Research Solutions, Inc. (NASDAQ:RSSS) Q1 2023 Earnings Conference Call November 10, 2022 5:00 PM ET
Company Participants
John Beisler – Investor Relations
Roy W. Olivier – President and Chief Executive Officer
Bill Nurthen – Chief Financial Officer
Conference Call Participants
Allen Klee – Maxim Group
Richard Baldry – ROTH Capital
Operator
Good afternoon, everyone, and thank you for participating in today’s conference call to discuss Research Solutions’ Financial and Operating Results for its Fiscal First Quarter Ended September 30, 2022. As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, John Beisler, Investor Relations.
John Beisler
Thank you, operator, and good afternoon, everyone. Thank you for joining us today for Research Solutions’ first quarter fiscal 2023 earnings call. On the call today are Roy W. 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 first quarter of fiscal 2023. The release is available on the company’s website, 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 the 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 these numbers to GAAP measures is included in the earnings press release issued this afternoon.
Finally, I would like to remind everyone that this call will be recorded and made available for replay via a link on the company’s website.
I would now like to turn the call over to Roy W. Olivier. Roy?
Roy W. Olivier
Thanks, John, and thanks to everyone for joining us for our first quarter fiscal 2023 results. The first quarter was a great quarter in many respects. The overall revenue growth rate, boosted by strong transaction revenue was 12%, which is the highest going back five-plus years. Platform revenue was up 34% with ARR up 33% and we were excited to see Platform revenue above $2 million and ARR exceeding $8 million for the first time.
All of this drove continued improvement in our gross margins, which contributed to very strong net income and EBITDA, both of which are records. I do have some additional details and comments I’d like to share about the quarter. But first, I’d like to pass over to Bill to walk through our fiscal first quarter 2023 financial results in detail and then I’ll wrap up with some additional comments. Bill?
Bill Nurthen
Thank you, Roy, and good afternoon, everyone. Total revenue for the first quarter of fiscal 2023 was $8.7 million, a 12% increase from the first quarter of fiscal 2022. Our Platform subscription revenue increased 34% and surpassed $2 million for the first time in a quarter. The growth was primarily driven by a net increase of Platform deployments over the last 12 months, including 23 in the first quarter and 166 over the trailing 12 months. We ended the quarter with $8.3 million in annual recurring revenue, up 33% year-over-year and 5% sequentially, reflecting our continued sales and upselling efforts and low churn of existing platform subscribers.
Please see today’s press release for how we define and use annual recurring revenue and other non-GAAP items. Our transaction revenue increased almost 7% from the first quarter of fiscal 2022 to $6.7 million. As noted in our press release, this was the largest year-over-year percentage increase in transaction revenue since the second quarter of our fiscal year 2018.
The increase was primarily due to an increase in paid transactions combined with some of the pricing initiatives we undertook in the second half of our fiscal year 2022. Our total active customer count for the quarter was 1,220, a net increase of 67 from the same period a year ago. The increase was due to more corporate customers over the past 12 months.
Gross margin for the first quarter was 38.6%, a 420 basis point improvement over the first quarter of 2022. This continued the trend of our gross margins moving up and to the right as our revenue mix continues to shift towards the higher-margin Platforms business.
Despite being only 23% of the revenue, the Platforms segment contributed 53% of the gross profit in the quarter. The Platform business recorded gross margin of 88.6% above our target gross margin range and approximately 490 basis points higher than the prior year quarter. This was primarily due to lower software costs as well as lower personnel costs associated with the Platform segment.
Gross margin in our Transactions business increased 100 basis points year-over-year to 23.4%. The increase was mainly due to some of our pricing initiatives. The margin is slightly down from the prior two sequential quarters where we had lightened some of our copyright royalty reserves, which we did not do in this quarter.
Total operating expenses in the quarter were $3.2 million compared to $3 million in the prior year quarter. The modest increase to last year was due primarily to increased head count in technology and product development as well as a increase in foreign currency loss due to the present foreign currency environment. I mentioned on our prior call that I expected operating expenses for Q1 of fiscal year 2023 to come in below where they were in Q3 and Q4 of last year and they not only achieved that, but were also below where they were in Q2 of last year. This largely reflects the offset of some items that impacted us on a onetime basis in fiscal year 2022 as well as some of our cost initiatives taken at the end of fiscal 2022.
Note that as we move forward, one item with some uncertainty related to the operating expenses will be the noncash stock compensation expense associated with our long-term equity stock plan. Recall that we implemented this plan this year to replace the old executive stock compensation plan.
On November 1 of this year, we issued 1,950,000 shares of restricted stock to the executive team. However, those shares will not vest until certain stock price thresholds are achieved. A third-party firm is doing evaluation on the grants to determine how much we should expense over the five-year life of the grant, which will have an impact on our net income, but not on our adjusted EBITDA. Keep in mind, however, that while the shares are outstanding, they only vest if the stock price thresholds and market cap improvement levels are attained.
All that said, net income for the first fiscal quarter was $215,000 or $0.01 per diluted share compared to a loss of $372,000 or $0.02 per share in the prior year quarter. Adjusted EBITDA for the quarter was $433,000 compared to a negative $181,000 in the year ago quarter. These were both quarterly profit records for the business. We think they are indicative of how our business can scale profitably as the Platform segment continues to grow and become a larger component of our overall revenue. In addition, this profitability will be further accelerated if our transaction business starts to grow again.
Turning to cash. The profitability I mentioned has translated into cash flow. We generated over $100,000 of cash flow from operations in the quarter. This is especially significant given that in the first quarter, we paid our executive bonuses for fiscal year 2022, some large commission accelerators related to our strong sales performance at the close of our fiscal year 2022 and also a material amount of publisher royalties. Keep in mind, I expect cash flow to fluctuate quarter-over-quarter, but overall to be roughly in line or slightly behind our EBITDA on a trailing 12-month basis.
Turning to our balance sheet. Cash and cash equivalents as of September 30, 2022, were $2.4 million versus – excuse me, $10.4 million versus $10.6 million on June 30, 2022. Note that during the quarter, we paid $300,000 related to the acquisition of customer contracts from FIZ Karlsruhe. The ending balance reflects that payment offset by the previously mentioned $100,000 generated in cash flow from operations. There were no outstanding borrowings under our $2.5 million revolving line of credit, and we have no long-term debt or liabilities.
In conclusion, while I think we have reached an important transition point from a profitability perspective, I want to caution against making assumptions that our adjusted EBITDA will continue to increase each quarter from here. There were some new hires slated for Q1 that were not hired until late in the quarter. Additionally, we previously discussed some changes to the cost structure of our team in Mexico, which will take effect starting in Q3 and will likely add over $100,000 of additional cost per quarter.
As a result, it is likely that you will see a drop in adjusted EBITDA for Q2 and see the EBITDA increase and decrease with transaction volume, which is seasonally better in Q3 versus Q4. All that said, we remain committed to being adjusted EBITDA and cash flow positive for the fiscal year and we are striving to accomplish that in each quarter this fiscal year.
I’ll now turn the call back to Roy. Roy?
Roy W. Olivier
Thanks, Bill. Given the short time since our last call, I will focus today’s comments on four topics. First, a product update, which I think is relevant to our FY 2023 goals. Second, I’ll provide some color on how we are thinking about fiscal 2023. Third, I’ll discuss the status and progress of the recently announced customer asset acquisition. And finally, I’ll provide an update regarding our general M&A efforts.
From a product perspective, we launched Curedatis about a month ago and I’m excited to announce that we did sign our first customer contract for the product with a German med tech company. The product’s initial launch has been focused on the med tech industry, but we will be adding the requirements to support other industries, for example, pharmaceuticals as we ramp up and continue to develop the product.
We believe the total addressable market for the med tech industry is around 92,000 companies or US$660 million. We believe the serviceable available market, or SAM, in the Europe and North American markets to be about 62,000 companies or about $450 million. These numbers are based on an average SaaS platform fee of around US$7,000. And I do remain very excited about this opportunity. So far, we’ve had a great response to the product launch.
We’ve also continued the development of Article Galaxy and Article Galaxy references. Due to our installed base of about 750 Article Galaxy customers and a major Russian-based competitor exiting the reference management business, we’ve seen strong interest in the references product. Today, we’ve upgraded or sold 38 customers on the standard version and 41 customers on the pro version. We’ve also built a large pipeline for new sales.
Turning to Article Galaxy Scholar, or AGS, which is our university library product, we’re changing our go-to-market approach to include both a standard and a freemium product. The standard product that we have today is basically – let me back up a second, the freemium product that we just launched is basically our standard product with some of the features removed. We did this to increase installs based on strong transaction sales from previously installed versions. The concept here is to land with the freemium product and to take the increase in our transactional revenue from that product and then expand to the paid version via upsells.
As a reminder, we are focused on the U.S. market today where the TAM is about 2,500 libraries or $7.5 million in Platform revenue and $45 million in transactional revenue. I’ll continue to report on progress with this new go-to-market strategy going forward.
Turning to my FY 2023 outlook. I do not want to – I do want to comment on Q1’s performance. We had very strong upsells, low churn for the quarter, both of which exceeded our expectations. However, we were behind our targets for new platform customers in Q1. Some of this is due to us pulling the Q1 opportunities into Q4 of FY 2022, some is related to us retooling some of our prospecting and internal systems and some is related to the general economy. While the first and second items I mentioned should resolve themselves over time, I have some concern about the general economy and the current interest rates potentially impacting the companies we sell to.
We have seen a few opportunities in our pipeline put on hold as some companies dial back spend in this uncertain environment. We may not have a clear view of the total impact of the economic issues until the end of our Q3 or early Q4. That said, I’ll provide updates in our future calls.
Based on what I know today, we continue to expect our ARR to be over $10 million for the year. As stated previously, we expect the business will be cash flow positive and generate positive adjusted EBITDA for the full year. We do not have any significant updates regarding the FIZ customer onboarding project that we announced last month.
We are progressing and we’ll have more to report in February. That said, we are confident that between this project and a large new customer coming online, we should see a nice increase in transaction revenues starting in FY 2023 Q3.
Finally, I’ll comment on our M&A activity. As I said in our last call, we’re finally seeing valuations that are actionable and much more willingness to find creative ways to get a deal done.
We remain committed to bringing on about $6 million in ARR over the three year window I described about 18-months ago and I’m confident we’ll hit that goal and have something to talk about soon.
Before I turn the call over for questions, I do want to remind everyone that we will be presenting at the Southwest IDEAS Conference in Dallas on November 17. Qualified investors that would like to attend or schedule a meeting should contact our IR firm Three Part Advisors. With that, I’d like to now turn the call back over to the operator for Q&A. Operator?
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] The first question comes from Allen Klee of Maxim Group. Please go ahead.
Allen Klee
Yes. Good evening and congratulations. So just taking a little more of explaining the strength in transactions. And then also, you said expenses will be up a little bit this year. Could you just go over that again of the numbers on that? Thank you.
Roy W. Olivier
Bill, do you want to take that and I’ll add some comments?
Bill Nurthen
Sure. Yes. So again, we’re with transactions where we actually are starting to see some strength and some pickup this year, and that’s coming from two things. It’s coming from increase in paid transaction count. So actually just transactions, where people are paying us a service fee and paying for an article actually going up in number.
The other thing is we did, as I mentioned, undertake some pricing initiatives last year, but they were done sort of in the second half of last year. And so that’s where that’s coming from. And again, we remain cautiously optimistic. I’ve said before, I’d like to see two consecutive quarters of growth minimally before we start to say there’s a trend in transaction growth and certainly, there was a nice quarter here. I think we’re off to a decent start in the month of October for transactions, but we’ll see how that plays out over the full next quarter.
With regards to expenses, I think, yes, we could see those go up. I don’t think we’re talking extremely materially. I will talk about, first, the sort of cash-related expenses. There were a number of hires that we had in our budget that just keep me in this environment took longer to fill the position than we had hoped.
And so some of those hires came on at the end – towards the end of our quarter and some in early October as well. And secondly, from the noncash standpoint, there is sort of an item out there with respect to the stock-based comp related to the long-term equity bonus plan that we’ll have to see where that gets valued and what that comes in at.
Once it is valuable, we’ll know the number for the future because it will be stable through each period. But we want to see where that comes out before cautioning or before sort of saying where we think the operating expenses will be. So I think that will be up in Q2. I think they will be, again, modestly up and still in a situation that allows us to generate a positive adjusted EBITDA in the quarter.
Allen Klee
Okay. Did I hear around $100,000 a quarter?
Bill Nurthen
That comment was related to our Mexico cost structure, which is changing, but that will not happen until Q3. That is $100,000 that will get added in Q3 and that will, again, it effectively starts Jan 1 with those expenses. So that will start, but that will also start the quarter that is traditionally our – seasonally our best quarter from a transaction perspective as well. So what I sort of see as kind of the EBITDA could go down and then go back up and then in Q4, the transactions drop off again. And so that will probably bring it down again. So it is going to move around a bit through the year and that was the main point I wanted to make in my closing of my statement.
Allen Klee
Okay. And then just my last question. The gross margins for the Platform segment increased and the decrease in transactions. Are both of the numbers that you saw this quarter kind of reasonable run rates going forward?
Bill Nurthen
I expect the platform gross margin to probably come down a little bit, not – and not too much, but then the transaction actually to go up a little bit. So I still think we’re on a trend where transaction margin will go up. There were a couple of things in the quarter that just had a negative impact on it. But again, these are not dramatic shifts in either direction, I would say.
Allen Klee
Thank you so much and congrats.
Roy W. Olivier
Thank you.
Allen Klee
Yes, thanks.
Operator
[Operator Instructions] The next question comes from Richard Baldry of ROTH Capital. Please go ahead.
Richard Baldry
Thank. Could you talk a little bit more about the customer acquisition on the Karlsruhe’s side, and I’m probably uttering that name, of course. But I think when I read was something like 700 total customers, maybe 400 more recently active, which is a pretty big number compared to your 1,220 base. So what are the implications of that? How – when could some of those move over? Are there revenue implications similar to your own customers? Just to give us sort of an idea of what the magnitude and impact of that could be over whatever period of time you want to choose to look at.
Roy W. Olivier
Yes. First off, I don’t think we’ll see any revenue impact until starting in January. So right now what we’re doing is we’re having conversations with customers about onboarding and moving them over. They do have about 400 active customers. So I think the maximum number of customers we would move would be 400 or some percentage of 400 obviously.
I think in terms of the incremental opportunity, Billy, you probably have the numbers of top of your head. I’ve forgotten them. But I want to say that the incremental opportunity here, if we were to onboard all customers and maintain their trailing 12-month revenue run rate would be about $1.5 million, Bill, is that right?
Bill Nurthen
Yes, it could be – again, if you look – depending on how you look at it, it could be a little bit more than that, but that is sort of a good number to use.
Richard Baldry
And can you talk about how comparable sort of the usage patterns that – like do you offer all the functionality would take sort of any way for us to gauge how likely it is for you to retain for all of that customer base or based on feature parity, however you want to think about it?
Bill Nurthen
Yes. I don’t think we have a good estimate on that. It definitely will not be 100%. There is some other competitors that are aggressively pursuing these customers. They’re trying to secure the customer relationship primarily through just price. And what we did, to address your question, is that we basically created a FIZ version of the Article Galaxy product that would meet the needs of those customers.
So we’ve created a, kind of, a special version of AG. It’s rolled into the package and they get all the functionality that they were getting under the FIZ relationship with a couple of exceptions I’ll talk about in a minute. And then there’s an upsell opportunity for our team to upsell them to the full Article Galaxy product later. So I think we line up very well from a product parity point of view. I will say the one thing that we’re making some progress on that we have to solve by January 1 is that FIZ typically did sell their – the transactions as well as the service fees in three currencies. We’ve historically operated in a single currency, the U.S. dollar.
So there has been a very large amount of meetings over the last 30, 45 days to figure out how we’re going to present yen for Japan, euro for Europe, actually, they do the British pound as well as the U.S. dollar. So we’re making good progress there and I’m sure we’ll get that done. But I think we’ve got a good chance of bringing over kind of the larger, more strategic customers. However, we are in a competitive slog with other folks that are going in there just pitching price trying to take that business.
Richard Baldry
Okay. And the strength in transactions obviously drove a pretty good EBITDA number in that you want to be cautious in trying to figure out how sustainable that is. But assuming it proves to be sustainable, what are the implications for your own sort of strategic spending, strategic hiring or the product side, go-to-market side? So if your profitability looks sustainably above prior expectations, where would you look – would you look to keep it all on the bottom line or maybe alter some of your plans and reinvest harder in some areas that might drive better growth?
Roy W. Olivier
I don’t think – I don’t know that I have a complete accurate answer there. I think that our intention would be to leave most of it on the bottom line. I think that there was an investment we have confidence in, we would certainly look at that. However, coming back to M&A, whatever we do from an M&A perspective, we need to make sure that we can fund. And if we do a deal in the combined organization throwing off more cash, like I said, I think the majority of that stays at the bottom line.
But if we do a different type of acquisition, we may need to use that cash to drive growth in that business or integrate the businesses. There’s – yes, I don’t think we’ve made a final decision because we haven’t gotten the M&A checkbox checked yet. But certainly, organically, we don’t need to invest in other areas of the business to drive growth in the short term. We’re try being this fiscal year.
Richard Baldry
Thanks for answering my questions.
Roy W. Olivier
Thank you.
Richard Baldry
Great. Thanks a lot.
Operator
This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Roy W. Olivier for any closing remarks.
Roy W. Olivier
Okay. Well, thank you, and thanks, everyone, for joining us on today’s call. We look forward to speaking to you in February to discuss our second quarter results. Have a great day.
Operator
This concludes today’s conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.
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