just on the cost saving initiatives, Stephen, in terms of costs coming out yet. Is there -- I would have thought with the risks that we've sort of reached sort of a new level of OpEx, is there room for more OpEx to come out yet? And then maybe specifically double-clicking on the potential COGS savings, in particular, you emphasized that more for '24. Just where if you could drill down at all, do you see efficiency opportunities in COGS?

Stephen Cumming

Yes. I mean I would say, firstly, we've made great progress with regards to the OpEx reductions. If you think about it from where we were in Q4 of 2022, we've got to a run rate about 28% reduction, about $60 million annualized. As we go into Q4, based on the guidance, there is going to be further OpEx reductions. I think it works out to be about $36 million, $37 million. So that's down from where we were in Q3. And I think we're going to be largely through most of those reductions. And as I said earlier, we're going to be [transit] but more COGS reductions. Some of those initiatives are more lengthy in terms of renegotiating with our bandwidth providers and colos, et cetera. But already, you can see on flat revenue guide to Q4 you're seeing our gross margin expand by 400-plus basis points. So you're really going to start to see that gross margin improvement and cost reductions kick in, in Q4 and into 2024.

Robert A. Lyons

And Daniel, let me add a little more color to that tie to a little bit more of a strategic perspective. So we -- 2 of the 3 pillars on driving costs out are improved unit economics and the asset-light strategy. And the stuff that Stephen just highlighted, which is reducing our peering and our hosting costs and those like types of things is really around improving unit economics, which is the large part of our COGS today. The asset-light strategy really gets that strategically where we partner with people who have those things already don't have to pay for them and we can take a lot of cost out of the system and focus on delivering our software on top of that.
So when you look at those 2 things together, we'll continue to improve costs on the unit economics by just running what we have more efficiently. And then the asset-light strategy will take more chunky costs out as we strategically think about our capacity differently as well as reduce our capital intensity at the same time.

Daniel Hibshman

And then just one more for me, kind of following up in a similar vein talking something about stepping away from less attractive revenue. I just wanted to zoom in there. Was that mostly in relation to this quarter? Or is that something you see as ongoing? And then just any boundaries you could put around what sort of scope of impact that might mean for revenue and also on the upside for gross margins?

Robert A. Lyons

Yes. I think -- I'll let Steve add any color he wants, but I'll just frame it for you. I think the way to think about it is actually a lot like what we just talked about in managing our costs. So the way that our business works is you essentially pay for capacity when you hit peak and then that's the level that you pay for, for the rest of the year. And so if we have customers who have super spiky business, let's say, for a couple of hours once a week, it drives our cost up and then the rest of the week we're paying for, but we're not using it. So it's really about looking at how do we manage traffic and optimize that yield so that we're not driving cost up and spikes, if you will, and carrying that cost across the rest of the business. And it really -- it's customer by customer. There's a handful of -- actually less than a handful of customers that caused most of that for us, and we're working with them to just smooth out the traffic and find other ways around that to reduce our overall threshold -- cost threshold.

Stephen Cumming

I'll just add a little color to that. Obviously, we're deliberately focusing on quality of revenue and focusing on our margins. I would say we've sort of been implementing direct margin thresholds and sort of weeding out poor quality revenue. But in terms of the overall impact going forward, I don't think we can quite sort of look at that sort of a straight coming out of revenue. So we're going to our clients and sort of renegotiating on contracts and some are amenable to sort of adding new services and new products to their existing business. So it's not just coming straight out of revenue, but certainly, we're going to be very thoughtful in terms of the type of business we're taking going forward and with a big focus on improving our EBITDA margin.

Operator

(Operator Instructions). There are no further questions at this time. Mr. Lyons, I turn the call back over to you.

Robert A. Lyons

Okay. Great. Thank you, everyone, for joining us today. We look forward to sharing our progress and continuing our conversations with analysts and investors as we go forward and have a great rest of your day. Thank you.

Operator

This concludes today's conference call. You may now disconnect.