Veritone, Inc. (VERI) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon. My name is Rob and I will be your conference operator today. At this time, I would like to welcome to the Veritone's Second Quarter 2019 Financial Results Earnings Call. [Operator Instructions]. Thank you. Brian Alger, you may begin your conference.

Good afternoon. Welcome to the Veritone's second quarter 2019 earnings conference call. I am Brian Alger, Senior Vice President on Corporate Development and Investor Relations. After the market close today Veritone issued a press release announcing results for the second quarter ended June 30, 2019. The press release is available on the Investor section of our website. Joining me for today's call are Veritone's Chairman and CEO; Chad Steelberg, President, Ryan Steelberg and CFO; Pete Collins. Following their remarks, we'll open up the call for questions. Please note that certain information discussed on the call today will include forward-looking statements about future events and Veritone's business strategy and future financial and operating performance, including its expected net revenues for the third quarter of 2019. These forward-looking statements are subject to risks, uncertainties and assumptions that may cause actual results to differ materially from those stated or implied by the statements. Certain of these risks and assumptions are discussed in Veritone's SEC filings, including its annual report on Form 10-K. These forward-looking statements are based on assumptions, as of today August 7, 2019 and Veritone undertakes no obligation to revise or update them. In addition to the Company's GAAP financial results, during this call we will be presenting and discussing the Company's earnings before interest expense, depreciation, amortization, and stock-based compensation, adjusted to exclude certain acquisition, integration, and financing related expenses or adjusted EBITDA, as well as our non-GAAP net loss excluding those same items. Both of which are non-GAAP financial measures. Reconciliations of these measures to the Company's GAAP net loss are included in the Company's press release issued today. Finally, I would like to remind everyone that this call is being recorded and will be made available for replay via a link available at the Investor Relations section of the Company's website at www.veritone.com. Now, I would like to turn the call over to our Chairman and CEO Chad Steelberg. Chad.

Thank you, Brian. Welcome everyone and thank you for joining us today. I am pleased with our financial and operating performance in the second quarter. Our revenue was a record $12.3 million, an increase of 194% compared with the second quarter of 2018, reflecting both the contributions of our recent acquisitions and organic growth. On an organic basis, revenues were up 45% year-over-year. Consistent with our comments on last quarter's call, we delivered 150 basis points sequentially improvement in our adjusted EBITDAS loss rate and we more than doubled the number of trials for Identify and Redact to-date. In Q2, our advertising business continued to outpace the competition, with first half revenues growing organically by 30% year-over-year. In addition, our Performance Bridge brings that growth to 77%. As Ryan will discuss in greater detail momentarily, the unique capabilities that aiWARE brings to this business are driving faster growth, higher commission rate and we announced this morning new business opportunities for us with radio stations, podcasters, online broadcasters and social influencers. Our SaaS revenues grew organically by 102% versus Q2 of last year. With their acquisitions last year that growth was 211%. As we had communicated on our call in May the sequential comparison was more challenging due to the large government project we completed in the first quarter, as well as the extended sales cycle for our new product in the government and legal markets. We expect to see strong revenue growth from these products beginning this quarter. Our content licensing and media services group posted another solid quarter with revenues of $3.8 million. In short, all our business delivered results in line with the expectations we communicated in May. Looking forward, we see tremendous market interest in our solutions. The number and size of our customer engagement continue to increase. As has been the case since we started Veritone, we continue to execute on our land and expand strategy with customers. To that end, I'd like to introduce by brother, Ryan, our President and Co-founder to discuss our operational progress in greater detail. Ryan.

Thank you, Chad. As Chad said, since we founded Veritone, our strategy has been one of land and expand, critical to this our product and solution innovation to attract new customers and grow our revenue from existing customers, as well as providing excellent customer service to retain those customers. This past quarter demonstrated the success we are having in pursuing that fundamental strategy. Our momentum with both new and existing customers was very strong in Q2. In our government market during the first half we conducted over 170 demos of Redact and Identify and initiated more than 30 contracted trials. We signed two six-figure SaaS contract with customers in Italy and Spain in the quarter and after the shift in our go-to-market strategy in the legal market that we have discussed in prior calls, we grew our legal revenues a 100% sequentially. In our media and entertainment vertical, we continue to produce sequential growth and we announced a new aiWARE SaaS agreement with Cox Media for 49 stations. We have now licensed and employed our software across over 800 U.S. radio and TV stations. We also continue to have a very strong retention in Q2 with the total rate above 95%. Veritone One, our advertising agency achieved 32% year-over-year organic growth in the first half well above the industry average. We believe that our aiWARE driven capabilities in this business are driving not only rapid share gains, but also higher than average commission rates. During the quarter, we added 21 net new customers in this business and our revenue per account continue to improve as it reflected in today's reported KPIs. As with the rest of Veritone, we had negligible customer loss in the business during the quarter. Another core element of our strategy has been to leverage technology and scale of our business to create new synergies and disruptive business opportunities across our markets. Our critical mass of aiWARE enabled broadcasters and advertisers has now created a unique opportunity for Veritone to introduce intelligent and autonomous unwired media networks. aiWARE listens, watches and understands media at scale enabling the programmatic targeting delivery, verification and clearance of native advertising across terrestrial broadcasting and digital media. These exciting new advertising and monetization solutions expand Veritone's advertising business into the network and sale side adding to our existing agency and [Indiscernible] business. Earlier today we announced the launch of Influencer Bridge, the first of these unwired networks. Influencer Bridge is a Pay-Per-Performance Advertising Platform that gives us podcasters and other influencers unprecedented access to advertising opportunities and conversely give advertisers the ability to place advertisement on these popular channels on a simple and cost effective basis. As the largest podcasting agency currently placing advertisements with over 3300 podcasters, we are uniquely positioned to pursue and grow this opportunity. To frame the opportunity of Influencer Bride in more detail, PWC estimates that podcast advertising revenue will be $678 million this year and exceed $1 billion by 2021. And we think it can grow ever faster than that. Last year, more than 85% of podcast ads were played on a CPM basis with more than 90% of the revenues going to a tiny fraction of the 700,000 active podcast and more than 29 million podcast episodes. In short, the mid and long tail had been completely ignored up to point. Influencer Bride aims to solve this problem enabling advertisers to effectively target the mid and long tail segments of the market expanding the total available market significantly. We believe that is similar to what happened in the early days of internet advertising. We've already seen tremendous interest in Influencer Bridge from advertisers and podcasters and we expect to have at least 10 advertisers and at least 500 podcasters using the platform this quarter. The second of the new unwired networks we are launching is MicroMentions, which is initially target at live broadcast. The platform connects aiWARE enabled broadcasters and advertisers to efficiently and autonomously transact organic libraries as opposed to traditionally scheduled spot ads. aiWARE then verify the libraries automatically and build the advertiser. We believe these MicroMention ads will sell at premium rates without cannibalizing the inventory of the broadcaster and complement existing advertising campaigns. The capabilities of our aiWARE technology and our scale in the media market with over 800 U.S. radio stations already aiWARE enabled uniquely positioned us to pursue and grow this disruptive new initiative. These aiWARE enabled stations collectively reached over 270 million unique users per week representing 98% of U.S. radio listeners. We are watching the beta of MicroMention this quarter with several prominent broadcasters and over 20 prominent advertising clients. Both Influencer Bridge and MicroMentions will initially be introduced to our existing advertising customers and we expect both of them to generate revenues this quarter with higher profit margins than our traditional agency business. Furthermore, we believe that the success of Influencer Bridge and MicroMentions will drive expanded adoption of aiWARE. In our SLED market we are seeing accelerating demand for both our Identify and Redact applications. Similar to the situation in California with Assembly Bill 748 we are seeing legislative action in New York and other states essentially accelerate the need for AI based solutions. For example, we have really seen an uptake of interest for Redact coming from a recently your craft New York Law which among other things requires prosecutors to provide all evidence to defendant within 15 days of arraignment and no less than seven days prior to expiration of post arraignment plea deal offers. While this law does not go into effect until January, we are in active discussions with several municipalities and agencies looking to acquire and we can use in our solutions prior to the implementation of the law. It also bears mentioning that many of our discussions have naturally led interest in our Illuminate application particularly from prosecutors looking to better process and understand the massive volumes of data gathered during the investigation and discovery phases before disclosing it to the defendant. Veritone's unique capability to utilize multiple cognitive engines across multiple classes of cognition, and tie unstructured data to structured content continue to differentiate us from single point solutions on the market today. While we are still cautious in forecasting revenues for SLED customers due to the lumpiness of deal and length and variability of the sale cycle, we are more confident than ever that we have unique products targeting significantly new opportunities in both the government and legal markets. We believe that this enable us to grow and diversify our revenues from these markets significantly over the coming quarters. To summarize, our advertising business continues to significantly outpace the industry due to our unique technical capabilities and we are on the cast [ph] of extending its differentiation and scale. Our new applications for government and legal markets have expanded our addressable market and increase our differentiation and we have seen tremendous customer interest from public safety and government agencies both domestically and abroad. Operationally, we are continuing to execute our land and expand strategy while maintaining discipline in budget control and we look forward to continue to deliver diversified revenue growth across all of our market segments. With that, I'll pass it back to Chad.

Thank you, Ryan. On last quarter's call, I said that, we are seeing an operational inflation point in our business. We believe that the customer engagement for our new products and the opportunities with Influencer Bridge and MicroMentions that Ryan just described, further validate this statement. To-date, we've identified three very large markets that we are targeting; media entertainment, government and legal and compliance. In each of these markets we have delivered products that specifically target improving specific workflows in ways that our customers couldn't have previously considered without the capabilities of aiWARE. In doing so, we are rapidly engaging new customers and increasing revenues from existing one with negligible customer loss. By building the aiWARE operating system, we have the ability to rapidly develop and deploy applications that address customer's specific needs. Moreover, we have tools to enable channel partners and third-party developers to customize their own application beyond the scope of Veritone's current offerings. The operating system approached to AI is unique to Veritone. And one that continues to be the foundation of our current and future growth. Companies without access to aiWARE will incur higher cost of development, longer development lifecycle and applications locked in the silos versus interoperating on a common framework. Our focus on enhancing the development tools for aiWARE remain front center targeting data scientists, engineers and even low-code, no-code analysts. Let me touch briefly on automate studio, our no-code low-code developer tool formally known as Flow. This is a great example of how we are enabling others to leverage the aiWARE ecosystem. Automate studio was originally designed to help us internally accelerate our product development. In fact Illuminate was largely developed with it. However, in talking with our channel partners particularly in the government vertical, it rapidly became apparent that automate studio represented an even greater opportunity for third parties than it does for us internally. I'm personally very committed to this product and expect great things as we roll it out to our customers and partners. With that, I'll ask Pete Collins, our CFO to review our Q2 financial results and update our guidance for Q3 2019. Pete?

Thanks, Chad, and good afternoon everyone. As Chad mentioned, we are pleased that we executed on the expectations we had communicated in May. Our organic net revenues increased by 45%, while our non-GAAP operating expenses excluding the businesses we acquired intangible, amortization and earn-out associated with those acquisitions and stock-based compensation decreased by approximately $60,000. This shows the operating leverage we can generate now that we have invested aiWARE for the past five years. First, I'd like to review our financial highlights of the second quarter of 2019 as compared with the second quarter of 2018. As a reminder, in the third quarter of 2018 we acquired three companies; Wazee Digital, Performance Bridge and Machine Box. Our net revenues in Q2 increased 194% year-over-year to $12.3 million due primarily to a $6.2 million contribution from the acquisitions I just mentioned, as well as with the addition of new customers and growth with existing customers. On an organic basis, our aiWARE SaaS net revenues increased by $876,000 or 192% in the second quarter and increased by $1.2 million or 59% in the first half compared with the prior year periods. Organic growth in both periods was driven primarily by our media and entertainment vertical, which increased by $689,000 or 83% in the second quarter and by $1.1 million or 73% in the first half compared with the prior year periods as we continued to land new customers and expand our business with existing customers. Our aiWARE SaaS monthly recurring revenue or MRR under agreements in effect at the end of the second quarter increased over the first quarter by approximately $51,000 or 10%. Our aiWARE SaaS bookings in the second quarter were $1.4 million, an increase of 3% over the first quarter level. The majority of our second quarter bookings were in the media and entertainment vertical. Our aiWARE content licensing and media services business had net revenues of $3.8 million. In total, our aiWARE software and services businesses contributed 52% of our total net revenues in Q2, continuing the trend we have discussed in prior quarters. Our advertising net revenues increased $2.5 million or 77% to $5.8 million including the $1.5 million contribution from Performance Bridge. Excluding this acquisition our Q2 advertising net revenues increased by 30% year-over-year. Thanks to a combination of new clients and growth with existing clients. In the second quarter of 2019, our total GAAP operating expenses increased to $24.4 million from $17.8 million in the same period of 2018 due primarily to the addition of approximately $3.3 million of operating expenses of the businesses acquired in the third quarter 2018. Approximately $0.6 million of intangibles amortization and earn-out compensation expense for those acquisitions. And approximately $2.5 million of additional stock-based compensation expense related primarily to awards under our 2018 [ph] performance based plan and acquisition related stock awards. The additional operating expenses from the acquisitions and the higher stock-based compensation were offset in part by the impact of our efforts to manage our overhead closely, while continuing to invest in software and product development. A non-GAAP operating expenses increased to $17.5 million from $14.5 million in the same period of 2018. This increase is due primarily to the addition of operating expenses of the businesses acquired. Going forward, we will keep a focus on driving revenue growth while controlling our spending which will reduce our use of cash. Loss from operations in Q2 was $16.7 million compared with the loss of $14.5 million in the second quarter of 2018. Our net loss totaled $16.7 million or $0.80 per share compared with a net loss of $14.3 million or $0.88 per share for the prior year. Now, turning to non-GAAP results. Our total non-GAAP operating expenses in Q2 were $17.5 million or 143% of net revenue compared with $14.5 million or 348% of net revenues in Q2, 2018 reflecting the leverage created by our higher revenue level and the benefits of our cost management efforts. Our non-GAAP net loss totaled $9.2 million or $0.44 per share compared with $11.0 million or $0.67 per share to the prior year quarter. Our second quarter adjusted EBITDA loss was $9.2 million or 75% of net revenues, down from $11.0 million or 263% of net revenues in the second quarter of last year. In 2019, we are continuing to leverage our revenue growth and prudent expense management and we expect to reduce our adjusted EBITDA loss rate on a year-over-year basis in each quarter of 2019. Our balance sheet remains strong. As of June 30, 2019, we had cash, cash equivalents and marketable securities totaling $45.3 million and no long-term debt. The cash and marketable securities balance includes cash received from clients for future payments of $8.9 million. During the second quarter, we raised net proceeds of $8.1 million through the issuance of 1.0 million shares of our common stock under the ATM facility that we set up in the second quarter of 2018. We have $35.5 million available under the ATM as of today. Turning to our guidance. We expect net revenue for the third quarter to be in the range of $12.6 million to $13.0 million. As in prior quarters this net revenue guidance range is based upon the signed agreements we have in place today. The expected net revenues from our aiWARE content licensing and media services based on recent historical trends and the planned spending by our advertising clients. This range of net revenues does not include potential projects including eDiscovery or media and entertainment archive processing that have not yet started as those are difficult to forecast accurately. We expect our adjusted EBITDA loss rate to be similar to the second quarter level. Later this quarter, we look forward to connecting directly with our investors and analysts. In early September, we will be presenting at the 18th Annual D.A. Davidson Technology Conference in New York City. To arrange meetings at the conference or in person we encourage institutional investors to reach out to their respective brokers or please contact Ryan. At this time, we would like to begin the Q&A session. Operator?

Thank you. [Operator Instructions] Your first question comes from the line of Patrick Walravens from GMP Securities. Your line is open.

Great. Thank you. And congratulations you guys for doing what you said you would do, which is great. Hey Chad, let me ask you – so, if we look at the aiWARE total contract value the new [Indiscernible]. I mean, were you happy with that? Is that a – was that a – is that a productive quarter for the sales organization?

Yes. It was a productive quarter for us. I think it was on part of what we did in the prior quarter 1.4. I think that we probably could expect a little more out of it. I think we're in the long-term negotiated contracts for that large on $100,000 revenue deal we had in Q1 this year and Q2 is about us really trying to ink larger contracts and that just extends that out a little bit. So, we expect that to start to hit in Q3 and Q4 and see that accelerate,

Okay, cool. And then, I mean 70 demos, seems like a lot, right? Are we – can we talked a little bit about sort of what the pipeline looks for that for Identify and Redact and how you see -- how and when you see that converting?

Actually, I believe it's over 170 demos and we have entered into over 30 contracted trials. So, yes, those numbers are very high for these type of demos, with those type of municipalities and agencies. So, we're very excited about that. That being said, the sales cycles can be very long as it relates to them. So we're getting great demand. I'm actually great usage in our trials, but again right now we want to make sure that we sort of set expectations that as those translate into long term contracted deals that may take a while.

All right. Great. And then, Pete, one for you, I know you're clearly not guiding the Q4, but just can you help us a little bit in terms of is there seasonality that we should be aware of this as we modeled out the three revenue areas. I mean, should they all go up sequentially or is there some wrinkle there that we should keep in mind?

Yes. The only real seasonality, Pat is in the content licensing business. In that, that is a soft time of the year for them, for us in that business, because of just the nature of some of the customers we serve which are sporting events that occur in the first, second and third quarters, since we just don't have that source of revenue in the fourth quarter. That being said, there are some other things that upset a good portion of that seasonal decline in other parts of the business. Advertising in the past year, probably two years has been kind of finish the year on strong mark. And then there's also a large contract that we got on the SaaS side that has a bonus component to it that [Indiscernible] back in our fourth quarter call that we did in February, we called out that we had picked up an extra 400 grants in the fourth quarter of 2018 related to the timing of when that bonus was achieved in the fourth quarter of 2018. As it stands today that bonus is still something we're pursuing for this year. So I think the only real structural seasonality is really in that content licensing business.

Hi, great. Thank you very much.

Thanks, Pat.

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

Great. Thanks a lot. Yes. Congratulations on the quarter. Just a clarification. I think, Ryan, you said you had two six figure deals in the quarter. Was that specific to Redact and Identify or something else?

No. They were more generic aiWARE. But I can't really go into too much detail on that. But they were not Redact and Identify.

Okay. Got it. And then I think you also talked a little bit about seeing strong revenue growth I think in the third quarter in government and legal. I just wanted to clarify that is the case. And if so that -- maybe what drives that?

Yes. No. I don't think it’s much stronger revenue. I think what we're seeing is a strong adoption of the platform with a number of trials that we're under and the demos that we're doing with the Redact and Identify products. That's really being driven by a couple of different factors. First, you just have this explosion of audio and video based evidence that's happening within law enforcement. And second you've got a lot of legislation that's coming forward in California, New York, Florida et cetera, that's changing the timeline by which agencies have to respond to Freedom of Information Request Act, as well as to DAs. And so that is putting tremendous pressure on the market for advanced solutions that can hold that human based timeline forward. And obviously, Veritone is at the forefront of that with both Identify and Redact. So, we think there's going to be tremendous customer uptick both in terms of trials pilots and even contracts, but in terms of actually impacting the revenue side just given what we've seen to date. The approval for those types of deals really needs to go to City Councils et cetera which can delay that by as much as a quarter to a year. So I don't think we're going to see a huge uptick. On the government side, however we talked about the 400,000 that we did in Q1 with a large system integrator out of the U.K. for multiple projects. We've been in negotiations with them throughout Q2 and expect revenue to start to kick back in from those agreements on the international side in Q3 and Q4 this year.

Got it. And then just last on automate studio, maybe Chad, can you elaborate a little bit on, I don't know, go-to-market. How you monetize that or just kind of the broader effect on that?

Yes, absolutely. So, one of the things that Veritone has been able to do is we built this product on a product called -- we built this product so they could to be a real time cognitive infrastructure for analysts inside of the enterprise to be able to harness the power of artificial intelligence and the over 350 engines on aiWARE and to integrate that seamlessly into their internal processes and business operations. On to-date you really have no product in the market that enables real time capabilities on the cognitive front. So Veritone's go-to-market is really predicated on kind of injecting this into our existing customer base to expand the number of applications and use cases that aiWARE can now touch to our significant installed customer base today. And two, a lot of the software that we've integrated actually comes from the open source market itself where there are literally tens of thousands of enterprise customers already using the base technology that we've integrated. So we believe this gives us a phenomenal base level customer base to push this brand new cognitive infrastructure into.

Great. Thank you.

Thanks.

Your next question comes from line of Chad Bennett from Greg Hallum. Your line is open.

Great. Thanks for taking my questions. Nice job again on a good quarter. So, just on the Q3 guide, Pete, so -- at the midpoint you're up about 500 grants sequentially. I guess, can you give us a sense within the revenue segment does the majority of that sequential growth come from aiWARE SaaS or any puts and takes in the other segments?

Yes. I'd say that the majority of it is in the aiWARE SaaS. The advertising business will be up. I think that the content licensing business is looking to be slightly down to flat. So, from an overall mix perspective the lion share of it that we're expecting is in SaaS with those other two being slightly up or slightly down to flat.

Okay. Thank you. And then maybe a little more of a kind of longer term question on growth. So, in the December quarter we annualize fully on the acquisitions you guys made last year. How should we think about the organic growth of the overall business? And then, if you're willing to share the aiWARE SaaS business growth organically?

Well, we call that the organic growth in Q2. I think, Chad, what you're getting at is once we've anniversary the acquisitions, what type of a run rate are we going to get from the combined business, right?

Yep, correct.

So, I think that the run rate on -- as a business stands today, so not taking into consideration some of the changes in the enhancements we're making like Ryan talked about with Influencer Bridge. But if you look at advertising, the run rate that we've got today between the historical Veritone One and Performance Bridge business is doing very well. So, a 30% growth in organic growth in the second quarter and a 32% growth on a year to-date basis, that business is teed up on a combined basis to continue a very healthy run rate. I would never tell you that we're going to bank on 30%. That's just a huge number. But the market is very right and we're very well positioned in the podcast market. On the SaaS side, it's difficult to predict that. We're very proud of the results we've got in our media and entertainment vertical. That's why we highlighted those in the remarks. We've been really penetrated there or had good sales efforts there for over three years now and have products that we're selling and continue to land and expand there. But like Ryan was just sharing with you that the feedback on Identify and Redact in the government market is very positive. But the sales cycles are also very long. So I think it's harder to predict that overall SaaS growth rate and that's why we're really kind of limiting ourselves at this point to kind of a quarter out just because we don't want to get ahead of ourselves.

Okay. Thanks. Nice job on the quarter once again.

Thank you.

Your next question comes from line of Darren Aftahi from ROTH Capital Partners. Your line is open.

Hey, guys. Good afternoon. Thanks for taking the questions and the nice quarter. Just clarification on this 32 engaged customer trials. The two they converted into new contracts. Are those outright paying contracts? So they're just renewing kind of their trial more but unclear about the language?

Yes. Those are paid contracts, Darren.

Okay. Fair enough. Then my question on that is how long were those two clients on trial? And then as you look at the pipeline of those other 30, where they kind of in a life cycle curve of trials?

There were definitely several months. So, for the bulk of these 30 recent contracted trials. If they are successful and they do get through Appropriation Committees, we do expect it to take several months for them to kick in on an annualized contract basis going forward.

The two contracts that did convert and they were in trial contracts with us. I believe one was about 90 days. The other one was a bit longer. It was one of the groups that we actually pioneered and piloted the technology from scratch with which so that was closed for about six months, yes.

And were those the two international ones that you spoke of earlier. I think Spain and Italy?

No. Those are both domestic, domestic law enforcement.

Got it. That's helpful. I guess second, maybe for Ryan, Influencer Bridge you now said this morning. What's kind of go-to-market strategy there?

For Influencer, it's kind of a running start here. This is our formal announcement. We've already over the last several quarters actually deployed in and sort of managed affiliate based campaigns through Influencer Bridge across over. I think at 2200 different podcast. So, this has been something that's been in the works with for a while. The go-to-market strategy, number one is we are taking advantage of Veritone One's position as the market leader in podcast advertising. So we have a very strong brand in that community. But the area that we're missing is our investment from through our agency was only focused on the top 3300 podcasters whereas obviously the huge opportunity of growth is the mid and long tail. So the opportunity for us to launch and grow Influencer Bridge, we are absolutely taking advantage of our well-known brand equity in the space, but we are using up a multitude of both PR traditional marketing efforts and direct sales efforts to go out and acquire and sign and attract new podcasters to Influencer Bridge.

Helpful. Thank you. And this maybe one for Pete. If my math is right year your revenue is up a little bit quarter-on-quarter. It looks like the mix was pretty similar. But your non-GAAP gross margin was down I think 400 basis points. I guess, one, anything kind of nuance there? And then two, as we think about gross margins kind of going forward how should we think about kind of a blended rate?

Yes. So, that's good call, Darren. One of things we did in the quarter was we enhance the capabilities of our cloud platform in order to be able to provide real time processing. And that had the impact of increasing our cost. And then we also expanded our footprint in Europe to support the revenue growth over there as well. So, those two were the main factors that drove that reduction in the gross margin rate on a non-GAAP basis. That being said, we think that there is some opportunities we've got to kind of refine some of the activities we undertook in the second quarter to be able to maintain the capabilities that we want, but to do it in a more cost effective way. And we've already implemented some of those and we've got more that are in process of being evaluated and hopefully executed on. So that should help to drive down some of those costs as we move into Q3 and the second half of the year. But from an overall perspective we are as the business shifts, the revenue shifts more towards the content licensing and SaaS, we do see the year-over-year impact in gross margins at this point.

Great. Thank you.

Yep.

[Operator Instructions] Your next question comes from line of Tom Diffely from D.A. Davidson. Your line is open.

Hi, guys. This is Franco in for Tom. Thank you for letting us ask. A few questions. First of all, I want to congratulate you guys and solidification. And then I did want to ask. There was very significant uptick on AI dollars per hour in the quarter. What is driving incremental spend per customer?

Can you restate? Is that in increased aiWARE utilization on a per customer basis?

On a per hour and video process hour basis.

Yes. So if you look at the hours of cognitive content process it's basically almost flat at 4 million from Q1 to Q2.

Okay. Yes. I think as people utilize our services they're acquiring enhanced seat licenses and licensing a broader array of applications. So even against the same number of hours that we have processed through cognition they're utilizing the platform more in a more diversified way which we do charge for, particularly through additional licenses and additional seats. So again this goes to kind of our land and expand strategy where we sign ESPN, they continue to use the platform, add more seat licenses, and then so in effect it's increasing our revenue per hour. We don't really peg our revenue as against hours of cognitive media, hours of cognition processed. But again, it is a favorable trend since it's more or less with the fixed cost and we're generating more revenue against that expense.

Okay. So we would expect that to go up over time?

It depends on the product mix. If you look at for example in the law enforcement sector Identify and Redact have very different sort of revenue per minute of content ingested and a very different cost. So I think as we continue to develop and innovate new products and services inside these three verticals each one has its own revenue characteristic. And again happy to dig into more detail with you guys and explain some of that stuff because I think it’s how we're running our business. Now our product managers think about their go-to-market and pricing.

But as of today Redact and Identify do generate higher revenue per hour of cognition processed than to our historical meeting entertainment broadcast customers.

Correct.

Okay. That's helpful. Thank you. And then when you look at the different laws that are being passed regarding facial recognition like the one in San Francisco a few quarters ago. How does that really affect your business and how are you addressing this topic?

At a macro level we're all in California. So we're very well aware of what happened in California where they were banning facial AI technology kind of [Indiscernible] across the state in other states. In other state you have the exact opposite, forces being driven which is Bay and in California as well. So you have Senate Bill 1421, Assembly Bill 748 California and a handful of others in New York as well as Florida like I mentioned, that are basically putting pressure primarily driven from groups like the ACLU to force law enforcement agencies to have a far more transparent service to the public. And what they're doing those laws are forcing fine upon the agencies that they can't comply with supplying redacted content on public information requests, as well as in the amount of time it takes for information to go from the investigators to the prosecutors, the D.A. and the defense. They're forcing agencies to be far more efficient in that process. And unfortunately it's not something that they're doing intentionally. It's literally a technical problem of how they're redacting content today as a human being sitting in front of a screen and going frame by frame using a video editing software to blur out content. With applications like Redact it now becomes something where the AI is doing 95% of the heavy lifting. And we can reduce both time and cost in an extremely profitable way for the company. So, we think that the legislation is moving far more I think in favor of Veritone in terms of increasing the demand and the pressures on agencies to adopt the technology than what we saw happening in the circus [ph] in California Sacramento.

Okay. That's great. Thank you. And then lastly on the adjusted EBITDAS loss rate, for the next quarter you mentioned it will be similar to the second quarter. And then you're getting up sequentially a little bit for revenues. What is driving the higher expenses?

Well we've got some primarily headcount increases that we're looking to continue to expand capabilities in software development, engineering in other kind of related teams. So some of that additional gross profit that we're expecting to generate frankly we're expecting to invest back into the business and that's why we've guided towards that flat rate.

Okay. Thank you, guys.

Thank you.

There are no further questions. I will now turn the call back to Chad Gilbert for closing remarks.

Thank you operator and thank you all for joining us on today's call. We're very pleased with our start to 2019. The takeaway from our standpoint is that an operational inflection point of product, channel and revenue diversification we have discussed since our IPO are happening. This early momentum is encouraging us to move forward aggressively to pursue these huge opportunities we see for our technology. In the coming months, we expect to see further revenue growth and diversification across products, geography, verticals and channel. And we look forward to reporting to you on our progress. Good Bye.

Ladies and gentlemen, thank you for your participation. This concludes today's conference call. And you may now disconnect.