Research Solutions - Q2 2024

Transcript

Operator (participant)

Good day, and welcome to the Research Solutions, Inc. second quarter 2024 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to John Beisler, Investor Relations. Please go ahead.

John Beisler (Investor Relations, Three Part Advisors)

Thank you, Betsy, and good afternoon, everyone. Thank you for joining us today for the Research Solutions second quarter fiscal 2024 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 second quarter of fiscal 2024. This 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 are 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 release issued earlier 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. I would now like to turn the call over to Roy W. Olivier. Roy?

Roy W. Olivier (Chairman, President, and CEO)

Thank you, John, and thanks to everyone joining us for our second quarter fiscal 2024 results. While there are a lot of moving pieces in this quarter's results, which Bill will help walk you through, I do want to take a minute to report a few milestones for the business. First, our core platform revenue from Article Galaxy and References is above $10 million in ARR for the first time. Second, our total ARR is now over $15 million for the first time. Third, the addition of Scite and Resolute are positioning the company well for the future. The new products from these acquisitions and the products we can build using the combined technology of the three companies, positions the company to provide competitive and unique functionality across the research workflow and into other departments in most research-intensive organizations. I'll speak more of that...

Speak more about that in detail after Bill walks you through our fiscal second quarter 2024 results. Bill?

Bill Nurthen (Former CFO)

Thank you, Roy, and good afternoon, everyone. Before I begin, I'd like to remind everyone that our second quarter results include a full quarter's contribution from the acquisition of ResoluteAI on July 28 and approximately one month of contribution from the Scite acquisition, which closed on December 1. For fiscal year-to-date numbers, there are approximately five months of ResoluteAI and one month of Scite factored into the numbers. Another item I would like to discuss before going deeper into the numbers is that the Scite acquisition brings with it a material amount of what we classify as B2C recurring subscription revenue. This is revenue from individual subscribers, who are typically students or research professionals, that subscribe to the services through Scite's website and make automatic payment on either a monthly or annual subscription basis.

I wanted to help everyone understand how we are accounting for those subscriptions from both an annual recurring revenue or ARR perspective and from a revenue recognition perspective. For the purposes of calculating ARR, in our financial and operational summary tables, we have separated out what we call B2B ARR and B2C ARR. B2B ARR consists of annual subscription agreements with corporations, academic institutions, and government entities. We have contracts with those entities across the Research Solutions, ResoluteAI, and Scite product platforms, and everything is aggregated across those product lines for the purposes of calculating B2B ARR. B2C ARR consists of individual subscriptions, some of which are annual, but most of which are month to month. For the purposes of calculating B2C ARR, we aggregate the monthly subscriptions by taking their monthly subscription amount and multiplying it by 12.

Please see today's press release for further information regarding how we define and use annual recurring revenue and other non-GAAP terms. Lastly, for the purposes of revenue recognition, all revenue resulting from our portfolio of B2B and B2C software products is flowing through the platforms line in our profit and loss statements. With that, I'll start going through some of the numbers. Total revenue for the second quarter of fiscal 2024 was $10.3 million, an 18% increase from the second quarter of fiscal 2023. Our platform subscription revenue increased 48% to $3.1 million. The year-over-year growth was primarily driven by the acquisitions of ResoluteAI and Scite, as well as organic growth in our core Article Galaxy platform.... We ended the quarter with $15.6 million in annual recurring revenue, up 77% year over year.

Scite contributed almost $4.4 million of the ARR, which was a good outcome when you consider at the time of acquisition, we announced that their ARR as of the end of October, was roughly $3.6 million. Article Galaxy also had a strong quarter, with net incremental ARR for the quarter being the best result in the last four quarters. On a standalone basis, Article Galaxy ARR is now over $10 million. The growth in Scite and Article Galaxy was offset by some churn in ResoluteAI. We do expect some continued churn in that product over the next six months before it stabilizes. However, we still feel there is tremendous value in the technology that was acquired as part of that transaction.

Our transaction revenue increased almost 9% from the second quarter of fiscal 2023 to $7.2 million, and our total active customer count for the quarter was 1,398, a net increase of 175 from the same period a year ago. The increases are primarily due to organic growth, notably in the academic segment of the business, which was enhanced by higher transaction volumes and contracts transferred related to the FIZ Karlsruhe acquisition effective January 1, 2023. I will note that we are now at the point where the FIZ transaction will anniversary itself starting in our Q3. This will slow the growth rate we have seen over the past four quarters in transactions. However, we still do expect organic growth on this line for the foreseeable future.

Gross margin for the second quarter was 43.5%, a 450 basis point improvement over the second quarter of 2023. The increase is due to the ongoing revenue mix shift towards our higher-margin platforms businesses, as well as some modest increases in transaction margins. The platform business recorded gross margin of 84.4%, a decrease compared to 88% in the prior year quarter. The decrease is related to the inclusion of ResoluteAI's platform revenues, which generate a lower margin. Gross margin on Article Galaxy remained consistent with recent history, and the gross margin of Scite's products are similar to that of Article Galaxy. Gross margin in our transaction business increased 230 basis points to 25.7%.

The increase was primarily due to increased copyright margins, aided by better fixed cost coverage due to the higher order volume. We did lower some copyright reserves in the quarter, which also contributed to the increase, so I would expect this number to fall back to somewhere between 24% and 25% on a more normalized basis going forward. Total operating expenses in the quarter were $4.9 million, compared to $3.7 million in the prior year quarter. A little over $700,000 of the year-over-year variance comes from the addition of the cost bases of ResoluteAI and Scite. In addition, this quarter's results included roughly $300,000 in costs associated with the acquisition of Scite, as well as other M&A activities in the quarter.

Net loss for the quarter was $54,000, or roughly breakeven on a per-share basis, compared to a net loss of $256,000, or $0.01 per share in the prior year quarter. Given some of the churn in Resolute, we did reduce a portion of their contingent earn-out liability, which generated some below-the-line income in the other income category of our operations statement. Adjusted EBITDA for the quarter was $318,000, compared to $201,000 in the year-ago quarter. It is important to note that the adjusted EBITDA result includes the aforementioned $300,000 of acquisition-related expenses in the quarter, and as a result, would have been $625,000 on a more normalized basis.

Turning to our balance sheet, cash and cash equivalents as of December 31, 2023, was $2.7 million, versus $13.5 million on June 30, 2023. The decrease was primarily attributable to the cash used for the Resolute and Scite acquisitions, which was approximately $10 million. We also had heavy outlays in Q1 related to the proxy issues, which have since been resolved, as well as costs related to our M&A activities. Despite continuing to incur expenses related to the M&A activities in Q2, we were able to generate $300,000 in cash flow from operations in the quarter. We expect our cash flow to improve as we move on from a number of these one-time expenditures and more fully integrate the acquisitions into our business. Additionally, we have experienced some good growth in cash in the early part of Q3.

As we look ahead, Q3 and Q4 will be much cleaner from an expense perspective, which will give us an opportunity to demonstrate the profitability of the business. We will have some M&A-related costs in the first month of Q3, but should not incur much after that. From a year-to-date perspective, recall that one, we had roughly $700,000 in costs related to the proxy matter and an additional $300,000 in M&A-related expenses. In Q2, most of the proxy costs were behind us, but we still had $300,000 in M&A-related expenses. Those expenses collectively total about $1.3 million year to date and are included in the year-to-date adjusted EBIT loss of $100,000.

In Q3 and Q4, we are aiming to produce a more normalized adjusted EBITDA result and see that result improve over time as we further integrate the acquisitions. From a cash perspective, we are targeting to improve cash flow as well. However, it should be noted that cash flow will likely lag behind adjusted EBITDA for the next six months. This is related to working off some deferred revenue associated with the acquisitions, paying off some of the one-time type items that were previously discussed, and paying down some severances that were previously expensed. All this said, I think Roy and I feel very good about where the business stands today.

Despite some of the proxy matters in Q1, which affected our profitability and cash position, we were able to execute on our acquisition strategy and now feel like we have the pieces in place to grow the business and realize the profit potential that will come from our ongoing mix shift to higher margin platform revenues. I'll now turn the call back to Roy. Roy?

Roy W. Olivier (Chairman, President, and CEO)

Thanks, Bill. I'm going to address several issues on today's call, but I'd like to start with what we plan on doing with acquisitions and the acquired products going forward. As a reminder, Scite is an advanced discovery tool or a search tool focused on scientific, technical, and medical content. It has a full text search capability for most published articles and has a great user interface. It also includes a citation badge that helps the researcher understand how often the article they are looking at has been cited by other papers. In addition to showing how many times the article has been cited, it shows the number of supporting, mentioning, and contrasting statements in that article based on Scite's unique learning model. Think of this as a FICO Score or a Rotten Tomatoes Score for the article the user's looking at.

It has been successful in academic and corporate segments worldwide. The B2B corporate and academic ARR is about $400,000, and the ARR associated with the B2C version, used by academic and corporate researchers, is about $4 million as of the end of the quarter. Scite's product have been successful, largely based on their full text search capabilities, the AI assistant, and their unique citation badge. Resolute has a similar advanced discovery tool, but with some very specific differences. In addition to searching available scientific, technical, and medical content, Resolute products also have over 10 external databases connected, so search results show the scientific, technical, and medical content, plus whatever the external databases return if they are turned on. Some of those databases include clinical trial information, patent data, FDA databases, financial information, and more.

Think of this capacity as providing a 360-degree view of the search, not just STM or scientific, technical, and medical articles. The advanced version of Resolute's platform provides for enterprise search capability. Think of this as searching the customer's internal databases. Some examples include scientific notebooks, videos, and other data. Resolute built a very flexible and capable product, but did not build specific workflows to solve specific problems for the customer. In my opinion, the Resolute technology was a black box with very advanced capabilities that had to be programmed to do specific tasks, like identifying key opinion leaders, post-market surveillance, and other solutions. As such, the user interface and the workflow was built largely on a case-by-case basis.

Moving forward, we are executing on what we call a one search strategy, where we will bring these tools together and then build solutions for our customers that will address specific problems that they are working on. Scite will be our front end and user interface layer, with Resolute adding the external and enterprise search capability. Scite will be our STM or scientific, technical, and medical search tool. Scite Pro will be Scite plus Resolute's external databases, and Scite Enterprise will be Scite plus Resolute's enterprise search and external databases. We will then use these tools to build new solutions that service the needs of other departments in research-intensive organizations. The initial solutions we will build are technology landscape solutions, clinical trial solutions, key opinion leader identification, competitive intelligence modules, patent data, and more. We will also be releasing enhanced post-market surveillance and the patent module.

These modules are key to our long-term growth objectives. The first release will be the tech landscape module, which will launch this quarter, with clinical trials coming in our Q4 fiscal 2024. The remaining modules will launch late this fiscal year or in the first half of fiscal 2025. So what does this do to our total addressable market and serviceable addressable market? The answer is simple: It expands it exponentially. The current IR deck shows that a couple of years ago, we offered solutions that serviced one part of the life sciences innovation value chain. Previous to these acquisitions, we organically built additional capacity that addressed four areas of the value chain. Not only does ResoluteAI and Scite add to the four areas we already serve. It also allows us to service a total of 13 areas of the value chain going forward.

For the first time, we can also provide solutions to areas outside of scientific, technical, and medical content and life sciences. Two-plus years ago, I set a BHAG, B-H-A-G, of $20 million in ARR in three years. In October of 2024, I will have been this formal CEO for three years. We are at 15.6 million in ARR as of 12/31, so I'm confident that we'll be close to $20 million by October, but likely a bit short. I'm happy that we did not aggressively acquire someone when valuations were still at or near top of the market. That said, our BHAG has been adjusted up to $30 million in ARR by the end of fiscal 2026, almost double where we are now.

We believe this number can be hit through all organic growth with the product portfolio we have today and no further acquisitions. In addition, margins should expand as we approach this goal, and we would expect the overall EBITDA margin at that point to be in the double digits. I want to reiterate, this is not guidance. This is our BHAG. Now, this is not to say that we will not continue to evaluate and acquire companies that align with our shareholder return objectives in addition to our business and product strategy. We expect to continue to focus on providing solutions throughout the research workflow and the innovation value chain. Regarding what I have recently referred to as acquisition number four, we have decided not to pursue that opportunity further. While we were excited about the technology, some items in the diligence did not meet our threshold.

We will continue to be disciplined about acquisitions moving forward. We do have other opportunities that we will continue to investigate. However, we will be more selective over the next two or three quarters to allow us to focus on getting our new strategy and the integration of the various products underway. Early returns on ResoluteAI have not been in line with our financial expectations, as we have experienced customer churn, some of which was expected when we signed the deal. We have developed a strong pipeline for new prospects. However, it should be noted that these products have the longest sales cycle of any products we offer.

On the other hand, we have been encouraged to find that the core technology is as strong as we believed it was, and we remain confident that we can utilize that technology in the new solutions described earlier, and that those solutions will be more relevant to our customers. We have added two senior sales executives selling that product and expect to see some results in the form of new sales in the second half of the fiscal year. Conversely, the early days of Scite has overperformed to our expectations on B2C and B2B. Our belief was that we could cross-sell Scite into our academic and corporate customer base through our existing sales teams. Those teams are trained and doing demos now.

In just the past few weeks, we've closed 50,000 in new ARR on what was a $400,000 B2B business, and we have a very robust pipeline going forward. We're excited about our prospects as we integrate Scite's best-in-class capability with Resolute's extensive external and enterprise data capabilities and tie that integration with our industry-leading document delivery platform. In closing, I'll say that the entire management team believes that we now have the building blocks in place that will allow us to transform Research Solutions from a document delivery company to a software solutions provider that can compete with anyone in the space. We're very excited about our future, and we'll continue to report our progress in our future calls. With that, I'd now like to turn it back over to the operator for Q&A. Operator?

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question today comes from Alan Klee with Maxim Group. Please go ahead.

Allen Klee (Managing Director and Senior Equity Research Analyst)

Yes, hi. Congrats on the quarters. Could you talk about why you think Scite has been performing so well? And then you also said that Article Galaxy was your best quarter. What do you think turned that around? Thank you.

Roy W. Olivier (Chairman, President, and CEO)

Yeah, thanks, Alan. In terms of Scite, I would say a couple of things. One is, I think Scite being part of a larger public organization has really helped its B2B prospects feel more comfortable with acquiring that platform. So I think that's helped accelerate some sales or even close some sales that maybe would not have closed because Scite was a small, independent company with a few employees. You know, we now offer 24/7 technical support. We have a whole onboarding team to help onboard customers. We have larger sales and support organizations, so I think that's really helped increase the velocity of some of the B2B business. The B2C business has a, actually, a very predictable investment return conversion rate.

In other words, if we invest in digital marketing, it typically results in a certain amount of trials, and those trials convert at a very predictable rate. So we have been ratcheting up digital marketing spend on the, on the B2C side, and we see those results literally in days or weeks. Whereas, as you know, we have at least a 20-week, or typically about an average 20-22-week sales cycle for Article Galaxy and a longer sales cycle for Resolute. So we're able to basically move that needle very quickly by investing more in marketing. Bill, anything you want to add to those comments?

Bill Nurthen (Former CFO)

No, I think that's good, Roy.

Roy W. Olivier (Chairman, President, and CEO)

Yeah, on the AG comments, I think that, we're seeing the new, new sales teams pick up the pace. They're doing a nice job. We've closed a number of large deals. We actually closed the largest deal that we've closed in, since I've been with the company during the quarter, and, we're seeing a pretty good success with larger deals, which is encouraging to me because there was a period there where we were closing a lot of new logos, but they weren't -- the average revenue per customer was not as high as we'd like it to be. So I think new, new is starting to perform well. Part of that is marketing is driving, I think, a, a nice amount of leads into that new, new team.

You know, I think our challenge going forward is taking what's working on the Article Galaxy, Article Galaxy References' new team, and applying it to upsells and Scite and ResoluteAI products. Bill, anything you want to add to that?

Bill Nurthen (Former CFO)

Yeah, I think I would say it was our, you know, our best quarter in the last four quarters. But just recall, the last four quarters have been kind of coming down steadily, so this was a nice rebound for us, this quarter. And we saw a nice bounce back. Not, it bounced up kind of to, you know, a rate that is acceptable to us, but not quite sort of the rates we've seen, you know, before we started talking about some of the issues with the economy hitting the sales process there. To Roy's point, new has been performing very well, so new sales are coming through strong. I think where we're still struggling a bit, at least for this year, is on the expansion upsell side of things.

Last year, we launched References, which was a big catalyst to upsells. You know, we don't have as much catalyst going into the fiscal year, so running a little bit behind there, but it was nice to see the platform sales turn around in Q2, and we're hoping that's a trend that'll, you know, continue on for the rest of the fiscal year.

Allen Klee (Managing Director and Senior Equity Research Analyst)

Oh, thank you. Then, also on site, you mentioned that most of the ARR is with the B2C business, and that while you have some annual customers, it's mostly under monthly subscription. So do you have enough data to have a sense of the churn of that? How confident can we say those monthly customers will be annual customers? Do you have a sense of that?

Roy W. Olivier (Chairman, President, and CEO)

You want to take that, Bill?

Bill Nurthen (Former CFO)

Yeah, I would say we don't have enough data yet. And that's part of the reason, you know, we definitely wanted to separate this out on a separate line to really isolate it and give investors a view of sort of the changes in that over time. We are gonna kind of look at it and continue to monitor it. I also will say that we do recognize that B2C tends to obviously have higher churn rates. We did see higher churn rates from that business in the diligence. However, what I would say is we're already, you know, hard at work on things to do to basically make that product more sticky and reduce the churn rates in that segment.

So there's some software we're using to help reduce churn, but there's also things that we can do from a pricing and packaging perspective, we think, to reduce churn in that segment. And so I think, you know, as we learn more over the next few quarters, we'll be able to discuss that in a little more detail with investors.

Roy W. Olivier (Chairman, President, and CEO)

Yeah, and I would just remind everybody that, you know, net churn rate in Scite B2C is higher than we want it to be. That said, its net ARR growth for the short time that we owned it went from $3.6 million-$4 million. So it continues to show a really strong growth profile in spite of its churn. We all, I think, are on the same page in terms of if we can cut that churn down, it's just gonna accelerate the growth even more.

Allen Klee (Managing Director and Senior Equity Research Analyst)

Thank you. My last question is on incremental ARR. Is there, you have more moving pieces now, so I was curious, do you have an internal target for what you shoot for each quarter?

Roy W. Olivier (Chairman, President, and CEO)

Well, Research Solutions definitely had very detailed budgets of what we expected in all the various sales categories. Scite did not, but we have applied, you know, our kind of planning to Scite, so we now do have specific targets for B2B. We really don't have specific targets for B2C other than continue to grow at the rate you're growing, because that is a new kind of animal to us. We've been a strong B2B player for years. B2C is relatively new for us. That said, Scite has some very experienced B2C people that are doing a great job. And then I think on Resolute, we did put a plan together, and I think on the top line, Resolute's not where we want them to be. On the EBITDA line, they are.

Scite's overperforming on both lines, and, you know, Research Solutions is doing a nice job on new, but we continue to see a little bit of softness on upsells and more churn than we would like to see.

Allen Klee (Managing Director and Senior Equity Research Analyst)

Okay. Thank you so much.

Roy W. Olivier (Chairman, President, and CEO)

Thank you.

Operator (participant)

As a reminder, if you would like to ask a question, please press star then one to be joined into the question queue. Press star then one to be joined into the question queue. This concludes our question and answer session. I would like to turn the conference back over to Roy Olivier for any closing remarks.

Roy W. Olivier (Chairman, President, and CEO)

Yeah. Thanks, everyone, for joining us on our call today. We will be participating in the Roth Conference in Dana Point, California, on March 18th and 19th. Qualified investors that would like to attend or schedule a meeting should contact their Roth sales representative. We look forward to speaking with you in May to discuss our third quarter results, and have a great day.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Roy W. Olivier (Chairman, President, and CEO)

Thank you.