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Readcloud (ASX:RCL) H1 FY2019 Half Year Report

Fabregasto — Sat, 02 Mar 2019 00:16:26 +0000

Readcloud (ASX:RCL) H1 FY2019 Half Year Report

When we last checked in on ReadCloud (ASX: RCL) a month ago – RCL #3 (limited edition with the holographic cover) the company had just released its 4C quarterly cashflow & operational update for the December quarter. This new information helped clarify some outstanding questions following the frenzy of activity over the last 6 months of 2018 and the level of opaqueness that existing previously in regards to seasonality of revenue and outgoings. A quick summary of what we learned:

The seasonal peak for cash receipts is indeed the March quarter every year (predominantly for customers invoiced in November and January). There was $1.6M of outstanding invoices at December period end which will be collected in the current quarter.
The majority of Reseller revenue (which represented the bulk of total RCL revenue in FY17 and FY18) will be invoiced in this March quarter. While the company is transitioning to a higher proportion of higher margin direct sales, presumably this will be for new schools signed up to the platform, and not shifting Reseller volumes to the direct salesforce. FY18 Reseller sales were $1.2M, and the company has communicated that the number of Resellers has increased by 48% between June (50) and December 2018 (74).
“Almost all” of the revenue from the recently acquired AIET is invoiced in the June half. This was $0.9M in FY18 with some growth expected in FY19.
Combined with Reseller revenue, this suggested that RCL was on track for $4M of FY19F revenue at least – plus additional school sales achieved in the current March quarter (remembering that a meaningful portion of school sales had been delayed into 2019 by a change to the school curricula in Queensland). While below the $7.5M FY19 revenue target needed to trigger the final tranches of management’s performance rights, this would still be a large increase on the $2M in FY18 (which included $0.3M of R&D incentive income).
The noticeable increase in operating costs for the December quarter was due to transaction costs for the AIET acquisition, as well as 2 months of AIET staff costs from 1^st November to 31^st

On Thursday the company released its half-year results for 1H19 (to December) and supplied an additional operational update. A lot of the metrics in that update were the same as those detailed in the 4C provided a month ago, but some of the information was new. Let’s look at this new intel, and then use it to parse the financials and what it potentially means for the remainder of FY19:

Direct schools: The number of Direct schools has increased from 20 at June 2018 to 38 at December with a further 3 signed in the last 2 months, and more expected by the end of FY19. Average revenue per school increased in 1H19 as a result of expanding the RCL platform to additional year levels in existing schools – a good sign for the potential scalability of the business;
AIET: Following the cancellation of the RTO licence of a leading WA provider to Vocational Education and Training (“VET”) schools in that state, AIET has signed up 20 new WA schools, plus a further 5 in other states in early 2019, to take its total to ~121 VET secondary schools. AIET’s RTO registration was recently renewed until 2025; and
Resellers: Based on the 48% increase in Resellers in 1H19, management expect a significant increase in revenue from this channel over FY19/20.

Back to the financials (summarised below). 1H19 revenue of $2.1M (excluding R&D rebates) was 102% higher than for 1H18 and is already higher than full year FY18. This was slightly higher than I expected based on the sum of 1Q18 and 2Q18 customer receipts plus the invoiced and uncollected revenue of $1.6M at December. It’s difficult to get a handle on half-by-half Gross Margin at this point – due to the timing of payments to publishers and booksellers (which have varied over the historical period, and may well vary again with the incorporation of COGS for the AIET business). Underlying EBITDA was a $0.5M loss, in line with 2H18. Higher opex reflects the increased cost base following the AIET acquisition (with invoicing occurring almost entirely in the second half -> cost ahead of revenue).

Based on the following factors (gleaned from management commentary to date), I believe that FY19 revenue is now likely to be in the region of $5M (excluding R&D income):

Invoicing of AIET revenues in the June half ($0.9M previously but likely to be higher given the new VET schools signed (above);
Invoicing of the majority of Reseller channel sales in the March quarter (which I would expect to be $1.5M to $2.0M based on the 48% increase in Resellers between June and December, and with reference to the $1.2M of Reseller revenue in FY18);
A portion of the delayed RCL platform revenue slipping from 1H19 into 2H19 following curricula changes in QLD – unquantified but could be a few hundred thousand dollars.

Full year FY19 sales of ~$5M would represent a near tripling at the top line from FY18 – off a low base but certainly nothing to sneeze at, and signalling some significant momentum since the end of FY17 – with a near tripling of revenue also achieved from FY17 to FY18. This would represent a strong base heading into FY20, when we could reasonably expect to see the first meaningful synergistic and cross-selling benefits from the combination of the core ReadCloud platform with the AIET business. Opportunities include:

Cross-selling opportunities for AIET content in RCL’s existing contracted schools;
The digitalisation of the AIET platform (update: delayed slightly, will now be ready in advance of the 2020 school year); and
Potential partnership with other content publishers in the wider VET market – with management disclosing that commercial negotiations have commenced in this regard (presumably in preparation for the 2020 school year, and too late to contribute to FY19F).

Management believe (per the 1H19 results commentary) that minimal additional headcount would be required to deliver significant growth – potentially suggesting the scalability that I originally expected to be a characteristic of this business (part of my personal investment thesis). Sounds positive – but they need to demonstrate this to me.

In our last piece on ReadCloud, I estimated that the company *could* generate a small profit (at NPAT level) in FY19 based off $5M of revenue and the improvement of gross margins back to pre-IPO levels. The volatility in COGS between periods (see table above) makes this difficult to predict – albeit management expect margins to increase in 2H19 – and so I believe that the company is more likely to generate a NPAT profit in 2H but not completely claw back the $0.9M loss for 1H19 above – and so record a smaller loss for full year FY19. I do expect the company to post positive underlying EBITDA however for FY19 (reversing the $0.5M 1H19 loss). Apart from COGS for the RCL platform, this also hinges on the contribution from the AIET business – which the company has described as generating higher margins that the core ReadCloud business, so potentially there is some upside to these rubbery estimates (we live in hope).

Again management have not provided any hard numerical guidance for FY19 – however the company had advised there will be an investor roadshow sometime this month with an accompanying investor presentation. This will be designed to increase awareness for the company and its growth profile – and hopefully may include some useful forecast information, or at least updated metrics on how the 2019 selling season has ended up (with school purchasing presumably finalised given we are now in March). If not, I would expect to gain this insight on the release of the March quarter 4C at the end of April (30^th April “Deadline Day” if previous lodgement dates are anything to go by).

It would be nice to see some further breakdown of revenues between RCL/AIET, Resellers/Direct schools for the core ReadCloud platform, as well as other metrics such as average revenue per school or by student – but that may be wishful thinking so early in the company’s listed life. Glossy presentations and a sea of KPIs don’t necessarily translate into profitability – just ask Livetiles shareholders.

As we flagged in the last ReadCloud update, the March quarter 4C will provide some clarity on whether more capital is going to be required to fund the company’s growth into FY20.

There was $2.9M in the coffers at the end of December, with a further $1.6M invoiced but not received as of that date.
In the December 4C management estimated $2.0M of outflows for the March quarter including $1.1M of COGS – so that suggests the company will have around $2.5M plus any receipts received by then from the billing of Resellers and AIET customers (net of further COGS for those volumes).
So it appears the company will be fully funded through the end of FY19 (excluding any further expansion of the salesforce ahead of the FY20 school year) – but note the seasonally weakest half of the year from a cashflow perspective is the December half.

I would hope the company has at least $2.5M-$3.0M in the kitty at June to get through the six months to December 2019. That’s because 1H19 operating cashflow was -$1.3M per our previous ReadCloud update, and we could expect that to increase to $1.5M including a full period of AIET staff costs. 2020 school year receipts would then start flowing into the bank account from January next year if normal seasonality is a good guide.

So there remains a lot to be optimistic about on this company, in my opinion. A 700-800% increase in revenue over 2 years (albeit from a sub-$1M base in FY17), while still posting only moderate losses, positions the company well for FY20. At a $13M market capitalisation, there would be meaningful share price upside from the company reaching its cashflow and profit breakeven inflection point in the next 12-18 months. In the meantime, I will await the upcoming investor presentation (this month) and next March quarter 4C (due end of April) with keen interest.

We continue to flag that RCL is relatively early on in its life cycle and as a result is a comparatively higher risk, speculative stock, at this point. We will provide a further update on the company in our next issue (RCL #5 Return Of The Killer ReadCloud) following the release of the March quarter cashflow report.

Disclosure: I (@Fabregasto ) own shares in ReadCloud and may buy more shares in the future – but not for at least 2 days after the publication of this article. Claude Walker owns shares in Readcloud and will not trade them for at least two days after the publication of this article. This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

ReadCloud (ASX:RCL) FY 2018 Annual Results: Initial Coverage

Fabregasto — Sun, 02 Sep 2018 02:01:15 +0000

Author: Fabregasto

On Wednesday, ReadCloud (ASX:RCL) announced its maiden full year results as a listed company.

Background

ReadCloud is an emerging Australian education technology company which provides digital learning solutions to Australian secondary schools. Specifically, ReadCloud’s Software-as-a-Service (“SaaS”) eReader platform delivers entire school curricula in one app. Within this app, teachers and students can collaboratively share notes, questions, videos and website links, and import third party content such as YouTube videos and TEDTalks.

The platform includes data analytics (so teachers can track actual reading time) and integrates with each school’s Learning Management System, to synchronise timetables and classes. The eReader platform is more cost effective for schools than traditional hardcopy textbooks, and in short, investing in the company is a play on the digitalisation of the classroom.

From the limited financial information included in the prospectus, ReadCloud’s growth trajectory seems to have been considered and steady and without the long runway of cash burn often seen in the technology sector. Founded in 2009, the first version of the eReader was published for iPad in 2011, and in 2013 the platform was deployed in two pilot schools. Per the prospectus, over 2014/2015 the current senior management team joined the company and redefined the commercialisation strategy. From three schools in 2015, the platform had been rolled out to 50 schools and 21,800 users at June 2017. Unlike a number of ASX listings in recent times, ReadCloud was already profitable at IPO, generating positive NPAT in FY16 and FY17 (albeit before incurring typical annual ASX listing fees and corporate expenses which it will from this point forwards).

In order to fund the next phase of growth, ReadCloud listed on the ASX in February 2018 with little fanfare (which has proven to be characteristic of management (a plus in my view)). The company raised $5.5 million (after costs) with which it aimed to fund an expansion of its sales and marketing team, plus further investment in the eReader technology platform.

ReadCloud generates revenue from selling licences for its eReader software and for eBooks in the digital library. At IPO this digital library included more than 170,000 titles via direct distribution agreements with global publishers such as Simon & Schuster, Allen & Unwin and Penguin Random House, and educational publishers such as Jacaranda and Macmillan. These agreements automatically make new eBooks available on the eReader platform as soon as they are released by these publishers.

The company operates two distribution channels:

(1) Direct sales to schools under 1-4 year contracts, with the majority of revenue received at the start of the school year (when that school’s curriculum is purchased); and

(2) Via resellers – such as Officemax (a large school book and stationery supplier) and Jacaranda (a sizeable textbook publisher).

ReadCloud also white labels its platform for a number of channel partners.

As you would expect, the company generates higher margins from supplying schools directly: the prospectus quoted respective gross profit margin per user of $42 from direct sales in FY17, versus $15 per user via the reseller channel. The planned use of IPO proceeds is to grow its direct sales capability. Management hope this will lead to significant gross profit growth as the product gains traction. In FY17, 88% of sales were achieved via the lower margin reseller channel, and 12% via ReadCloud’s direct salesforce. The prospectus set a target to double direct sales to 24% of total revenue for FY18, but actual FY18 results showed this had already increased to 29%.

Accelerating growth into FY19 and reported FY18 results

The prospectus included no financial forecasts, but did include a June 2018 target of 45,000 users across 75 schools. In a quarterly update to the market in late April, ReadCloud announced it had at that point surpassed 50,000 users across 70 schools and that, following a significant increase in inbound enquiries from potential new schools, the sales pipeline ahead of the 2019 school year was at record levels. In a late July 2018 update the company disclosed that the sales pipeline for CY2019 was more than 6 times the level of the pipeline at the same time last year.

In the April 2018 update, the company noted that the $500K FY18 EBITDA hurdle (needed to trigger a portion of performance rights held by management (more on these later)) would not be met due to the decision taken to scale up its workforce to meet the strong sales pipeline. While management easily met the first half of the Class A performance rights target with 8 months to spare, the decision to pull forward expenditure into FY18 in order to accelerate the growth trajectory in FY19 (and “sacrifice” a portion of management incentives in the process) is noteworthy. However, the FY18 EBITDA hurdle may not have been met, anyway, based on the full year FY18 results released yesterday.

The FY18 results confirmed the late July guidance that FY18 revenue exceeded $2 million – a significant increase from FY17, though obviously off a low base. As is not unusual for a newly listed entity, maiden reported full-year results included some significant one-off costs related to the IPO (presented below Underlying EBITDA (management’s definition) below).

As noted above, the company previously did not incur corporate expenses associated with being a listed company: blue shaded costs below are management’s estimates of these costs from FY15 to FY17 (which seem a little on the low side), included in Underlying EBITDA in the FY18 results.

The first thing that stood out to me from the FY18 results is the unexplained significant increase in publisher & bookseller fees – from ~30% of sales between FY15A and FY17A to ~73% of sales in FY18A – and the resulting decrease in gross profit margin. The annual report commentary explained this away as “a result of growth in sales during the period”, but this was unexpected (to me), and a 559% increase in cost of sales on a 189% increase in sales revenue – which looks like it may contain a large one-off payment – requires some explaining in my view.

All else being equal, if ReadCloud had generated the same ~68% gross profit margin for FY18 as it did in FY17, Underlying EBITDA would have been $723K higher (and $576K instead of -$147K). Approximately $0.7M of R&D costs were capitalised during the year.

FY19F and management performance rights

The expansion of the sales and marketing team flagged in the prospectus (which has driven the significant increase in the CY2019 pipeline as noted above) is behind the material lift in employee operating costs in FY18. The June 2018 4C included estimated quarterly cash operating expenditure outflows of $430K (excluding ~$300K of R&D spend, the majority of which I’d expect to be capitalised). This suggests that the annualised cost base of the business is now closer to ~$2M at the commencement of FY19. This sounds “about right” given the business is probably targeting revenue of around $7.5M for FY19F – being a trigger for management’s performance rights (discussed shortly, I promise).

I say “probably” because no formal FY19 guidance has been provided by the company (just as no forecasts were included in the prospectus). The FY18 results press release also did not provide a further update from the positive commentary included in the June quarterly 4C (just one month ago, to be fair). Shareholders will already have surmised that the company is not “flashy”, and doesn’t bombard the ASX announcements department (if there even is such a thing) with bombastic press releases on its progress.

I don’t mind this at all – I prefer management to be focused more on execution and growing the business, and less on spruiking the company on Soviet-era-looking internet forums and engaging in nefarious behaviour on Twitter. But it does mean there may not be a further update on progress until ReadCloud’s AGM in November.

So – as with all genuine high-growth companies, this is going to come down to execution. Specifically, the conversion of the strong sales pipeline communicated by the company, into actual sales.

Cash at the end of June was $4.5 million (noting $5.5 million was raised in February). The company has flagged previously that the December and March quarters are the seasonally strongest quarters from a cash flow perspective. This is to be expected with Australian school years commencing in January / February and school curricula presumably purchased between November and March.

The June cash balance of $4.5 million should comfortably fund operations through the quieter September quarter, and through the seasonally higher Q2/Q3 sales cycle – but clearly actual sales conversion will be critical for cash generation through the back half of FY19 (duh, Gent). And then, through the seasonally quieter first quarter of FY20.

Now, to the performance rights. As brazenly noted in the May 2018 investor presentation (Thorney Group, who put on the conference, holds ~13% of the company), “management are rewarded for doubling user numbers again for FY19”. The full suite of management’s performance rights – which vest in halves (50%/50%) – comprise:

Class A: 45,000 users by December 2018 (met); 100,000 users by December 2019 (pending)

Class B: FY18 revenue of $2M (met); FY19F revenue of $7.5M (pending)

Class C: FY18 EBITDA of $500K (not met); FY19F EBITDA of $2M (pending)

Class D: share price VWAPs of $0.30; and $0.40 for 30 consecutive (presumably trading) days (likely met, given the share price has not been below $0.40 since 18^th June).

Shareholders will be hoping that management are successful in triggering the FY19 $2M EBITDA hurdle above. The big question is whether they mean reported or underlying EBITDA. If it is reported EBITDA, the majority of this $2M EBITDA would fall to NPAT. In this scenario, investors can dream of a ~20-25x P/E ratio for FY19F (based on yesterday’s $0.43 share price). Claude’s note: colour me sceptical.

Business momentum heading into FY19 is strong based on management commentary. The May 2018 investor presentation referenced a significant shortening in the sales cycle – via two examples of a successful sale to a large school in 2017 (4 months) versus another in 2018 (3 weeks). The company attributes this to growing awareness of ReadCloud’s platform – which will be key to meeting FY19 targets. Also key is likely to be a partnership with the Queensland Secondary Principals’ Association (QSPA) which was announced in May, and which gives ReadCloud exclusive marketing access to 175,000 students in 210 Queensland schools over a 30-month period until November 2020.

Looking beyond FY19: dare to dream

ReadCloud’s stated target market is the Australian secondary school sector, comprising 2,700 schools and 1.6M full time students – but there doesn’t seem any natural impediments to expanding into the adjacent Australian primary or tertiary markets, or indeed moving offshore. The company cited a forecast by business intelligence firm ORC International that 63% of Australian schools (~1,700 of the 2,700 schools above, likely to be in the region of 1M students) will be completely digital by 2020.

In the company’s characteristically un-flashy manner, the May 2018 investor presentation also casually included a line referencing the $5.8 trillion global education market, 2% of which is digital according to IBIS. ReadCloud’s existing alliances with global publishing giants would likely position it well for any future international expansion – though we are getting a little ahead of ourselves in daring to dream these dreamy little dreams. Management’s near term focus is, rightly, on the Australian secondary school market, and on converting the strong pipeline leading into the CY19 school year. Nail that first, global domination can come later. Cool? Cool.

Going forward, as with most SaaS companies, ReadCloud’s platform should be inherently scalable as it adds users, with the potential to generate significant ROIC in future years if/when the product gets real traction.

Small cap volatility

While the potential growth runway is undeniable, and the recent trajectory is impressive, readers should note that ReadCloud is on the more speculative side of the spectrum. At yesterday’s closing price of $0.43, its diluted market cap is under $50 million. Trading is relatively illiquid and the stock is not widely known at this point (certainly not big enough to have attracted broker coverage just yet).

Recent price action has been volatile. Its late May investor presentation drew the market’s attention to the strong growth in FY18 and potential market opportunity. The share price ran from $0.33 at that point to $0.45 in the week preceding the release of its June quarterly 4C statement in late July. The quarterly 4C confirmed full year revenue of $2.1M and so the share price quickly ran up to its all-time high of $0.62 in mid-August. However, the share price retreated to $0.47 immediately prior to the release of results (potentially profit taking and nerves ahead of results), and plumbed an intraday low on Wednesday of $0.41. Savvy investors will note however that the sell-off from $0.60 on 21 August down to $0.43 yesterday has been on very low volume – only ~850,000 shares traded in total over this 7-day trading period.

As noted above, there is potentially an information vacuum for the next 2-3 months until a further update is provided at the November AGM. At that point in time, the company should have reasonably good visibility as to pipeline conversion and what the start of the CY2019 school year will look like. Until then however, the share price may be volatile and potential investors will need to determine for themselves if ReadCloud is in line with their risk appetite.

Disclosure: I (@Fabregasto ) own shares in ReadCloud – accumulated between February and early August 2018 at a VWAP of $0.396 – and may buy more shares in the future – but not for at least 2 days after the publication of this article.

Note from Claude:

This is an excellent and thorough piece of writing about a relatively unknown and fascinating small company. I own shares in Readcloud and I am inclined to purchase more in the future (not for at least 2 days after publication, though).

However, I note that there are unanswered questions. First, why did gross margins take a hit? Second, do the performance rights trigger with underlying EBITDA? And Third, why, if management are focussed on the business, is one of the performance rights hurdles based on share price?

In my view the decision to incentivise management based on a temporary share price trading range lacks a compelling rationale. So although I like this stock; I own this stock; and I may buy more of it: I am cautious.

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Disclosure: The author (aka the Gentleman), and Claude Walker own shares in RCL at the time of publication. This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.