FiscalNote - Q3 2023

Transcript

Operator (participant)

Good morning. My name is Dizz, and I will be your conference operator today. At this time, I would like to welcome everyone to the FiscalNote Third Quarter 2023 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you'd like to ask a question during this time, simply press star, then the number one on your telephone keypad. To withdraw your question, press star one again. I would now like to turn the conference over to Sara Buda, Vice President in Investor Relations. Please go ahead.

Sara Buda (VP of Investor Relations)

Hi, everybody. Welcome to the FiscalNote Q3 2023 earnings call. During this call, we may make certain statements related to our business that are forward-looking statements under federal securities laws. These statements are not guarantees of future performance, but rather are subject to a variety of risks and uncertainties. Our actual results could differ materially from expectations reflected in any forward-looking statements. For a discussion of the material risks and other important factors that could affect our actual results, please refer to the SEC filings available on the SEC's EDGAR system and on our website, as well as the risks and other important factors discussed in today's earnings release. Additionally, non-GAAP financial measures and other KPIs will be discussed on this conference call.

Please refer to the tables in our earnings release and the investor relations portion of our website for a reconciliation of these measures to their most comparable GAAP financial measure. With that, I'd like to turn the call over to FiscalNote's Chairman, CEO, and Co-founder, Tim Hwang.

Tim Hwang (Co-Founder, Chairman, and CEO)

Thank you, Sara. On today's call, we will review our third quarter results, which mark our first quarter of Adjusted EBITDA profitability. This is a tremendous milestone for the company. A year ago, we committed to Adjusted EBITDA profitability, and that is exactly what we've delivered. In fact, we've delivered this one quarter earlier than we had originally forecast, even amidst a more challenging macroeconomic environment. If you look at where we were when we began this year, we've essentially shifted our Adjusted EBITDA from a minus $7 million per quarter loss in Q1 to positive Adjusted EBITDA in Q3. This is an annualized improvement of over $30 million in Adjusted EBITDA as compared to where the company started this year in Q1. We have been laser-focused on this milestone, and we are delighted to achieve it ahead of initial expectations.

At the same time, we have made significant advancements to accelerate our decades-long leadership in AI, aligned our sales teams on the highest growth customers, and refined our product portfolio. Now, as we end 2023, it is time to build on this foundation and turn our focus towards re-accelerating growth. I'll get into the details of that growth strategy shortly. First, let me remind you of our mission here at FiscalNote and the value we bring to more than 5,000 customers every day. At FiscalNote, we're on a mission to help our customers make sense of the complicated and constantly changing world we live in, by delivering a proprietary AI-enabled platform that aggregates and organizes regulatory, political, and macroeconomic information and analyze the impact on their organization. Changes in policies, regulations, and laws impact the decision-making of almost every organization around the world.

Using our proprietary AI capabilities, we aggregate, synthesize, and analyze mass amounts of legislative, policy, regulatory, and macroeconomic data and information around the world and provide actionable intelligence to customers in a subscription model. As such, we've built an enduring company for the world's most important and influential decision-makers, from hundreds of government agencies and public sector customers, from the Department of Defense, the White House, every member of the House and Senate in the U.S. Congress, the Federal Reserve, and public sector organizations in Europe and Asia, to major corporate customers, including more than half the Fortune 100. Beyond large enterprises, FiscalNote serves a wide and diverse range of business customers, ranging from healthcare and pharma, financial services, technology, energy, food and beverage, transportation, automotive industries, and beyond.

These customers rely on FiscalNote every day to discover, process, and navigate the impact government policymaking on their organization, and more importantly, to take actions which achieve their business objectives and minimize political and economic risk. This forms the base of our durable and long-term growth. Helping our customers analyze over $6.4 trillion in government spending and tracking over 500,000 elected officials in the United States, along with similar policymakers around the world, is an immense digital challenge, one that requires unrivaled information about the need-to-know policies, embedded workflows to manage regulatory risks, and powerful analytics and research to understand mission-critical updates.

With every global conflict, every time the United States and China get into a spat over semiconductors, and every other new tariff, sanction, regulation, and geopolitical disputes, FiscalNote's data and information are more relevant than ever to help companies and organizations navigate through an increasingly challenging, complex world. This is a $37 billion market opportunity that companies spend every year trying to obtain this critical information and data. We have become an increasingly critical and ubiquitous Bloomberg Terminal of political, legislative, and regulatory information at the local, state, federal, and global levels. The same way that other information companies such as S&P Global, IHS Markit, FactSet, Morningstar, CoStar, and Avalara have innovated in their respective information fields. FiscalNote continues to deliver mission-critical information that has a direct impact on their customers' operations and created an entirely new category within the data information services space.

We've invested $ tens of millions in almost 10 years building a defensible combination of data, intelligence, and AI technology to collect, synthesize, and make sense of an exploding pace and volume of dynamic, unstructured, regulatory, political, and legal information around the world, and the software workflow tools to help our customers respond. This forms the basis of our market leadership position and is the underpinning of our durable growth strategy. Further, with our AI pedigree and our vast array of validated, trusted data, we are in a unique position and have a clear competitive advantage. We are a compounding growth company with a broad and diverse customer base against the backdrop of increasing global complexity uncertainty, that we believe only FiscalNote could address with our unique and proprietary products and data sets.

Now, let me provide a brief summary of our Q3 results and our ongoing momentum as we reach the inflection point of Adjusted EBITDA profitability next quarter and beyond. In Q3, we delivered another strong quarter of growth with revenue of $34 million. This marks an increase of 17% year-over-year, and is yet again consistent with the guidance we provided. We also enjoy consistent high gross profit margins. Q3 adjusted gross profit margins were 83% in the quarter. These margins are hallmark of FiscalNote and stem from our SaaS business model, AI pedigree, and data-rich products, all of which form the basis for strong free cash flow in the future. On the bottom line, our third quarter Adjusted EBITDA was positive $700,000, in line with the guidance we provided on the last call.

Our cash and short-term investments at the end of the quarter were $24 million. Turning to management KPIs, we delivered run rate revenue of $138 million. Our ARR was $123 million, growth of 14% year-on-year total, and growth of 8% on a pro forma basis. Our net revenue retention increased to 100%, driven by ongoing success in our large enterprise customer base, where NRR rates continue to be well above company average. So now let's turn to the nuts and bolts of the business. First, we'll review the things that are going well. Second, we'll look at the things that we need to improve on. And third, we'll discuss the pathway for the company moving forward to accelerate growth now that we've achieved profitability. First, on the things that are going well.

We are now profitable on an Adjusted EBITDA basis. For the last year, considerable management time and attention has been placed on this goal. This delivers a tremendous inflection point of delivering positive Adjusted EBITDA for the first time in the company's history, and one quarter earlier than initially forecast. We enabled strong operating leverage, driving 160% conversion of incremental revenue to Adjusted EBITDA this quarter. To achieve this, we took a number of actions, including reducing our G&A for efficiency, reducing our editorial and other expenses, shifting our R&D expenses, and making hard decisions about product spend, and sunsetting underperforming, unprofitable products. We made major changes in our sales team to focus on large enterprises with larger ACVs. This has proven to be the right strategy with impressive outcomes.

By shifting our R&D spend to higher value, higher growth products, we have reinforced our competitive moat and secured AI partnerships with market-leading organizations that recognize and accelerate the applicability of our market-leading data, intelligence, and AI. We have brought to market successful new products such as Risk Connector and FiscalNote GPT, which are both starting to gain traction in the market. By aligning our sales team and reallocating resources to focus on large enterprise accounts with larger ACVs, we have turned large enterprise into our largest, fastest-growing customer group, with NRR rates well above company average, trending well above 105% on an LTM basis. There is more upside here as we introduce new enterprise products with higher ACVs and continue to upsell and cross-sell.

By modifying our go-to-market model and reallocating sales and marketing spend, we are starting to drive growth in the areas of the business with the strongest upside potential. More importantly, by taking cost actions across our organization, we have achieved Adjusted EBITDA profitability, ahead of initial plan, and positioned the business for very strong conversion of incremental revenue to Adjusted EBITDA profit. And ultimately, we have created a durable, profitable company with highly innovative products and a superior market leadership position. We expect the company will continue to see strong conversion of incremental growth into Adjusted EBITDA in the long term. Overall, the company has spent the last decade building an operational and technical infrastructure that is poised for rapid growth.

With global operations ranging from Washington, D.C. to London to Seoul and Sydney, the company has an extremely talented management team, data, technology, and AI organization, as well as a go-to-market infrastructure to continue to grow. The changes we have made have resulted in a leaner, more disciplined organization poised for growth. All of this is a testament to the hard work and dedication of our teams and the unparalleled value we deliver to our 5,000 customers every day. So where do we see areas of improvement for the business then? Candidly, we are watching two data points very closely within the business. First, while we have seen great continued growth in our subscription business, we have seen some challenges in our one-time non-subscription revenue, which is typically very strong in the second half of the year.

With a challenging macro and some underperformance in some few non-core products, this one-time non-subscription revenue didn't deliver on pace with our traditional seasonality. Second, we had some slower-than-expected pipeline conversion as we shift toward larger strategic accounts, which are taking longer than expected to close, also due to the macroeconomic environment. While we have retooled our product strategy to go after larger, bigger accounts, launched new products and features, and structured our go-to-market teams to go after these deals, under the current macroeconomic environment, these deals are receiving more scrutiny in company P&Ls. So what is the company's plan to reignite growth and profitability now that we've achieved the inflection point of Adjusted EBITDA profitability? It is now time for us to shift our management time, focus, and attention to allocate our time, and resources, and capital to reaccelerating growth.

This is the singular focus of the operating team: to drive sustained growth within the organization, as we have done for the last 10 years. Fundamental to this growth reacceleration is a refined product strategy. This is where we drive incremental upside to the durable base of revenue that we have in place today. Let me give some context. First and foremost, we will sustain and build upon our core products with the strongest demand profiles. Our regulatory and policy data solutions continue to be the strongest offerings in our portfolio with robust demand. Organizations are facing significant increases in regulatory complexity, and it is spreading globally, which creates uncertainty for all organizations and significant top-line and bottom-line impact for companies that operate globally as well.

We've spent the last decade applying proprietary AI expertise to structure, normalize, analyze, and digitize vast amounts of regulatory, legal, macroeconomic, and geopolitical information, and to embed workflows that make data useful and actionable for our customers. Today, thousands of organizations, including those in the public sector and private sector, rely on FiscalNote's regulatory and data policy solutions. As such, we'll continue to invest and build upon the success of those core products with new product enhancements, new datasets, and new AI workflows that reinforce our superior competitive position and bring unparalleled value to our customers. We believe there's ample opportunity to continue our land and expand strategy with our largest customers as we continue to upsell and cross-sell legal and regulatory datasets. Second, we will pursue adjacencies to core products in fast-growing areas of risk and compliance.

This includes products such as Risk Connector, our new internally developed risk intelligence solution that enables enterprise to reveal operational, relational, and reputational risk. Risk Connector brings the power of our proprietary data and AI capabilities to map relationships and identify risks within an organization's supply chain, as well as the organization's customers, investors, partners, and any other vectors through which risk could materialize. This empowers large organizations in the private and public sectors to anticipate, understand, quantify, and track risks emanating from their operations and a full web of relationships in a way that current solutions cannot. Only a few weeks after public launch, we already have our first anchor customer and several other active proposals in market with large enterprises. We are delighted with the early momentum of this new product, which exemplifies our AI leadership and our unrelenting commitment to innovation that delivers customer value.

Risk Connector is just one example of a product adjacency. We have additional products in development that will enable us to accelerate growth through adjacencies such as this. We also continue to pursue geographic adjacencies as well. This year, we invest in our Europe expansion, both organically and through acquisition, which allows us to be able to bring new datasets to our customers. Finally, we are investing in new generative AI capabilities for our customers with a new go-to-market strategy that we expect to result in faster revenue generation. We are placing a substantial shift in our new product strategy to focus on AI Copilot agents. Our first new product initiative is our FiscalNote AI Copilot program, through which we are developing a series of AI-enabled applications that provide intelligent assistance for policy and risk management professionals.

The Copilot program leverages our decade-long investment in AI, ML, and NLP, proprietary defensible reasoning and data aggregation tools, as well as the tens of thousands of proprietary and public verticalized datasets and comprehensive information that FiscalNote collects, provides lightweight applications in very specific use cases. The goal of FiscalNote is to launch a constellation of AI agents that include quick applications catered to our individual customer personas, that automate the day-to-day work of creating legislation, drafting regulatory and legal analysis, doing advocacy outreach, and conducting constituent communications and regulatory responses. In doing so, Copilot will reduce countless hours that our customers spend drafting legislation, responding to legislation, communicating with constituents, and other tasks.

Delivered as lightweight self-serve apps, these Copilots build on our FiscalNote GPT generative AI platform we announced earlier this year and enable new go-to-market models with an array of FiscalNote products that are easy to sell, easy to deliver, and easy to scale across users. The value to FiscalNote customers is clear, as we essentially enable both existing and prospective customers to quickly and easily leverage our AI-powered solutions to get their jobs done faster with a higher degree of confidence. The context for this Copilot program is evident. Despite major advances in AI and the use of large language models in the technology industry, there is a crucial need for organizations to specifically address the unique complexity that exists in the legal and regulatory world.

With our expertise in data ingestion, collection, cleansing, and curation, and of course, our extensive archive of legal and regulatory datasets from around the world, it is logical for FiscalNote to fill this void with FiscalNote GPT and now our new AI Copilot program. Of course, FiscalNote Copilot complements and builds upon our integrations with large language model providers like OpenAI and Google. With our new Copilot-focused AI strategy, we'll develop new go-to-market models aligned with expectations for per-user pricing. We expect that these products will be sold on a per-user basis that allows users to be able to purchase these products individually with the swipe of a credit card, substantially eliminating friction in our go-to-market process, enabling mass adoption of our generative AI tools, and ensuring faster revenue generation.

We expect our Copilot strategy to begin rolling out over the next several weeks and months as we embark upon building a constellation of AI agents on top of our data. Our Copilot program marks yet another development in FiscalNote's ongoing leadership as we develop and bring to market AI-enabled solutions specifically aimed at the legal and regulatory sector. You can expect to hear more from us in the coming weeks about FiscalNote Copilot and our other new product developments that, over time, provide incremental growth paths to complement our proven, durable base of recurring revenue solutions. In summary, there have been a lot of changes in 2023 as we dedicated our time, energy, and resources to achieving profitability.

We are now pivoting our focus to new avenues for accelerating growth in 2024 and beyond, with a refined three-pronged product strategy and go-to-market strategy that will enable us to build on our core products with the highest growth potential, pursue natural adjacencies to offerings to broaden our value to customers, and develop new products with new channels for growth. This reflects our ongoing commitment to building a durable, profitable, compounding growth company that provides unique value to the world's most important decision-makers, and scaling this business to $200 million, $300 million, $500 million, and $1 billion in recurring revenue and beyond. Separately, you all saw the disclosure that I have informed the board of my interest in exploring and leading a going-private transaction.

As a result, the board has appointed a special committee to evaluate any proposed transactions I may submit in light of the company's strategic options in the best interest of shareholders. While I can't comment further, I will reiterate what I've said on our past calls. We have approximately $140 million in run rate revenue, a proven durable compounding recurring revenue model with more than 5,000 customers, 80% adjusted gross margins, and now have achieved adjusted EBITDA profitability. The business has never been in a stronger position, yet our stock price does not reflect the strength of these fundamentals, and we continue to trade well below other sector-specific information services leaders.

Ultimately, we will always do what is in the best interest of shareholders to achieve a valuation that recognizes and reflects the value of our fundamentals and our future growth opportunities as we build a long-term, large-scale market leader in AI-driven information services. Regardless of the outcome, the entire organization will remain committed to growing our business that is delivering value for the world's most important decision-makers, who trust FiscalNote to discover, process, and navigate the impact of policymaking on organizations, and more importantly, to take actions which achieve their business objectives and minimize political and economic risk. Now, let me turn it over to Jon for details on the financials and our outlook going forward.

Jon Slabaugh (CFO and CIO)

Thank you, Tim, and good morning. I'll spend some time going through the details of our quarter, and then I'll walk through some of the operational changes we've made and our commitment to ongoing adjusted EBITDA growth moving forward. Let me start with the quarter. Third quarter GAAP revenue was $34 million, marking year-over-year growth of 17%. Third quarter subscription revenue, which makes up approximately 90% of our total revenue, was $30.1 million. This is an increase of 15% from year, from a year ago and 7% growth on an organic basis, excluding the non-cash deferred revenue adjustment from 2022. Our advisory and other revenue was $3.9 million, an increase of $1 million year over year. We entered Q3 with run rate revenue of $138 million in total, marking 14% year-over-year growth.

On an organic basis, run rate revenue was $129 million, reflecting 7% growth on a pro forma basis as defined in our press release. NRR or net revenue retention for the quarter was approximately 100%, a sequential quarter increase of 200 basis points and a year-over-year increase of 100 basis points. Let me provide some more details here because it is important to see the traction among our various customer groups. As you know, we have 3 primary customer groups we serve: public sector, not-for-profit associations, and enterprises. As we've said, enterprise is our largest customer group, and large enterprise and strategic accounts represent the fastest-growing, highest NRR customers. And that has been the impetus for some of the changes we've made to our sales organization to capitalize on this underlying demand and to extend our growth in large enterprises.

This quarter reinforced this is the right strategy. NRR rates among our large enterprise corporate customers continues to trend above company average. Demand for our regulatory and policy data continues to be strong, particularly among large enterprises. With some of the recent changes we've made, from product strategy to sales allocation, we see opportunities for NRR rates in this large enterprise group to expand further. Like many companies, we tend to see a bit more churn in the small enterprise space, particularly in this macro. Turning to ARR, we grew our total annual recurring revenue or ARR to $123 million as of September 30th, an increase of 14% compared to the same period in 2022. Organic ARR, as we defined, was $116 million as of quarter end.

This represents a 7% growth rate when compared to the ARR in Q3 of last year on a pro forma basis. While our ARR continues to trend up, it is slightly behind the pace we expected in Q3. This is largely due to budget tightening and longer sales cycle as we shift towards larger enterprise customers in the midst of the current macro environment. And a few of our ancillary products are underperforming expectations. That said, the pipeline rate remains robust, and the demand for our core policy, regulatory, geopolitical, macroeconomic, security, and operational risk products continues to be strong. These products are crucial to help large enterprise customers manage global complexity and operational risk. Large enterprise continues to be our fastest-growing customer group on an organic basis. Looking at gross profit, we continue to enjoy strong margins.

Our Q3 gross profit was $23.6 million, representing a 69% margin. Our third quarter non-GAAP adjusted gross profit was $28.4 million, representing an 83% adjusted gross profit margin after adjusting for amortization. Our adjusted gross profit margins remain consistently high in the 80% range quarter after quarter. In Q3, total operating expenses decreased by approximately $2 million year-over-year, excluding non-cash stock-based compensation expenses, cost of revenue amortization, and transaction costs. Sequentially from last quarter, total operating expenses declined by about $3.2 million, excluding non-cash stock-based comp and other non-cash expenses. This, combined with our Q4 cost actions, means that we will realize almost $20 million of annualized OpEx cost savings this year. We are delivering on the cost management programs while continuing to invest in innovation and growth for the future.

Within OpEx, sales and marketing costs were $11.2 million for the quarter, a decrease of $600,000 year-over-year, even after acquisitions, and a decrease of $450,000 from last quarter with our sales realignment program. R&D expenses were $4.5 million, a $1 million decrease from last year, and essentially flat from last quarter. Editorial costs were approximately $4.5 million, a slight increase year-over-year, driven by acquisitions, and a slight decrease from last quarter. G&A expenses for the quarter were $14.4 million. Excluding non-cash, stock-based compensation, and other public company expenses, G&A was $9.5 million for the quarter.

This is a decrease of about $400,000 year-over-year, and a decrease of almost $1 million sequentially from last quarter, reflecting the favorable impact of our ongoing expense management program. The operating loss for Q3 was $13.5 million in total. This includes $6.2 million of stock-based compensation. Our total interest expense was $8 million. Of this, cash interest expense was approximately $5.4 million, which is a good proxy for our quarterly cash interest expense going forward, depending on rates. You'll also note that our weighted average shares outstanding for Q3 2023 decreased by about 5.3 million shares from last quarter and is now 129 million shares. This is related to our previous disclosed exchange agreement with GPO, a pre-listing note holder.

The GAAP net loss for Q3 was $14.5 million, and as we forecasted, Adjusted EBITDA was a positive $700,000 this quarter, marking our first quarter of profitability on an Adjusted EBITDA basis, one quarter ahead of our initial guidance. We are delighted to achieve this important milestone for the company, which reflects our diligent cost management and solid top-line growth. It is important to note that in Q3, we delivered 160% conversion of incremental revenue to Adjusted EBITDA. This reflects the power of our business model. Despite the challenging macro, we're driving strong incremental revenue through a new logo acquisition, cross-sell, and upsell without adding incremental costs. This operating leverage is a strong indicator of what to expect as we move this company from Adjusted EBITDA positive to a free cash flow-generating growth company over time.

Our balance sheet remains solid, with approximately $24 million of cash, cash equivalents, and short-term investments as of September 30th. We expect to increase our cash position in Q1 of 2024 through continued compounding increases to prepaid ARR and seasonally strong collections. You see that we did file a shelf registration. This is a 3-year, $100 million registration that simply gives us flexibility and optionality in our capital structure. This is the right time to put a shelf in place, and it is a common practice one year after public listing. As we committed, FiscalNote achieved positive Adjusted EBITDA 12 months after our listing date and a quarter ahead of schedule and without raising additional capital. Now that we have achieved positive Adjusted EBITDA, our operations are self-sustaining.

We are now actively looking at opportunities to strengthen our balance sheet, resources that will further accelerate organic and inorganic growth. As we turn our focus to re-accelerating growth, we will have the capital structure and flexibility to invest strategically and drive our business to the next phase of growth. Now let me comment on our guidance and how we are positioned for profitable growth next year and beyond. For Q4, we expect revenue of $34 million-$35 million. We expect positive Adjusted EBITDA of approximately $2.5 million. The swing from a $7 million adjusted EBITDA loss in Q1 to a $2.5 million adjusted EBITDA profit in Q4 is remarkable, particularly in light of the more challenging macro. For the full year, we expect GAAP revenue of $132 million-$133 million.

This is a reduction from our prior guidance, with the majority of the impact driven by lower non-subscription one-time revenue. We expect run rate revenue of $139 million-$141 million. As Tim mentioned, we've been making a lot of changes this year to position the company for greater growth. We've realigned our sales force, we've adapted our product strategy and sunset unprofitable products, and we've reduced our cost structure. At the same time, we've allocated capital to the areas of the business with the strongest upside potential. As a result, we are well positioned as we exit the year. Our enterprise sales team are continuing to execute well against strong demand, particularly for our regulatory and policy data.

Our AI leadership is broadening our market with new partnerships and enabling us to bring breakthrough innovations to market, including Risk Connector, FiscalNote GPT, and now our FiscalNote Copilot program. We have reached the inflection point of Adjusted EBITDA pre-profitability and paved the way for free cash flow over time. With strong operating leverage, we are well positioned to drive compounding recurring revenue growth. All of this positions us for ongoing revenue and Adjusted EBITDA growth in 2024 and beyond. With that, I will now open it up to questions. Operator?

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, simply press star, then the number one on your telephone keypad. Our first question is from the line of Matt VanVliet with BTIG.

Matt VanVliet (Director of Equity Research)

Yeah, good morning. Thanks for taking the question. I guess first on the sales opportunity, not just in the fourth quarter, but maybe as we look out into 2024, and I guess sort of two factors there. One, what's the sales realignment doing in terms of driving more upsell, cross-sell? Anything from an actual process standpoint that you've put in? And then, as we think about sort of the maturity of that sales team, especially at the larger enterprise accounts, where are we in terms of sort of reps fully ramped, or what's the mix of fully ramped? And then secondarily on that, you know, where are you seeing the biggest impacts from the macro in terms of feedback from customers, and how is that impacting, I guess, either deal flow or maybe deal sizes?

Josh Resnik (President and COO)

Hey, Matt, this is Josh Resnik. I can address that. So, in terms of upsell, cross-sell opportunities, part of what we've been doing with the sales realignment has been adjusting staffing, responsibilities, quota setting, commission plans, and such to align around upsell and cross-sell. And have in fact established a team that is focused specifically on upsell and cross-sell, 'cause we do see significant opportunity up there, especially when it comes to large enterprise clients. The team has gone through significant restructuring over the course of the year.

We've been viewing that as an optimization of our approach to go to market, both in terms of how we structure the teams, but also in terms of overall the quality of the talent that we have on those teams, and as well as our effectiveness, efficiency, and speed in ramping new talent as we bring talent on board, and continuing to build a pipeline of talent across the board that we can use as we continue our growth down the road. And in terms of the macro impact, I would say we are still seeing strong demand for the products.

We have a lot of confidence in our pipelines, including in regards to some of the new products that we've launched, such as Risk Connector, where we tend to see an impact really is on sales cycles and really the time to bring those home as prospects see budget pressure internally.

Matt VanVliet (Director of Equity Research)

Okay, very helpful. And then can you just remind us, as we look at the guidance, you know, I think you mentioned that on the one time, that's certainly being impacted by some of the product sunsetting and winding down of the underperforming products. But can you help us in terms of what the impact is on the subscription line, limiting the growth there than maybe we were previously expecting? And then how that's maybe balanced with the success of the better products, especially around the regulatory and policy data? Thanks.

Josh Resnik (President and COO)

Sure, Matt. So yeah, as you noted, lower non-subscription, so one-time revenue certainly played a large role in what we're seeing. Second half is typically strong for one-time revenue, and, you know, that hasn't materialized this year due to largely due to budget uncertainty related to the macro. On the ARR subscription side, we have seen some slower pipeline conversion, like I was saying. And especially as we move to larger enterprise deals, where the sales cycles naturally are longer, again, the macro is gonna have an impact there.

Matt VanVliet (Director of Equity Research)

Okay, great. Thank you.

Operator (participant)

Your next question comes from the line of Mike Latimore with Northland Capital Markets. Your line is open.

Mike Latimore (Managing Director of Equity Research on Artificial Intelligence)

Great. Thanks very much. Good morning. Yeah, congrats on the positive EBITDA, and sequential change was pretty impressive there. Gross margin, that seems to be at a record level and was also up sequentially. Can you just sort of describe the impacts there? Was this kind of, you know, de-emphasizing some of the lower value products? You know, is this sustainable? Just a little more color on gross margin would be great.

Jon Slabaugh (CFO and CIO)

Mike, I think the, you know, we're gonna continue to see the gross margin stay pretty consistent. We saw some benefits from some credits this quarter that I don't think will be continued or repeat quarter over quarter. So in terms of thinking about it going forward, you know, at 80%, adjusted gross margin numbers is probably the right way to think about it.

Mike Latimore (Managing Director of Equity Research on Artificial Intelligence)

Got it. Okay, great. And then on the just kind of some of the vertical effects here, the federal government vertical, have you seen any kind of nuances there that, you know, were unexpected?

Jon Slabaugh (CFO and CIO)

In terms of revenue?

Mike Latimore (Managing Director of Equity Research on Artificial Intelligence)

Bookings, primarily, and pipeline.

Jon Slabaugh (CFO and CIO)

Booking customer behavior? Josh, you might want to handle that, but we've done, we've done contingency planning around it as we think about guidance for the upcoming quarter.

Josh Resnik (President and COO)

Sure, yeah.

Jon Slabaugh (CFO and CIO)

Go ahead.

Josh Resnik (President and COO)

Sorry. Yeah, Mike, this is Josh. I would say it's, you know, largely continues to be steady. You know, federal government tends to be a good, steady revenue driver for us. We've seen, you know, some impact from budget pressures in the federal government, not surprising given the atmosphere on Capitol Hill, but still largely remains steady.

Mike Latimore (Managing Director of Equity Research on Artificial Intelligence)

Got it. Okay. And then the comment about, you know, this is the opportunity to kind of reaccelerate growth, is the implication there that you would try to maintain current EBITDA margins while you reaccelerate growth, or how do you think about balancing those two?

Jon Slabaugh (CFO and CIO)

...Mike, we will continue to drive the margin. We're not giving any guidance with regards to 2024 at this time, but our operating plan will continue to push the company towards a more industry normative operating EBITDA margin over time.

Mike Latimore (Managing Director of Equity Research on Artificial Intelligence)

Got it. Okay, great. Thanks very much.

Operator (participant)

Your next question comes from the line of Zach Cummins with B. Riley. Your line is open.

Zach Cummins (Equity Research Analyst on Software and Ad Tech)

Yeah, thanks. Good morning, and also congrats on the inflection to positive Adjusted EBITDA in the quarter. In terms of, I know you're not giving formal 2024 guidance, but just given the updated run rate revenue outlook, is that sort of a good baseline to start from once we think about setting expectations for 2024?

Jon Slabaugh (CFO and CIO)

Thanks for the question, Zach. Yes, that's why we give the run rate guidance. I think it's a good way to kind of start your modeling for the beginning of the year, and then kind of look at any, you know, updates we give further in the year as we see how, how we're gaining traction or other events that would drive the number north of, that level.

Zach Cummins (Equity Research Analyst on Software and Ad Tech)

Got it. And in terms of the cash balance, I mean, Jon, can you give an update on are there any one-time items impacting overall cash burn in this quarter? And any sort of update you can give on expectations for cash burn in Q4?

Jon Slabaugh (CFO and CIO)

So, you know, our interest expense and CapEx tend to be around $7 million per quarter. I think that's kind of when we think about, beyond the adjusted EBITDA, how to think about that. The fourth quarter tends to be the lowest point of our year in terms of cash. We're not giving specific guidance around what we think the year-end cash balance will be. And then we begin to see very strong cash collection going into the first quarter of each year. So we expect to see the balance kind of building back up as we kind of move into the first quarter. But we model it, you know, we plan around it.

The actions we've taken, to date have all been done in light of, you know, cash requirements and maintaining the liquidity we need to keep the business where it needs to be.

Zach Cummins (Equity Research Analyst on Software and Ad Tech)

Got it. And final question is really around, I believe you, you're expecting a bounce back in the cash balance in Q1 of next year. Is that assuming that you're gonna start consistently generating positive cash flow from Q1 and beyond next year, or is it more of just the strong collections to start the year and maybe it'll take a little more time to get to a consistent free cash flow generation?

Jon Slabaugh (CFO and CIO)

So there is a seasonality to our business, where we generate significant kind of positive cash flow in the first quarter because of the amount of sales activity that takes place in the fourth quarter and the billing and collection cycle off of that. From a, you know, income statement standpoint, we will be moving towards free cash flow from a EBITDA standpoint relative to our fixed charges, but haven't given guidance as to when we cross over that. But, you know, it's certainly a focus of ours as we move forward to get to that level.

Zach Cummins (Equity Research Analyst on Software and Ad Tech)

Understood. Well, thanks for taking my questions, and best of luck in Q4.

Jon Slabaugh (CFO and CIO)

Thanks.

Operator (participant)

Once again, ladies and gentlemen, if you have a question, it is star one on your telephone keypad. Your next question comes from the line of Rudy Kessinger with D.A. Davidson. Your line is open.

Rudy Kessinger (SVP and Senior Equity Research Analyst)

Hey, guys. Thanks for taking my question. So, you know, the trend the last few quarters has been revenue coming in below the midpoint of guidance and the forward revenue outlook being lowered. And Jon, I know last quarter you said you guys were assuming similar close rates in the second half of this year as you've seen in prior years. And so with this lowered revenue outlook, just could you comment specifically on your assumptions for Q4 as it relates to close rates, renewals, expansions, et cetera, relative to past years?

Josh Resnik (President and COO)

Hey, Rudy, this is Josh. Yeah, I can tell you, and I'll reiterate that the biggest impact came from lower non-subscription revenue, where typically we would have expected a better results seasonally in the second half, and we didn't see that come through, largely due to budget uncertainty, some underperforming products. And then, on the ARR side, it's been slower pipeline conversion than we typically see. And so, you know, like I said, as we move to larger enterprise deals, you tend to see longer sales cycles, which is fine, but we saw an impact largely due to the macro in the second half and conditions worsening in the second half.

Jon Slabaugh (CFO and CIO)

Sure. Rudy, as it relates to the guidance for the remainder of the year, we've taken into consideration the close rates that Josh referenced and the slower pacing into that guidance, and that's why we adjusted the revenue figure down for the quarter. We've reviewed the pipeline and looked at it in light of the conversion rates that we're actually seeing, and that's why we took the adjustment that we did.

Rudy Kessinger (SVP and Senior Equity Research Analyst)

Okay. And then I hear, I guess, what you're saying on the Q1 cash bounce back, given changes in net working capital. But, you know, with, I think, roughly $7 million a quarter in cash interest expense, I guess just what level of annualized EBITDA do you need to get to, to be free cash flow break even to positive on an annual basis?

Jon Slabaugh (CFO and CIO)

Our cash interest expense, to be clear, is a little bit over $5 million, and then our capital expenditures are between $1 million and $2 million per quarter, generally. That's the reference to the $7 million. You could annualize that and kind of back into the number we would need to get to, to be truly free cash flow positive, on a standalone basis.

Operator (participant)

Your next question comes from the line of Mike Albanese with EF Hutton. Your line is open.

Mike Albanese (Equity Research Analyst)

Yeah, good morning, guys. Thanks for taking my question, and nice quarter, you know, given some of the macro headwinds and lengthening of the sales cycle. I just wanted to get an update on the AI front and how you guys are utilizing technology, and really, if you're seeing any green shoots, you know, improving efficiencies across the organization, and I guess specifically, where you're pulling out any synergies. Thanks.

Tim Hwang (Co-Founder, Chairman, and CEO)

Yeah. No, thanks, thanks for the question. So I think that a couple different things. So the first thing that we pointed out to you today on the call was the progression of some of the new products that we have in the market, namely Risk Connector and some of the traction we're seeing there. That was completely wholly built in-house product that we kind of went out to market with to go after the sort of supply chain market and the like. You know, in the second half of my earnings call, you know, I basically had talked about some of the new initiatives that we're launching here in the market.

Mike Albanese (Equity Research Analyst)

Mm-hmm.

Tim Hwang (Co-Founder, Chairman, and CEO)

I guess what I would say is that the generative AI market in general has started to coalesce around the type of product and type of go-to-market that is somewhat different from what we've kind of gone to market with traditionally. So if you look at, you know, very recent product lines, you know, from Microsoft or from kind of, you know, growth-oriented startups and the like, you know, a lot of the product lines that we're seeing are coalescing around call it per-user pricing of, you know, $50-$200 a month per user. Then pricing, you know, very, very targeted generative AI capabilities for those customer sets.

Essentially, what I talked about is that, you know, over the course of the next couple of weeks, our intention is to implement a similar kind of Copilot strategy for the legal and regulatory space. To essentially take the data that we have embedded within kind of generative AI capabilities, and then help, you know, lawyers, legal professionals, regulatory professionals, you know, draft documents, create legislation, create laws, whatever the case is, and then effectively charge, you know, in a similar price point, you know, $several hundred a month per user, such that people can essentially go out there and swipe a credit card and go to market very quickly.

So that effectively means that, you know, we've been in development with a series of these Copilot products for some time now, and we expect that actually in a different go-to-market channel, different from, you know, a heavy enterprise sales model, that we're gonna try and go with a more product-led growth kind of user-driven model here to drive faster revenue generation, and kind of really lead into the generative AI market a lot more aggressively. So, we are seeing pretty good traction here overall, and I think that's something that we're, you know, we're gonna continue to monitor as we try and accelerate the growth of business.

Mike Albanese (Equity Research Analyst)

Got it. Thank you.

Operator (participant)

Once again, ladies and gentlemen, if you have a question, it is star one. There are no further questions at this time. I will turn the call back to CEO Tim Hwang for closing remarks.

Tim Hwang (Co-Founder, Chairman, and CEO)

Yeah, appreciate everybody taking the call here and, definitely looking forward to another great quarter. Thank you, everybody.

Operator (participant)

This concludes today's conference call. We thank you for joining. You may now disconnect your lines.