Research Solutions, Inc. (RSSS) Q2 2023 Earnings Call Transcript

Thank you for standing by. This is the conference operator. Welcome to the Research Solutions' Second Quarter 2023 Earnings Conference Call. The conference is being recorded. I would now like to turn the conference over to John Beisler, Investor Relations. Please, John, go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to the Research Solutions' second quarter fiscal 2023 earnings call. On the call today are Roy Olivier, President and Chief Executive Officer; and Bill Nurthen, Chief Financial Officer. After the market closed this afternoon, the company issued a press release announcing its results for the second quarter of fiscal 2023. The release is available on the company's website at researchsolutions.com. Before Roy and Bill begin their prepared remarks, I would like to remind you that some of the statements made today will be forward-looking and made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those expressed or implied due to a variety of factors. We refer you to Research Solutions' recent filings with the SEC for a more detailed discussion of the risks that could impact the company's future operating results and financial condition. Also on today’s call, management will reference certain non-GAAP financial measures which we believe provide useful information for investors. A reconciliation of those measures to GAAP measures is included in the earnings press release issued this afternoon. Finally, I would like to remind everyone this call is recorded and made available for replay via a link on the company’s website. With that, I would like to now turn the call over to Roy.

Thank you, John, and thanks to everyone joining us today. As I review and think about our Q2 results, I'm generally happy with the 30-plus percent year-over-year growth in our Platform revenue and the continued growth in our Transaction revenue and the cash flow and EBITDA performance versus the same period last year. We are experiencing some headwinds in terms of net ARR growth, in what we call new bookings which is defined as a new platform and a new transaction customer. While our net renewal rates continue to be over 110%, we have seen some increase in churn in smaller customers related to the general economic conditions and uncertainty. The overall net ARR growth is behind where I'd like it to be but it is a significant improvement over Q1 in terms of our new bookings. Transaction revenue growth was strong for the second consecutive quarter and does not include any revenue from the FIZ acquisition which will start to show up in Q3’s results. We’re very proud of the $1 million in EBITDA improvement and the $1.3 million in cash flow improvement in the first half of ‘23 versus the same period in 2022. I will provide some more detailed comments about the state of the business after Bill walks you through the results in more detail. Bill?

Thank you, Roy, and good afternoon, everyone. Total revenue for the second quarter of fiscal 2023 was $8.7 million, a 10.7% increase compared to the second quarter of fiscal 2022. As noted in our press release, this represents our second consecutive quarter of double-digit revenue growth. Platform revenue increased 31% to $2.1 million, primarily driven by a net increase of Platform deployments over the last 12 months, including 34 net new deployments in the second quarter and upselling of current Platform customers. Annual recurring revenue or ARR, at the end of the quarter stood at $8.8 million, up 5% sequentially and 28% year-over-year, reflecting our continued sales and upselling efforts and low churn of existing Platform customers. We also had three sales in the quarter related to our newly launched Curedatis product. Please see today's press release for our definition and use of annual recurring revenue and other non-GAAP items. As I turn to Transaction revenue, I note that the numbers to follow do not include any impact from the FIZ transaction that was completed in our fiscal Q1. This customer acquisition will begin impacting transaction revenue in our fiscal Q3 and I will talk more about that later. Transaction revenue for the second quarter was $6.6 million compared to $6.3 million from the prior year quarter. This represents 5.4% growth year-over-year and is the second consecutive quarter of growth for the Transactions business. In the past, we had noted wanting to see two consecutive quarters of growth prior to stating that we could be well positioned for growth in this segment going forward. We are now seeing signs that trend can continue as we are experiencing growth in both academic and paid Transaction counts. Transaction customer count for the quarter was 1,223 versus 1,179 in the second quarter of fiscal 2022. The increase was driven by an increase in corporate customers. Gross margin for the first quarter was 39%, a 300 basis point improvement over the second quarter of fiscal 2022. The increase stems from the revenue mix shift towards our higher-margin Platforms business which now constitutes 24% of the revenue and 55% of the business' gross profit. With some limited exceptions which I will note later in the call, we see no reason why the trend in improvement in corporate gross margin percentage cannot continue as the mix of Platform revenue continues to grow. The Platform business recorded gross margin of 88%, a 240 basis point increase from the prior year quarter due to proportionately lower labor and software costs. I expect that for the foreseeable future, we can continue to maintain Platform gross margin at 85% or above. Gross margin in our Transaction business was 23.4%, similar to the prior year quarter. Our expectation is that Transaction gross margin will continue to stay within a range of 23% to 24%. Total operating expenses in the quarter were $3.7 million compared to $3.3 million in the prior year quarter, due primarily to higher noncash stock-based compensation costs and higher discretionary sales and marketing spend. I want to take a moment here to explain the stock compensation expense as it is notably higher for this quarter. As many on the call are aware, starting with this fiscal year, we ended the prior Restricted Stock Program for executives and installed a new Long-Term Equity Bonus program. The fundamental change when we did this was to eliminate a program where executives received restricted stock as part of their quarterly bonus and replace it with a program designed to better align executive compensation with stockholder interests. This involved the granting of 1.8 million restricted shares across the executive team which vest in 20% increments when the stock attains and maintains price levels of $3, $3.75, $4.50, $5.25, and $6 per share within the next five years. If the stock prices are not attained, the shares do not vest. Conversely, if the stock fully vests at $6, this would imply a market cap increase of over $100 million with the payout to executives being under 10% of that amount. Restricted stock grants such as these require a third-party valuation to determine how they are expensed. The high volatility of our stock drove the value of the grant upwards and it has been determined that the value of the grant is roughly $2.5 million to be spread over approximately 2.6 years. Thus, this is the amount that we will expense during that time. The net of all this is that from a stock compensation expense standpoint, we are presently dealing with the runoff expense from the old plan while effectively accelerating or pulling forward some of the expense associated with the new plan, as the expense for the new plan is weighted more earlier than the 2.6-year period and will eventually expense to 0 and not continue indefinitely. Additionally, in Q2, we also had our annual Board Stock Option Grant which served to increase the compensation expense as well. For Q3 and Q4, I expect stock compensation expense to be approximately $500,000 for each quarter, $300,000 coming from the new plan and $200,000 coming from the runoff of the old plan. In fiscal year 2024, we should start to see the expense come down from these levels. I apologize for the long-winded explanation there but we thought it important to discuss it given the expense level in Q2 and also to reiterate the point that we believe the new plan over the long term will prove more beneficial for our shareholders. Turning back to profitability, net loss for the quarter was $256,000 or $0.01 per share compared to a net loss of $482,000 or $0.02 per share in the prior year quarter. Removing the effects of the new restricted stock plan, our net income would have been close to breakeven from a GAAP perspective. Adjusted EBITDA was positive $201,000 compared to a loss of $165,000 in the year-ago quarter. We have now generated over $600,000 of adjusted EBITDA in the first six months of the fiscal year compared to a loss of over $300,000 in the first six months of our prior fiscal year. Turning to our balance sheet and cash. The increase in adjusted EBITDA has been backed by an increase in cash flow which I think speaks well to the quality of our earnings as they grow. Cash and cash equivalents as of December 31, 2022, were $11.3 million versus $10.6 million on June 30, 2022. We have now generated over $1 million of cash flow from operations in the first six months of our fiscal year. There were no outstanding borrowings under our $2.5 million revolving line of credit and we have no long-term debt or liabilities. As we look ahead, I wanted to make everyone aware of a few items. First, on January 1, we moved all of our employees in Mexico to a direct hire relationship. We expect this will result in approximately $400,000 of additional annualized cost and may cause a slight dip in gross margin in Q3, before it starts rising again. Second, commencing January 1, we will start realizing revenue from Transactions related to our FIZ customer contract acquisition. It is too early to provide a projection of the impact of these new customers, but we do believe it gives us an opportunity to continue to push transaction growth upward, perhaps hitting double-digit growth rates in that segment. There are some unique expense items that will be hitting us in Q3. As a result, I expect our operating expense level to be at its highest level for the year in Q3 before coming back down again in Q4. Adjusted EBITDA for Q3 will likely be flat to down from Q2 but then showing upside in Q4, resulting in a very strong finish to our fiscal year. I'll now turn the call back to Roy.

Thanks, Bill. In the next few minutes, I'll give you an overall update on how the business is working and how that will translate into long-term value creation. First, I'd like to discuss marketing and sales. As you know, we brought in a new Head of Marketing in 2022, who has built out a new team that is starting to execute around driving marketing qualified leads or MQLs. We have, for the first time, launched several programs around webinars, newsletters, product release notes, and social media. These programs are driving more MQLs and are generating both new sales and upsells. While there's still a lot left to do, I'm very excited about the progress of this team in terms of driving activity in MQLs and sales. Regarding sales, we showed an improvement in the new sales team for Q2 versus Q1, but we are still behind our internal plan. Upsells and existing sales continue to show strong results as reflected in our net renewal rate continuing to be over 110%. We've seen an uptick in churn primarily from businesses shutting down or being acquired. You may recall that our target for net ARR growth is over $500,000 a quarter and we are not at that level, nor do I expect to be at that level in the second half of the year. That said, we are doing a lot of great things in the sales teams in terms of training, better materials, better products, more MQLs and upgrades to our business development teams that drive leads. I believe in the long term, that will help drive more results as the economy continues to improve. We feel that we are well prepared to regain momentum and accelerate sales as the market recovers. From an operational perspective, we made many improvements to customer onboarding, technical support, and transaction operations that are driving improvements across the organization. This is reflected in our NPS score remaining over 60 and the fact that we can deliver the increase in Transactions reflected in the year-over-year growth in that segment with no new headcount. Turning to product releases, our Reference Manager products, specifically References and References Pro, have had strong early adoption. We've upgraded over 125 accounts which has helped us maintain the high net renewal rates I referenced above. The Curedatis launch is going well and we are tracking with our rather conservative plan for '23, and we have over 200 opportunities in the pipeline. We've also continued to see positive traction with our add-in products, specifically our Outlook and Word add-ins as well as our browser extensions. All of this has resulted in a nice uptick in active users. Our active users at the beginning of fiscal '23 ran in the $22,000 a month rate. Most recently, we are seeing almost 40,000 active users on the platform which helps explain some of the Transaction year-over-year growth. The Transaction business in Q2 improved primarily from significant year-over-year growth with the academic and government users. The FIZ implementations and customer onboarding is complete but not reflected in the Q2 numbers. Preliminary numbers indicate that we transferred almost 70% of the FIZ customer base which has resulted in early signs of strong revenue growth in January. In looking at the January numbers, we are seeing similar academic and government year-over-year growth as Q2, plus strong corporate growth based on FIZ and the aforementioned increase in active users. We continue to be very active in M&A opportunities and have walked away from two opportunities that were in the IOI or LOI stage. We maintain a strong focus on improving our overall product value through integrating AI and natural language processing solutions into several points in the research and workflow. Getting the right deal done remains our highest priority. As I mentioned in my earlier remarks, I remain cautious about the outlook for the next couple of quarters in terms of net ARR growth. However, this does not change my view regarding the long-term opportunity for our business. I'm more excited than ever about the activities that we are doing in sales, product, marketing and M&A and remain confident in the value that our products bring and will continue to bring to our customers. I believe we are really well positioned to deliver shareholder value as the general economy and markets improve and we are poised to see growth in both our top and bottom lines. With that, I'd like to turn it back over to the operator for Q&A.

The first question comes from Richard Baldry from ROTH Capital.

I know you guys are newer at the helm of the company. I’m curious if you know from the Board level, the chatting, what has the pattern been historically for macro pressure in churn? I would assume that in the short term, people can make decisions to kind of step back briefly but this seems central to what most of your customers do. So how quickly do they tend to come back afterwards, what sort of pattern should we think about there?

Yes, this is Roy. I think that's a great question. And we did some research on public companies, specifically the publishers and what they went through in the last kind of economic downturn. All of them remained pretty strong. They maintained maybe a few points below their previous growth rates and then they bounce back very quickly because many organizations don't stop doing research and don't stop having a need in a down economy. I think that is reflected in the churn that we are seeing, which is typically from our smaller customers. They are very, very small. When we look at logo count, it’s a little higher than we would like. The dollars are not anywhere close to our average revenue per sale. So we are seeing a little bit of an uptick. We are concerned about it but it is not happening with larger, more established accounts. It’s primarily very small accounts. Anything you want to add, Bill?

Yes. Just to add on to that, I think the larger accounts that have been with us for a long time, they do actually achieve and realize the savings associated with being on the platform. So it's something where they're actually saving money by being on the platform. Therefore, I think we're less concerned about issues there and losing customers there. I think more of the pressure is just getting new customers to adopt the platform in the current environment.

Then can you talk a little bit about the successes you’re starting to see early in the vigilance side? How is that working in the sales motion? Are you going to put dedicated people on that as you start to see the successes and have more referenceability? Can your existing group kind of handle both products at once?

Yes. We think that the model we have now, which is the existing group handling the products with the support of a product specialist, is the right approach. I think as we grow, we may reach a point where we want a dedicated sales team, but right now, certainly, our hunting and upsell teams of over a dozen people are effective in setting appointments and generating interest. And then we have a product specialist that goes in, gives the demo and observes the customer using the product. So I think that's working well and I don't expect that to change between now and the end of the fiscal year.

And then with the FIZ Karlsruhe type of acquisitions and partnerships, how do we think about what should happen with active customer counts starting this year and sort of the impact that could have on ARR going forward?

Well, I think in the short term, it will have very little impact on ARR because these are primarily transaction-only customers. Two things are happening: one, we're onboarding them and they're starting to buy articles from us, which I believe will reflect a nice bump in year-over-year growth rates in the Transaction business. The Transaction business has a low incremental cost to deliver those since we don't need to bring on any incremental headcount to handle that growth. So I expect that will positively impact our bottom line. Regarding the ARR side, all these customers represent an opportunity to upsell into the full platform. When we consider what that looks like in the calendar year, the initial impact may be limited, but over the next one to two years, I believe we could convert a percentage. I don't know what that percentage is, but as a reminder, Research Solutions generally converted over 60% of their existing transaction-only customers over 2.5 to 3 years. So we could potentially convert a significant percentage of them, if we execute effectively.

The last thing would be the first half cash flow from operations has been pretty strong. Was there anything unusual in that? Is there any seasonality we should be considering? And how do you think that plays out in the second half?

Bill, do you want to take that one?

Yes. There isn't much unusual in it. There are a couple of things we've done. Firstly, we had made prepayments to some of our publishers that previously were occurring about three times a year. That caused some lumpiness in the cash flow. We've restructured those arrangements to make them occur four times a year in equal increments. That has improved the flow. While there was some variation in past quarters, I believe that will bring less variability moving forward this fiscal year. We are getting a bit more interest on our cash, but that's not contributing significantly to the overall gain. Furthermore, seasonally, the toughest quarter is Q1 since that’s when we pay out both year-end and sales bonuses for overachievement. We sort of got through that in Q1, which was not applicable in Q2 and won’t be applicable in Q3 and Q4. Thus, I believe we can continue to produce strong cash flow for the rest of this fiscal year.

Congrats on the quarter.

The next question comes from Allen Klee from Maxim Group.

I was curious how you think about what percent of incremental ARR drops to EBITDA?

Bill?

Yes, that's a good question. The vast majority of that, at an 85% gross margin, means we don't require significant additional G&A or support costs to support an additional dollar of ARR. Therefore, increasing the ARR dollars is our quickest path to profitability. We have demonstrated that over time. As we see the gross margin increase, we can accommodate additional revenue without a proportional increase in costs. Any additional dollars that appear below the gross margin line come down to whether we are reinvesting those or not. If you look at our expenses, we are making intentional uplifts in expense, but they're in the right areas – sales and marketing, and product. It’s not in G&A and things like that. Hence, it'll align with those gross margin levels.

Got it. And I was a little confused on something. I heard that as you add new customer transactions, there’s very little cost to that. So a lot of it drops to the bottom line. But I thought that the Transaction gross margins were kind of saying 24% to 25%. So could you explain what you meant by what you said?

Yes. To clarify, I should have indicated that the gross margin from the incremental Transaction revenue we are bringing in will mostly drop to the bottom line because we are managing it with the current staff and team. Bill, I'm sorry, I interrupted you.

Yes. It's important to keep in mind that a significant part of that gross margin is influenced by the margin on the articles themselves, which maintains a tight margin. Hence, while the incremental cost to process transactions remains low, the margin dynamics can fluctuate favorably for us. However, as the Transactions grow, more EBITDA will flow to the bottom line.

The next question comes from Peter Rabover from Artko Capital.

I had a bunch of questions. One is the more housekeeping on the cash flow. It looks like the majority of that came from lowering the prepaid royalties. Is that more of the lumpiness? Or are you expecting that number to go down in general going forward? So that’s one.

Yes, sure. When you look at that, there are basically two things causing the variation when you look year-over-year. First, we were making prepayments three times a year. Therefore, in certain quarters, we did not have a prepayment in, which led to a comparison with other quarters where we had one. That has now changed. As of this fiscal year, we're making our payments equally each quarter. This should help smooth some variability there. Additionally, those prepays are being exhausted more quickly due to the Transaction growth. So as the Transaction grows, we are exhausting those prepays. Those prepays go down. What you noticed is that we had put a lot of prepays on the books at the beginning of the year. By the end of December, we had exhausted a significant amount of those, which contributed to the cash flow gains from that perspective. However, I believe with the coming six months we will see less variability in those accounts as we move forward.

Okay. And then I noticed the $300,000 asset purchase. What is that - is that what the Transactions business that you were mentioning earlier?

Yes. That is the deposit we made on the FIZ transaction that we've been discussing, the customer contract acquisition.

Okay. Roy, I got a question for you. So for some of us that have been here for a few years, a lot of the marketing stuff that you mentioned, webinars, social media, et cetera, if I remember, that was tried in 2017 and 2018. There were experiments with those marketing tools which did not yield much success. I’m curious what changed now that makes you so confident these initiatives will result in MQLs?

Yes. I believe the most significant change is that the team is now very metrics and dashboard oriented. We literally have a live dashboard that displays lead sources in our CRM system, allowing us to attribute investments back to actual sales. I was sitting through a marketing review last week, and they reported that year-to-date, a percentage of our upsell revenue was connected directly to these programs, along with a similar percentage of our new revenue. This has enabled us to make better decisions about where to invest. I'm not privy to the strategies employed in 2017, but we now have systems in place that allow us to measure effectiveness. Therefore, our goal is to double our investments in effective programs and scale back those that aren't delivering satisfactory returns.

Okay, great. And I was hoping you could give us an update on the academic platforms product. I know you rolled it out a few quarters ago. And to address the partnership with Evidence Partners from almost three years ago, I'm curious how that's progressed and whether any advancements have been made.

Yes, good question. Regarding the Article Galaxy Scholar, we have both a free and paid version. Earlier this year, we decided to focus on promoting the free version to drive installs which would generate transactional revenue in the short term and provide an upgrade ARR opportunity in the long term. This has been quite effective. We've seen high adoption rates this year with significant year-over-year growth in the academic segment. I’m not as enthusiastic about the amount of ARR being generated in the academic scholar space because it’s considerably more challenging than our corporate market, but it’s contributing a nice incremental transactional revenue. We're managing to gain installs that we can later convert to the premium version of AGS. So, overall, I believe this strategy is effective. Regarding the partnership you mentioned, I believe we could improve our performance with partnerships. We have had some wins based on specific collaborations, and we maintain around 12 to 13 partnerships. However, none of them are generating substantial revenue. The heavy lifting is achieved through our direct sales force.

The next question comes from George Melas from MKH Management.

On the new products such as Curedatis and Reference Management, can you provide an update on that? How are you progressing? Based on the updates, the Reference Management product seems well-received.

Yes. Regarding References, as I mentioned, we have 125 or 126 upsells this year. It's been an exciting product; customers appreciate it. It's entirely integrated into their workflow, allowing them to perform searches, document acquisitions, and storage all in one place. Hence, we've seen high engagement and numerous product demos. I think this product is a genuinely solid performer. Regarding Curedatis, it is proceeding according to plan; we had a very conservative initial outlook. The customers that have embraced it find it effective, and prospects we've demonstrated it to generally express interest. We are still refining the sales model, however, as it's different and involves different decision-makers. Overall, I believe Curedatis will pick up momentum in the latter half of the year.

Great. Curedatis is a new product, while the Reference Manager seems to be replacing existing products. Can you elaborate on that?

Yes, we have several drivers for the Reference Management business. We did have a lighter Reference Manager application called Biblilogo that you may recall from earlier discussions or public filings. References and References Pro are ultimately replacing Biblilogo. The figures I mentioned represent customers upgrading from prior solutions or new customers we've sold due to References. Do you have another question or was that it?

I’m curious about how you’re progressing in replacing competitors' products, as some companies hold a significant share in that market.

Yes, that's a salient question. There is a competitor in Europe with a strong hold over the Reference Manager application. They utilize a freemium model, giving away the basic version while providing an upgraded corporate enterprise option later. They are aiming to expand into document delivery, an area we are already present in. Conversely, we are pivoting from document delivery to Reference Management. We have seen virtually no churn to that competitor, and we have not lost significant deals to them. While they may have the edge in terms of features, we provide about 90% of their essential capabilities and do much better in terms of document delivery. Moving forward, we will naturally continue to address any feature gaps to compete robustly. While we haven’t taken substantial market share yet, we are actively competing with them in securing smaller accounts. We haven’t successfully captured any large enterprises yet, as those opportunities often require extended sales cycles. Nonetheless, we are competitively engaged in pursuing larger accounts.

This concludes today's question-and-answer session. I would like to turn the conference back over to Roy Olivier for any closing remarks.

Great, thank you. A quick reminder: We will be participating in the ROTH Capital Partners Conference in March. For more information on that event, please feel free to contact your ROTH sales representative. I appreciate everyone for joining us today and wish you all a great afternoon.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.