Earnings Call Transcript - NOTE Q1 2023

Operator, Operator

Thank you for joining us. My name is Briana, and I will be your operator for today’s conference. I would like to welcome everyone to the FiscalNote Q1 2023 Earnings Call. I will now hand the call over to Sara Buda, Vice President of Investor Relations. You may begin your conference.

Sara Buda, Vice President of Investor Relations

Hi, everyone. Welcome to the FiscalNote Q1 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 are rather 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 our 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 directly 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, CEO

Thank you, Sara. On today's call, we'll review our first quarter. I'll discuss our stable compounding revenue, strong gross margin, macro trends influencing our business, and more. I will also highlight our long-term opportunities for significant upside as we innovate around new products and customer segments. Then, I'll pass it to our CFO, Jon Slabaugh, to discuss our financial details as we aim for approximately breakeven adjusted EBITDA in Q3 and positive adjusted EBITDA profitability in Q4, staying on track as a profitable long-term growth company. To start, let me provide a brief overview of FiscalNote and what we do for those who are new to us. Our mission is to help customers navigate the complex and ever-changing world by delivering a proprietary AI-enabled SaaS platform that aggregates, organizes, and analyzes regulatory, political, and macroeconomic information and its impact on their organizations. Policy, regulation, and law changes affect decision-making for organizations worldwide, from regulatory requirements to mandatory reporting obligations. Using advanced machine learning and AI, we aggregate and analyze large amounts of legislative, regulatory, and macroeconomic data globally, providing actionable insights to our customers through a subscription model. We are building a resilient company for influential decision-makers, serving hundreds of government agencies and public sector clients from the Department of Defense to Fortune 100 companies, all of whom need to stay informed about the dynamic regulatory and geopolitical landscape. These clients rely on FiscalNote daily to understand the effects of policies, legislation, and macroeconomic changes on their organizations and, importantly, to act in ways that achieve their business goals while minimizing political and economic risk. This is the foundation of our sustainable and long-term growth. We are increasingly recognized as a critical source for political and regulatory information at all levels. Just like other leading information companies, FiscalNote continuously delivers crucial information directly affecting our customers' operations. We've invested significantly over nearly ten years to create an indispensable blend of data, intelligence, and AI technologies that help our clients manage the rapidly evolving environment of unstructured regulatory and political information. Now, let's summarize our financial results that support our continuing profitable growth in 2023 and beyond. We recorded another quarter of predictable revenue growth. Q1 revenue was $31.5 million, reflecting a 21% increase year-over-year, aligning with our previous guidance. Our diverse customer base consists of thousands of organizations that renew their contracts annually, and we continue to attract new clients, from state governments to Fortune 100 companies. Our customers depend on FiscalNote to assess the implications of policies and other changes on their institutions and take necessary actions to meet their goals. We also maintained high gross profit margins, achieving 80% adjusted gross margins in Q1. These margins are characteristic of FiscalNote and derive from our SaaS business model and data-rich products, which set the stage for strong future cash flow. Our adjusted EBITDA loss was about $7 million, which aligns with our expectations. We plan to reduce our adjusted EBITDA loss, starting in Q2, aiming for breakeven in Q3 and profitability in Q4. Jon will provide further details. Our cash position at the end of the quarter stood at $47.5 million, with an additional $94 million in available debt capacity. We have enough capital to support our growth without needing extra capital raises to meet our adjusted EBITDA profitability goals and future free cash flow. In terms of KPIs, we reported a run rate revenue of $134 million, including our recent acquisition of Dragonfly. Excluding Dragonfly, our organic run rate revenue was $126 million. Our annual recurring revenue reached $119 million, a 10% year-over-year pro forma growth and 9% organic growth when excluding Dragonfly. We anticipate our ARR will continue to grow throughout the year, as is typical. We are also seeing positive effects from operational and organizational changes, with expectations for these improvements to show in our accelerating growth in the second half. For this quarter, net revenue retention was 96%, and adjusted NRR was about 98% in the first quarter, adjusting for the expected expiration of a legacy licensing relationship. Over the past year, our net revenue retention was at 97%. Our strong net revenue retention reflects our successful cross-sell and upsell strategy, as well as the essential solutions we provide. We reaffirmed our 2023 guidance, projecting GAAP revenue between $136 million and $141 million, representing growth of 20% to 24% year-over-year. We also expect our run rate revenue to fall between $148 million and $155 million this year, and our roadmap to profitability remains intact. Our continued performance is driven by predictable recurring revenue growth, strong retention rates, and a high gross margin profile. All these factors lead us to anticipate positive adjusted EBITDA profitability in Q4, which we believe will convert into future free cash flow. Now, let me highlight some macro trends that support our growth. Our market is shaped by political developments and a regulatory landscape that is becoming increasingly complex at a rapid pace. In the 2022 legislative session alone, U.S. state houses introduced over 84,000 bills, passing around 24,000. Each legislative body is accompanied by numerous regulatory agencies that consistently implement a variety of regulations affecting industries from healthcare to consumer privacy to employment law. The variety of legislation can pose compliance challenges for organizations operating across different states and for government entities tracking these regulations. Globally, regulation and policymaking are also at unprecedented levels, with EU legislative acts increasing by 13% since 2020. New regulations often expand quickly from local to global contexts, particularly in areas like semiconductors, crypto assets, and climate change legislation, resulting in significant regulatory complexity. Geopolitical and macroeconomic risks are closely tied to regulatory changes, with conflict and unrest driving politicians worldwide to respond with new regulations, creating uncertainty that can significantly impact organizations. A recent PwC survey found that more than half of global CEOs believe changes in regulation will most influence profitability in the next decade. Last year, corporations faced substantial penalties from SEC actions and losses related to sanctions on Russia, with supply chain disruptions leading to over $4 trillion in lost revenues within a year. This backdrop underscores the need for FiscalNote; without our services, organizations struggle with cumbersome, costly processes for tracking regulations and geopolitical issues. From our founding, we recognized a significant market opportunity to leverage AI for the structured analysis and digitization of regulatory and geopolitical information, embedding software workflows that make data actionable for our clients. Today, we possess unmatched data breadth and AI depth in our market. Consequently, FiscalNote is in a superior position to innovate continuously and effectively turn insights into actionable strategies for risk management. Our approach has been validated by high-profile customers who recognize us as a vital source of truth amid prevalent misinformation. Allow me to discuss our growth model and the potential for long-term asymmetric upside. Our team focuses on directing capital towards areas of the business that promise the highest returns. We are committed to both gradual and revolutionary growth. In terms of gradual growth, we consistently deliver strong organic growth bolstered by strategic acquisitions that facilitate cross-selling and upselling among our customer base. Our model involves retaining existing customers, upselling them with new offerings, and adding new clients annually. The resilience of our recurring revenue model showcases the strength of our products and deep customer relationships, providing predictability in revenue. Coupled with our 80% adjusted gross margin and disciplined operational cost management, this drives significant operational leverage, paving the way for adjusted EBITDA profitability in Q4 and future free cash flow. We anticipate achieving free cash flow margins similar to sector leaders in information services, typically exceeding 20%. Thus, our steady growth continues to expand our recurring revenue base while adhering to high gross margins and positive adjusted EBITDA. Additionally, we see significant growth potential in the heavily regulated European market, which currently contributes only 13% of our revenue. We believe we can develop a European business comparable in scale to our North American operations with our existing products. Opportunities also abound in the state and local government markets, with approximately 90,000 local governments in the U.S., each making pivotal decisions affecting community issues. Recently, we announced a major deal with Georgia's State Senate and other local entities to enhance these relationships. Such opportunities exist across every state. Now, let’s explore revolutionary growth opportunities we have been nurturing that could push us beyond our current growth trajectory. We aim to leverage partnerships for broader customer engagement and improved product development. FiscalNote is being recognized as a leader in AI and data for managing risk. Earlier this year, we partnered with Peraton, integrating our solutions with their national security technologies to deliver comprehensive solutions to clients in defense and security sectors. There's great potential for transformative multi-year government contracts through these efforts. We are also forging other partnerships; for example, OpenAI selected us as one of 14 inaugural trusted partners, incorporating our data into their ChatGPT platform. Additionally, Databricks recently chose FiscalNote to provide regulatory data for their data marketplace, which serves over 9,000 clients. These partnerships show the importance of our sector and our leadership position. Other potential catalysts for growth include new product development, fueled by our decade-long investment in AI. We have promising opportunities to innovate in areas that significantly impact our customers. The advancements in AI technologies will help us create new products quickly and efficiently, enabling us to address issues in clients' businesses and supply chains stemming from legal and regulatory developments. This is just one area of our ongoing product development strategy that will deepen customer relationships and open new revenue avenues for future growth. We continue to explore selective M&A opportunities to support our incremental growth strategy. Our January acquisition of Dragonfly is already showing promise as we assess security and operational risks in the markets. We're maintaining a selective approach to acquisitions, remaining open to clear opportunities for significant growth. In summary, we are constantly innovating around new customer segments, product lines, and offerings, striving to enhance the value we provide to our clients. We are committed to sustainable growth and profitability, high retention rates, and maintaining our strong gross margins and cash flow generation. With these solid fundamentals, we focus on strategies that will enable us to achieve our growth and profitability goals while positioning us for significant upside in the future. We will keep prioritizing activities and innovations that yield the strongest returns and remain dedicated to delivering exceptional value to our customers. In conclusion, we are capitalizing on the opportunities ahead, enhancing our growth model driven by continual macro trends. Our foundation of recurring revenue, high gross profit margins, and effective operational strategies will lead us to adjusted EBITDA profitability in Q4 and significant free cash flow shortly thereafter. We believe our unique blend of data, AI, and human intelligence gives us a sustainable competitive edge. Although our fundamentals might not yet be reflected in our stock price, we are confident that eventually, our valuation will align with our business fundamentals. Our focus as leaders is on building a resilient, profitable, and growing company that delivers unique value to key decision-makers and scalability towards achieving recurring revenues of $200 million, $300 million, $500 million, and beyond. Now, let me hand it over to Jon for further insights into our financials and future outlook.

Jon Slabaugh, CFO

Thank you, Tim, and good morning. I'm going to spend some time providing further details on the quarter. I'll also discuss what to expect in terms of financial performance for this year and walk through our path to positive adjusted EBITDA and, over time, positive free cash flow. Let me first start with revenue. First quarter revenue was $31.5 million, marking growth of 21% year-over-year in total and 10% growth on an organic basis. We are executing on our strategy to deliver compounding growth, driven by strong organic growth and complemented by accretive, strategic tuck-in acquisitions. This has been our track record, and we expect to continue this revenue performance moving forward. First quarter subscription revenue, which makes up 90% of our total revenue, was $28.5 million. This is an increase of 25% from a year ago and 14% on an organic basis, once again showing our strong recurring revenue model. Our advisory and other revenue was $3.1 million, a slight $200,000 decline year-over-year. We exited Q1 with run rate revenue of $134 million in total, marking 10% growth year-over-year. Run rate revenue is defined as ARR plus non-subscription revenue earned during the last 12 months. It is a key management metric and serves as a baseline for the subsequent quarters and beyond. On an organic basis, run rate revenue was $126 million, reflecting 9% growth on a pro forma basis as defined in our press release. NRR, or net revenue retention for the quarter was approximately 96%. On a trailing 12-month basis, NRR was 97%. NRR rates can fluctuate slightly from quarter-to-quarter. This quarter, our NRR was affected by the anticipated conclusion of a large licensing contract with FiscalNote inherited through an acquired business. Excluding this contract roll-off, NRR would have been 98% for the quarter. We do find that NRR rates are highest among our large enterprise and public sector accounts and lower among midsized companies and trade associations. Enterprise and strategic accounts now represent our largest, fastest-growing, highest retention customer group and will continue to drive increasing total NRR. We are continuing to scale our strategic and enterprise accounts teams and reallocating our sales resources accordingly, and grew our total annual recurring revenue or ARR to $119 million as of March 31, an increase of 19% compared to the same period in 2022. Organic revenue, as we define, was $113 million as of quarter end. This represents a 9% growth rate when compared to our ARR in Q1 of last year on a pro forma basis. This is consistent with our expectations for the year as we anticipate most ARR growth will take place in the second half of the year, consistent with prior years. Looking at gross profit, we continue to enjoy strong margins. Our Q1 gross profit was $22.6 million, representing a 72% margin. Our first quarter non-GAAP gross profit was $25.2 million, representing an 80% gross margin after adjusting for amortization. Sales and marketing costs were $12.3 million for the quarter, an increase of $2.8 million year-over-year. R&D expenses were $5.1 million, a reduction of about $1 million from a year ago, due in part to increased efficiencies and the completion of certain rebuild projects. Editorial content costs were approximately $4.3 million, a modest increase year-over-year. G&A expense for the quarter was $18 million. This includes approximately $5.6 million related to the accounting treatment of noncash stock-based compensation expenses. Excluding these noncash charges, G&A was approximately $12.7 million, an increase of about $2 million year-over-year, largely due to public company costs. The operating loss for Q1 was $27 million in total. This includes $6.5 million of stock-based compensation, a $5.8 million goodwill impairment charge related to the performance of our Equilibrium software product versus its forecast and $1.4 million of transaction costs, largely related to the accounting treatment of the acquisition of Dragonfly. Our total interest expense was $6.7 million. Of this, cash interest expense was $4.7 million, which is a good proxy for our quarterly cash interest expense going forward, depending on interest rates. The GAAP net loss for Q1 was $19 million, which is reconciled to our adjusted EBITDA loss of $7 million in our press release. Our balance sheet remains solid at $47.5 million of cash and cash equivalents as of March 31. We have sufficient capital to support our growth initiatives and fund our path to positive adjusted EBITDA in Q4 of this year. As we stated in our last call, we are taking steps to reduce our operating expenses, which should result in $6 million to $7 million of in-year cost savings. These cost reduction steps include actions we've already taken and will continue to take this year, including adjusting our allocation model, aligning our sales teams to focus on the highest potential clients and segments, using technology to improve our internal processes and workflows, consolidating product development groups and R&D teams and vendor consolidation and elimination. These actions will start to benefit our adjusted EBITDA in Q2 and will continue in the second half of the year. Lower costs, combined with higher second half revenue, will drive us to be approximately breakeven on an adjusted EBITDA basis in Q3 and generate positive adjusted EBITDA in Q4. This brings me to our guidance. For Q2, we expect revenue of $32 million to $34 million. Our adjusted EBITDA is expected to be a loss of $4.5 million to $3.5 million depending on revenue and the timing to realize the benefit of certain cost reductions. For the full year, we are reiterating all of our guidance previously provided, including a run rate revenue of $148 million to $155 million, inclusive of the recent Dragonfly acquisition and excluding any future acquisitions we may make. GAAP revenue of $136 million to $141 million, marking growth of 20% to 24% year-over-year, including the acquisition of Dragonfly. We expect adjusted gross margins to continue at approximately 80%, and we are reiterating our guidance for adjusted EBITDA loss between $8 million and $6 million for the full year. We are also providing new visibility to our plan to be adjusted EBITDA breakeven in Q3. Given our guidance for the year, this clearly means solid adjusted EBITDA profitability in Q4 of approximately $3 million to $5 million, resulting from the cost action we discussed previously and our seasonally stronger second half revenue. As we continue to deliver strong 80% adjusted gross margins, leverage the operating platform we have in place and continue to manage our costs, we expect to drive strong conversion of incremental revenue to adjusted EBITDA. As we reached the inflection point of adjusted EBITDA profitability in the short term, we expect this operating leverage will enable us to deliver strong free cash flow margins in the long term. We have approximately $94 million of debt capacity subject to certain conditions. Our lenders remain flexible and are supportive of the company's focused strategic acquisition program. As Tim discussed, we will continue to pursue selective M&A opportunities that are accretive to our profitability and that drive cross-sell opportunities within our stable and growing base of thousands of customers. And of course, given our stock price, we are focused on transaction structures heavily weighted towards earnout and structured stock consideration with terms that give long-term upside with minimal dilution. In closing, we are delivering on top line growth. As we execute on our strategy to build a compounding growth, profitable business that drives mission-critical solutions to the world's most important decision makers, there are secular trends propelling our business and creating sustainable demand from increasing regulation to geopolitical threats to macroeconomic uncertainty. Only FiscalNote has the breadth of AI-enhanced data and human intelligence to help customers navigate this increasing operational complexity. We continue to leverage our investments in AI to drive new growth opportunities and drive efficiencies throughout the organization with highly predictable recurring revenue, strong gross margins and ongoing cost management. Our path to profitability is clear, and we have the operational structure and capital we need to scale this business and drive long-term value.

Michael Latimore, Analyst

Congrats on the results and strong outlook there. Jon, I just want to make sure I got the number down correctly. Did you say that you're expecting positive EBITDA of $3 million to $5 million in the fourth quarter?

Jon Slabaugh, CFO

That's right, Mike. We mentioned that we're approaching breakeven in the third quarter and the expectation of $3 million to $5 million in the fourth quarter.

Michael Latimore, Analyst

Okay. Great. And then just on the strategic account strategy. Can you elaborate a little bit more on that? What are the resources you're devoting to that? And what's the pipeline build look like? And maybe what percent of the pipeline is in this category at this point?

Joshua Resnik, President

So we don't disclose down to those level of metrics down to that specific line, but I'll tell you that generally speaking, we see a tremendous opportunity there as we can bring our full portfolio of products to larger enterprises and really leverage what we've built across the portfolio of the entire company. And we've seen our ability to do it kind of case-by-case within our enterprise approach generally. And we believe that by applying resources to focus on this, we can drive growth in that area going forward.

Michael Latimore, Analyst

Great. And then just in terms of the environment and overall companies, any change in sales cycles or deal sizes this year relative to the end of last year?

Joshua Resnik, President

Yes, Mike, this is Josh. So we're still continuing to see essentially the same issues in macro that we've been talking about for the past couple of quarters, where we see some elongation of buying cycles, some budget pressure from clients, and we're continuing to work our way through that. And that's built into our forecast for the year.

Michael Latimore, Analyst

Right. But no change in those dynamics?

Joshua Resnik, President

No.

Michael Latimore, Analyst

No change relative to last year?

Joshua Resnik, President

No, no significant change.

Michael Latimore, Analyst

Got it. You mentioned some asymmetric upside potential, particularly in the federal space. Are those opportunities more long-term at this stage, or are you currently tracking a few task orders that could have a meaningful impact?

Tim Hwang, CEO

Mike, this is Tim. We haven’t actually predicted any of the upside we've mentioned. Most of the foundational elements we're currently establishing are based on the anticipation of future upside, but they haven't altered our forecast. However, we do need to dedicate time to them. We have resources being invested because we believe there is significant potential in the areas we've identified.

Matthew VanVliet, Analyst

I guess digging in a little more on the enterprise and strategic account side of things. I wonder if you could just walk us through kind of what percentage or how many of the modules that you're selling, do you feel like are appropriate for a number of those customers sort of the first part of the question. The second part, what is sort of the typical average of maybe the larger cohort of customers that have taken on the platform, maybe expanded a couple of times as sort of a near-term opportunity with the first part of the question being sort of the upper bound as you look at that opportunity?

Joshua Resnik, President

Yes, Matt, this is Josh. I'll try to answer your question and please let me know if I captured it correctly. We don't provide specific breakdowns among our segments. However, regarding the share of our products that may be relevant, large multinationals face numerous challenges, including legal and regulatory issues, political and policy matters, as well as security and cybersecurity concerns. We offer solutions across our different business lines that address these needs. The applicability of our products really depends on the specific challenges faced by each business. Overall, we believe we can offer product bundles that will meet the requirements of larger enterprises.

Matthew VanVliet, Analyst

Can you provide any insight into the near-term opportunity? Specifically, how many customers are utilizing a portion of the platform? Many seem willing and perhaps capable of expanding their usage. Do you have customers already using several modules that give you the confidence to allocate more resources and prioritize this area? I'm trying to understand the actual near-term opportunity and why resources might be redirected to this aspect.

Joshua Resnik, President

Sure. I mean, what I can tell you is we do see a significant portion of customers that are using multiple products already; the number of products per customer are increasing. So in other words, within our existing sales structure or previous sales structure, we were able to create those bundles and do the right upsell and cross-sell to meet the needs we are seeing from those larger multinationals. And so we believe that by taking these resources and focusing more on creating those broader bundles and being more intentional about what we actually bring to market that we can drive the growth in that way. So again, we don't disclose specifics to that segment, but we're seeing, like you said, we're seeing users who buy onto these bundled offerings. We're seeing the number of products per customer increase, and so we know the trends are there. And with that focus, we think we can drive that further.

Jon Slabaugh, CFO

Thanks, Matt. So headcount accounts for a vast majority of our total operating expenses. So from an efficiency standpoint, that's going to be the primary source of efficiency as we drive forward and look at leveraging our staff in each functional line of the business. We've already identified and taken actions, and we'll continue to kind of think about ways to be more efficient down the road. We've also been very aggressive on the vendor side. We specifically looked at areas where we're spending the most and focused on those contracts. But we've also eliminated a lot of contracts. We just made the decision we no longer need it. As it relates to the revenue growth and matching revenue growth with the cost reductions, we're on a biweekly basis looking at the pipelines, making sure that we're pacing towards what we expect in terms of revenue growth and revenue ramp. And we'll continue to monitor that but stay committed to all aspects of our guidance, both the revenue and the EBITDA that have a lot of levers to pull along the way if we see the adjustments are necessary or opportunities to accelerate, present themselves in one segment or another.

Rudy Kessinger, Analyst

Just one question for me. Understanding your years are back half loaded from a new business standpoint. The guide clearly implies greater sequential growth Q2 to Q3 and Q3 to Q4 on both a dollar basis and a percent basis than last year. And just what gives you the confidence to hit those numbers? Most companies at this time are guiding to smaller sequentials and smaller dollar growth back half of this year versus last year.

Jon Slabaugh, CFO

Thank you, Rudy. To begin with, we have assessed the productivity of our sales team from last year and the slight changes we made entering this year. Our performance in the first quarter meets our expectations and aligns with previous years. There was an exceptional event that affected our net retention rate in the first quarter, but aside from that, the performance looks consistent with prior years. We are on track for the ramp we have experienced before, and we have a wider range of products compared to past years. Additionally, we have more innovations and new features to cross-sell. We will focus on a few new initiatives, and as I mentioned, we monitor the pipeline biweekly with all teams to ensure they stay on track for the year's expectations and adjust resources as we identify growth opportunities. We aim to accelerate wherever possible.

Tim Hwang, CEO

Great. Thank you, everybody. I appreciate everybody jumping on the call here. We've got another great quarter and really looking forward to at least delivering on the results that we've guided towards here and really continue to execute on the business. So I appreciate the time. Thank you, everybody.

Operator, Operator

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