Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the D2L Inc. Fiscal 2023 first quarter results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided for you at the time. If anyone has any difficulty hearing the conference, you may press star zero for operator assistance at any time. Listeners are reminded that portions of today's discussion will include statements that contain forward-looking information. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from a conclusion, forecast or projection in the forward-looking information. Further, certain material factors or assumptions were applied in drawing a conclusion or making forecasts or projection that reflects in the forward-looking information.
For identification and discussion of such risks, uncertainties, factors, and assumptions, as well as further information concerning forward-looking statements, please refer to the risks identified in the company's annual Management's Discussion and Analysis of most recently filed Annual Information Form. In each case, as filed under the company's profile on SEDAR at www.sedar.com. In addition, during this conference, reference will be made to various non-IFRS financial measures, including annual recurring revenue, or ARR, adjusted EBITDA, and free cash flow. These non-IFRS financial measures do not have any standardized meanings prescribed by IFRS and may not be comparable to similar measures presented by other public companies.
Please refer to the company's MD&A for the first three months ended April 30th, 2022 for more information about these and certain other non-IFRS financial measures, including, where applicable, a reconciliation of historical non-IFRS financial measures to the most directly comparable IFRS financial measures from our financial statements. This morning's call is being recorded on June 9th, 2022 at 8:30 A.M. Eastern Time. I would now like to turn the call over to Mr. John Baker, President and Chief Executive Officer of D2L. Please go ahead, sir.
Thank you, operator, and thank you everyone for joining us this morning for our Q1 earnings call. I'm joined by Melissa Howatson, our CFO. After markets closed yesterday, we released our Q1 fiscal 2023 financial results for the period ending April 30th, 2022. You can find this information on the investor section of our website at D2L.com. Please note that the results we're discussing today are in US dollars unless we indicate otherwise. It was a solid start to fiscal 2023 against a favorable market backdrop. Our total revenue for Q1 was up 21% to almost $42 million. Our Q1 annual recurring revenue increased by $23 million or 17% over the same period last year, and we ended the quarter at $159.3 million in ARR.
We're also pleased to see even faster growth in our gross profit of 26% over the last year. Overall, we see continued healthy demand environment as more schools, universities, and businesses invest in digitally enabled learning, consistent with the view that we've had since the IPO. Our conversations with academic and business leaders reinforce the pressing need for investments in better learning experiences. During past economic cycles, our business has benefited from the resilience of our end markets, and our expectation is that investments in improving learning outcomes will be largely unaffected by the macro conditions. In fact, in the corporate setting, labor market tightness is emphasizing the importance of better onboarding and upskilling for employees. You don't have to look hard for evidence.
For example, Statistics Canada recently reported that unfilled job positions reached record levels at the end of March, and you can see the same trend in the U.S. This intense competition for talent bodes well for our corporate business. It's acting as a tailwind. As we work to capture the market demand, the war for talent that most of the technology industry is currently experiencing has been a headwind as it's taken us time to build our sales and marketing capacity globally. Identifying, recruiting, and training sales and marketing personnel always requires significant time and attention, and that's even more pronounced today. Nevertheless, we're competing well in the circumstances and scaling the team, supported by our mission-driven culture and with the help of Brightspace to support an exceptional onboarding experience. These delays, along with the impact of foreign exchange, have affected our revenue growth outlook for fiscal 2023.
Melissa is going to go through the details in a minute. While it's disappointing to lower our growth expectations for the year, I want to be very clear this is not a reflection of the market opportunity changing. The market dynamics we have talked about remain strong, and we continue to expect healthy organic new bookings growth for fiscal 2023. It's just expected in the back half of the year. Bottom line is that we're adding the capacity we need to drive our sales pipeline and cultivate customer relationships. These near-term challenges aside, we are adding great new clients to the D2L learning innovation platform while continuing to strengthen the value proposition for our users through our investments in our platform enhancements. Our new implementation win rates in markets like higher education continue to climb year-over-year as we invest in our platform to pull ahead of our competitors.
It was another active and productive period in higher education. Domestically, we signed new customer agreements with Brock University, one of Canada's top post-secondary institutions, to deliver D2L Brightspace to more than 19,000 students. In the U.S., we signed agreements with two prestigious universities along the East Coast to deliver D2L Brightspace to tens of thousands of students. Building on our strong footprint in the Netherlands, Breda University of Applied Sciences selected D2L. Now more than half of the top universities in the country use D2L. Also, on the international side, the University of Limerick chose Brightspace to build a flexible technology-enhanced learning platform for more than 16,000 students. In K12 education, among many other new customer wins, we recently welcomed Orange Lutheran High School, which chose D2L Brightspace to support flexible, personalized approaches to online schooling.
We're working hard to efficiently onboard one of our largest customers, British Columbia Ministry of Education and Child Care, with the majority of school districts indicating they'll start the rollout this summer. Our teams in education continue to be encouraged by the prospects and the outlooks. In corporate, our fastest-growing market, we also had a good start to 2023. Among many new customer wins, we welcomed the National Payroll Institute, which sets the professional standard of excellence and sharing of critical expertise.
The institute will soon be providing their digital designation programs through D2L Brightspace. We also signed up Reading in Motion, a nonprofit organization dedicated to helping young learners read, to deliver programming for students and professional development for staff. I spend a lot of time talking to business leaders, and I can't recall a period when the topic of talent acquisition and retention has been more front of mind.
Given these challenges, organizations are increasingly investing in technology tools to support a better onboarding experience and a more modern competency-based upskilling that helps them retain and attract talent. We continue to make investments to pull away from our competitors as we deliver best-in-class experiences for our clients. Market-leading customer support and product innovation have always been key success drivers for D2L. On the services side, during Q1, we expanded the suite of personalized offerings to provide D2L Brightspace customers with enhanced management of learning administration, learning and creative services, and better insights from data to support better learning experiences and improved outcomes for our clients. On the product side, we recently introduced Brightspace Creator+ as an early access program. Creator+ makes it easy for subject matter experts to build highly engaging learning experiences.
It includes a package of beautifully designed templates, drag and drop interactives, video capture, and practice exercises that allow creators to craft inspiring and instructionally sound content with ease. We're also enhancing the Brightspace platform through our growing partner ecosystem of over 1,800 integrated technologies. D2L has always kept the learner and educator at the center of our platform design. We believe this is a key reason why Brightspace is regularly recognized as the best-in-class offering. We proudly announced that D2L Brightspace was the finalist or award winner in nine categories, including Best Learning Management System and Best Personalized Learning Solution at this year's Software and Information Industry Association CODiE Awards, the industry's only peer-recognized awards program. At this point, I will pass it over to Melissa, who will discuss the financial results in more detail. Thanks, Melissa.
Thanks, John, and good morning. Our full Q1 statements and MD&A were filed last night, so I will focus my comments on the key highlights for the quarter. Total revenue for Q1 increased by 21% to $41.9 million. Recurring subscription and support revenue was $35.8 million, up by $5.2 million or 17% over the same period last year. This growth reflects new customer wins coupled with revenue retention and expansion from existing customers. While the total revenue growth was above 20%, the subscription and support revenue for Q1 could have been stronger and we're working hard to make up this ground in the back half of the year. It was a particularly good first quarter for professional services and other revenue, which increased by 54% to $6.1 million.
The results for the quarter were driven by several significant delivered professional services engagements, including new customer implementations and content development work for new and existing customers. This higher level of activity speaks to larger implementations underway with a positive impact on subscription and services revenue emerging in the back half of the year. A high level of professional services engagement typically drives better experiences and outcomes for our customers and greater retention for D2L. As John mentioned, another highlight in the period was the gross profit and gross profit margin performance. Gross profit increased by 26% to $26.4 million, and gross margin was 62.9%, up from 60.5% last year. The year-over-year improvement reflects growth in revenue outpacing related increases in cost of revenue, in particular for subscription and support revenue.
Gross profit margin for subscription and support increased by more than 400 basis points to 68% in the current period. The increase is due to our engineering team continuing to optimize our cloud technology, which improves our cost of delivery. It also reflects easing COVID-19 restrictions and the return to more in-person learning, which meant our platform was used for both blended and online learning rather than a more fully online experience in the prior period. Q1 operating expenses were $30.8 million, an increase of 35% over last year, mainly due to higher employee headcount to support the business growth. With a strong balance sheet, fiscal 2023 will remain a year of investment for D2L.
At the same time, as we presented in our updated outlook, we are strategically prioritizing our investments and placing a heightened focus on cost optimization across the business. We are investing in growth with confidence born from our established history of disciplined spending and profitability. In terms of operating profitability, Q1 adjusted EBITDA was a loss of $1.5 million or negative 3.6% margin, compared to a loss of $95 thousand or negative 0.3% margin in the same period last year. The Q1 EBITDA loss reflects the planned increase in our OPEX to support future growth. We reported negative cash flows from operating activities of $15.3 million in the current period, a 23% year-over-year improvement from negative cash flows of $19.8 million in the prior year.
Q1 free cash flow also improved to -$16.2 million, compared with -$19.9 million in the prior year. As we have stated previously, cash flows from operations generally have a seasonal low in the first quarter each year and a seasonal high in the second and third quarters due to the timing of annual invoicing with our higher education customers in the United States. We finished the quarter with $98.1 million in cash and no debt, leaving the company very well positioned to take advantage of the favorable growth trends in our market. With today's results, we updated guidance for fiscal 2023 to reflect lower revenue growth and reduced adjusted EBITDA loss.
Specifically for fiscal 2023, we are expecting total revenue in the range of $175 million-$178 million, implying growth of 15%-17% over fiscal 2022, and adjusted EBITDA loss in the range of $9 million-$11 million. The change in the expected revenue growth for fiscal 2023 mainly reflects the time required to ramp our sales and marketing teams, in addition to the impact of changes in foreign exchange rates, in particular, the strengthening US dollar. Recall that roughly 45% of our revenue is from outside the US. In addition, we are now expecting a lower adjusted EBITDA loss in fiscal 2023, reflecting disciplined cost optimization and prioritization of our investments, thereby putting us on an accelerated path to profitability. I will now turn it back to John for closing comments.
Thanks, Melissa. Before we open the call to questions, I want to leave you with four key points. One, our business fundamentals remain strong, and we expect that to continue. Two, we've seen a short-term impact on revenue growth velocity due to FX and the timing of sales and marketing hiring, which we're addressing. Three, the market backdrop remains strong as organizations invest in better learning experiences across all customer groups. Four, we're making progress on operational excellence, including product gross margins, which is giving us a faster path to profitability. With that, we'd be happy to take your questions. Back to you, operator.
Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, it is star followed by one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. Our first question today comes from Daniel Chan from TD Securities. Please go ahead. Your line is now open.
Hi. Good morning, guys. Just wondering if you could help quantify how much of your revised guidance is due to FX and how much of it is from the slower hiring?
Morning, Dan. Thanks for the question. It's really a mix of both of those. There is some FX and some of the slower hiring. It's not one that's more predominant than the other. It's a combination of both.
Okay. Thanks for that. Given your higher EBITDA guide for the year, should we expect this to be an acceleration of your margin goals, or should we expect hiring and expenses to catch up throughout the year to put you back on your original plan?
We're tracking well on our gross margin improvements, and we do expect to continue progress there. But there will be some back-end loaded hiring that will happen as well. Although I would point out that we do have some lumpiness in spend. For instance, we have our Fusion annual user conference in Q2, and this year will be our first return to an in-person conference, which we believe is actually gonna be really helpful with building pipeline and solidifying customer and prospect relationships. It will take some time for some of the operational efficiencies to scale in the back half of the year. In general, EBITDA losses will be lower in the back half of the year.
Okay, thanks for that. Finally, is your fiscal 2025 target still valid?
It is. The medium-term model is still valid.
Great. Thanks. I'll pass the line.
Thank you.
Thank you. The next question today comes from Thanos Moschopoulos from BMO Capital Markets. Please go ahead. Your line is now open.
Hi, good morning. Just maybe expanding on that last point. If the fiscal 2025 target is still valid, that would imply an acceleration in revenue growth in 2024. Is that the right way to think about it?
Yes, that's right. We do think that, you know, we have, once we catch up on the sales capacity, we'll have some acceleration that happens with bookings in the back half of this year as well, as well as into fiscal year 2024, and that's what will help keep the model in effect.
Great. In terms of the delayed hiring, is it impacting a particular segment or geography more than others? You know, corporate versus higher ed versus K-12, international versus North America, or is it kind of across the board?
It's a great question, Thanos. It's across the board. Our corporate team is doing a fairly good job in terms of staying at capacity. Across education and our global groups, we're definitely seeing pressure on the war for talent.
Okay. On the macro side, I mean, you know, I think it stands to reason that education customers are gonna be macro resilient. But just to clarify, you know, on the corporate market as well, you know, are you seeing any signs of a slowdown or is it kind of, you know, business as usual given all the macro stuff happening?
Another great question, Thanos. I spent some time traveling, visiting with some of the different CEOs of companies, visiting with our clients in different regions. It's very clear that we're not seeing any slowdown. In fact, the opposite. We're seeing more demand for better onboarding experience for companies to retain, to attract talent, more demand for upskilling. We're certainly seeing that in a number of initiatives that are rolling out both within our client base as well as within governments around the world. We see the same thing in higher education. There's a lot of demand for improving the online learning experience.
We just did a recent survey which showed less than 1% of the folks that we surveyed wanting to return to just the way it was pre-pandemic. Very clearly seeing a mix of both on campus and online in the academic space as well too. Big picture, addressable market still looks great. We're trying to increase capacity to improve our participation rate. Win rate looks really good, and that's giving us the confidence in the model and confidence in the fundamentals of the business.
Great. I'll pass the line. Thanks.
Thanks, Thanos.
Thank you. The next line today comes from Christian Sgro from Eight Capital. Christian, please go ahead. Your line is now open.
Hi, good morning. I wanted to talk about the visibility into bookings, you know, kind of growing into the back half of the year. D2L's always had good visibility with the subscription model. Just wondering, my question is, do you see the booking strength coming from some of the recently announced customers and their plans to get onto the platform and expand? Or do you think that some of the booking strength will come from new customer wins and new activity that will start in the back half of the year?
Yes. A great question, Christian. The core run rate business is healthy. If you look at the bookings that we're doing in terms of new client adds, we definitely see that still being healthy and picking up pace in the back half of the year. There's a good pipeline of opportunities that are in our core markets globally. Yeah, no, I think that's probably the quick answer.
Okay, that's helpful. I'll ask one more question on the headcount. There's been a couple of questions here already, but maybe in terms of some more specifics, you know, how hiring is going across different teams. I mean, if I understood Melissa correctly, it sounds like the plan is still to hire aggressively into all areas, maybe through the year. Like, has your, let's say, ultimate plans for sales team headcount, you know, changed into the year? Or is that all maybe just pushed out, but still the same?
We've largely kept the headcount just in terms of openings, in terms of job queues things you mean, Christian? If so, yes, we've largely kept that intact. There's no change there. We've just been slower to acquire the capacity that we need to support the growth that we're looking for.
Just to add, our focus there is really on that quota-carrying capacity as well as that, what those that help build pipeline.
Okay, perfect. I'll ask just one more question today. You know, a rounded CAD 100 million of cash on the balance sheet. Wondering any thoughts on M&A, if your perspective there has changed or, you know, if organic initiatives will see the focus through the next bit here.
Our story to date has been an organic growth story. We're still focused on that in the near term. That said, there is opportunity for us to expand growth through M&A. We are still taking a look at that strategically, Christian. Good question.
Okay, perfect. I'll pass the line. Thanks for taking my questions this morning.
Thank you.
Thank you. The next question today comes from Doug Taylor from Canaccord Genuity. Please go ahead. Your line is now open.
Yeah. Thank you. Good morning. You've spoken to an accelerated, you know, path back to profitability with these results. I think you said the medium-term targets fiscal 2025 remain intact. I guess I'm asking you know, can you quantify or detail what you mean by that accelerated path back to profitability? Is the break even timetable been moved forward, or are you signaling just a shallower kinda trough before you kinda arc back up towards break even? That'd be helpful.
Sure. Our current view is that we will achieve break even sooner in fiscal year 2024, and more importantly, that we will be cash flow positive.
That's helpful. Let me ask a couple questions, I guess, about the very strong professional services. You detailed that was kind of in advance of what you expect to be more substantial subscription growth in the back half. Should we be expecting that pro serve line to remain at these elevated levels over the next couple quarters?
For this quarter, that does reflect some significant growth in new customer implementations and content development work for both some new and existing customers. There is always some lumpiness to that kind of work based on the implementations that are going through. That would not necessarily be a trend we would expect going forward. You will have seen in the past some of that lumpiness, and there will be some of that that continues in the future.
Okay.
I think just adding to what Melissa.
Go ahead.
Oh, sorry, Doug. Yeah, just adding to what Melissa was saying there. I think it is still a good indication that clients are investing in building out new online programs, investing in their online offerings. We're not seeing that going away. We actually see that as a big opportunity. There may be some seasonality, as Melissa pointed out, where you know folks might not be working as hard on this over the summer, or they may be working harder. I'm not sure yet. You know that lumpiness is certainly there, but the general trend is more investment in building online programs. Both in-
Okay. One last question.
Education and in corporate.
Okay. One final question from me. I mean, the gross margin gains, I think what you're signaling is that those are the efficiencies and the benefits of the technology investments you've made should be permanent from here. Should we be expecting, you know, given the mix shift from pro serve to subscription for that to continue to trend higher towards the back of the year, and all the investment that you're making in sales and marketing and other, you know, will be focused more on the operating expense line rather than gross profit or cost of goods sold?
I think there's a couple parts to that. I think on the mix of professional services versus software. No, I think we're gonna probably trend back to where we were previously, Doug, on that front. You know, we definitely are investing heavily into making sure that we're growing our software business. The 90-10 rule should be something that we're trending back to. Q1 might have been a bit of an anomaly there. I don't know, Melissa, if you want to take the other part of that question or did that answer the question, Doug?
Yeah. I guess there was just one, you know, follow-up on the permanence of some of the gains you've made in gross margins, you know, over this quarter or year-over-year.
Oh, sure. Yeah.
Yeah. We do expect-
Any other-
Those to continue. We do expect those improvements to continue to trend, and we do continue to focus on optimizing as we make our way towards that midterm model.
Yeah. Doug, just building on that again, you know, there is a good, healthy pipeline of things that we can do from a gross margin improvement as we continue to invest in our cloud offerings, so that we should see that path to the mid-term model that we've already guided.
Wonderful. I'll pass the line. Thank you.
Thanks, Doug.
Thank you. The next question today comes from Brian Peterson from Raymond James. Please go ahead. Your line is now open.
Thanks, John. Thanks, Melissa. John, first one for you. If we step away from the fiscal year 2023 or fiscal year 2024 dynamics, because it's kind of hard to call the timing for some of the stuff, particularly for your higher ed or K-12 customers, what does that pipeline look like? And if you're thinking about the displacement or replacement of some of the legacy solutions, like what does the pace of change look like over there over the next, let's call it three to five years?
That's a great question, Brian. The pipeline today looks very healthy. I don't think I've had a time where we've seen more large deals flowing into the pipeline for future implementations. We were just looking at it yesterday, again in a bit more depth. It's looking very healthy as we look out into the back half of this year and into next. I think generally speaking, many of the institutions in the education space were in a bit of a lockdown as part of the pandemic, and they're now starting to open back up and are looking for a better experience both on campus and online. The idea of going back to just simply supporting on campus only doesn't seem to be the path forward for many of these institutions.
We see a great opportunity to replace legacy technology, think dated technology that doesn't support mobile very well, or still has maintenance windows, still isn't fully accessible. These are great opportunities for us to move clients to a more modern platform that provides a world-class experience. I think that trend is gonna continue to pick up pace, back half of this year and into next as more and more organizations start to implement those strategies now that they've come out of this pandemic. We see similar on the corporate side, Brian. You know, for many of the CEOs I'm talking to, talent attraction and retention is the number one priority.
If we can go in with a better onboarding experience, as a great example, and reduce the churn of new hires, it has a material impact on the companies that we're working with, where they will be saving, in some cases, CAD millions, as they roll out our technology to support that better experience because they're not churning as many individuals. On the tight labor market, I think you're gonna see a lot of companies leaning into upskilling their current employees to be able to provide a better experience for, not only the future of their company, but also a better experience for the new hires that they've just made to retain the talent. These bode very well for our new initiative, D2L Wave.
They also bode very well for our core Brightspace offering, where we can provide that better experience for learning.
Understood. Thanks, John. Maybe just kind of double-clicking on some of the go-to-market questions. Has there been any change to Salesforce retention? I'd be curious if, is it more about net new hires, or has there been any change on retention? Maybe you could talk about some of the partner channel efforts. I know that that's driven some of the new deals internationally in the first half of the year. Well, I guess first half of the calendar year. You know, any help on understanding the contribution that partners may mean to the go-to-market going forward? Thanks, guys.
Yeah, no, it's a great question. Great couple questions there. On the partner side, we are definitely leaning in with our partners to drive acceleration in partner-driven revenue. We've talked about that, incorporating that into about a doubling of the revenue coming in from channel partner in the last couple of years. We want to see that continue as we look out, as we continue to scale those efforts. That's a key priority for us. We're not seeing any change there. That seems to be a pretty solid way for us to grow globally. The war for talent has had an impact on some of the retention as well as on the recruiting side. Just being very transparent there.
That's that to us is really important and we're addressing both of those strategies.
Thank you. As a reminder, if you would like to ask a question, please press star followed by one on your telephone keypad. Next question today comes from John Shao from National Bank. Please go ahead. Your line is open.
Good morning, guys. Thanks for taking my question. I just have one question regarding the professional services, which is obviously very strong this quarter. My question is, to what extent can we think the PS revenue is a leading indicator of future growth in ARR?
That's a great question. It definitely. The way we think about professional services is they really help to set up a customer well for future adoption of the system and those who are buying learning creative services as well. It creates more stickiness and retention with customers, so it's definitely a strong sign about future growth in our ARR.
Thanks. I'll pass along.
Thanks, John.
Thank you. There are no additional questions waiting at this time, so I'd like to pass the conference over to Mr. John Baker for closing remarks.
I just wanna say thank you for joining us on today's call. We're really looking forward to updating you again on our Q2 results in the near future. I wish everyone a happy day. Thank you, everybody.
That concludes today's conference call. Thank you for your participation. You may now disconnect your line.