Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the D2L Inc. Fiscal 2023 Q2 Results Conference Call. At this time, all participants are on listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided for that at the time for questions. If you have any difficulty hearing the conference, you may press star followed by zero for operator assistance at any time. Listeners are reminded that the 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 product projection in the forward-looking information. Further sets of material factors or assumptions were applied in drawing a conclusion or making a forecast or projection as reflected 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 or most recent filed annual information form, in each case, as filed under the company's profile on SEDAR at www.sedar.com. In addition, during this call, references will be made to various non-IFRS financial measures, including constant currency revenue, annual recurring revenue or ARR, and constant currency annual recurring revenue, adjusted EBITDA and free cash flow. These non-IFRS financial measures do not have any standardized meaning 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 three months ending July 31st, 2022.
For information about these statements and 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 September 8th, 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 on our Q2 earnings call. I'm joined by Melissa Howatson, our CFO, and Stephen Laster, our COO. After markets closed yesterday, we released our Q2 fiscal 2023 results for the period ending July 31st, 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 U.S. dollars. We're here to build the future of work and learning, and as we look forward, we see healthy long-term demand across all our markets as organizations replace legacy technology and experiences with modern platforms built to engage and inspire learners of all ages. During our Q2, we held our first in-person users conference in three years, and we're very pleased with the success of the event.
We had great participation from current customers who were excited to return to an in-person event and from prospects who were considering Brightspace as a replacement to their current vendor. Our team walked away from the conference with an even greater conviction in D2L's value proposition and competitive differentiation. Our investments in our learning platform and in things such as video capabilities, ease of use, artificial intelligence, and our team's relentless focus on customer service. These investments were well received by our customers and prospects. The hard work D2Lers are putting in to building a world-class product and services is helping D2L stand out as the leader in learning innovation and enable us to grow our users and retain our customers for the long term. Turning to our Q2 financial highlights.
Total revenue grew 12% and constant currency revenue, a new measure we introduced this quarter, grew 15% to $42.4 million. For the year to date, total revenue is up 16%, and constant currency revenue rose 18%. Annual recurring revenue increased by 10% to $158.5 million, and constant currency annual recurring revenue increased 13% to $162.4 million. Our gross profit continues to grow, increasing by 13% in the Q2 and 19% for the fiscal year to date. Gross margins are trending stronger, and we're putting in the effort for continued improvements. Although this represents healthy organic growth year over year, the overall pace of new business closing in the Q2 was slower than expected and was affected by several factors.
In particular, as we discussed during our Q1 reporting period, in a competitive talent market, it's been difficult to build sales and marketing capacity and to bring these new team members up to full productivity in the time required to influence this year's results. While we're optimistic, we are turning the corner. Unfortunately, this affected the total volume of opportunities in a pipeline and our ability to cultivate prospects and ultimately convert them to ARR. This dynamic, combined with elongated buying cycles in our corporate market, as well as the impact of changes in the foreign exchange rates, led us to reduce our revenue growth expectations for the fiscal year. Given our current performance, and as we look ahead over the medium term, we believe the best path forward is to balance our pursuit of top-line growth and long-term market leadership with a heightened focus on profitability.
Melissa will cover the revised outlook in her remarks. That said, we remain confident in the business fundamentals with strong long-term market demand, healthy gross margins, long-term contracts, and high customer retention. We're pleased with our win rates, which tell us our investments are working as we have a winning platform. These attributes provide a solid foundation for future growth. Turning back to the operational highlights, we're adding great new clients to the D2L learning innovation platform while strengthening the value proposition for users through continued enhancements to our product and to add-on packages, including the launch of our early access program for Creator+. In higher education, our largest market, our new implementation win rates increased to above 50%, both in North America and Europe. This bodes well for future growth as we strive to become the market leader.
We signed a new customer agreement with the University of Windsor to deliver D2L Brightspace to transform the learning experience for their 17,000 students. Building on our success in the U.S. East Coast, we signed up Bentley University in Massachusetts and St. John Fisher University in New York. We also signed a new customer agreement with Colorado Christian University, just to name a few. In K12 education, Boston Public Schools, which comprises 125 separate schools, recently selected Brightspace to help it deliver professional learning for all of its staff. In corporate learning, among the new customers this quarter, we welcomed the American College of Lifestyle Medicine, which selected Brightspace to scale the reach of their certifications and to grow their membership conversion rate. Midwest Communications, a radio and digital media company, selected Brightspace to support automation of employee onboarding, training, and development.
In addition to new logo acquisition, we want to grow our share of wallet over time by upselling high-value solutions and services that address clear customer needs. During the quarter, we introduced Brightspace Creator+ as an early access program. Creator+ is a purpose-built solution to support course creators, faculty, and instructors in the efficient development of world-class learning experiences. This product was featured at our users conference, and the early feedback was positive. 84% of customers we surveyed exiting the conference expressed interest in using Creator+ immediately. At this point, I'm going to pass it over to Melissa, who will discuss the financial results in more detail. Thank you, Melissa.
Thanks, John, and good morning. Our full Q2 statements and MD&A were filed last night, so I will focus my comments on the key highlights for the Q2 and year to date. Please note that we introduced new constant currency measures for revenue and ARR. We believe these non-IFRS measures provide a more accurate picture of our performance as they exclude the impact of foreign exchange between periods. Total revenue for Q2 increased by 12% to $41.2 million, and as John mentioned, constant currency revenue increased 15% to $42.4 million. For the fiscal year to date, revenue rose 16% to $83 million and 18% to $84.5 million on a constant currency basis. Looking at the revenue breakdown, Q2 recurring subscription and support revenue was $35.8 million, up by 9% over the same period last year.
For the year to date, subscription and support revenue increased 13%, reflecting growth in new customers coupled with revenue retention and expansion from existing customers. As John mentioned, performance has been weighed down by challenges we've experienced in expanding our sales and marketing capacity and the impact of foreign exchange, among other factors. It was another strong quarter for professional services and other revenue, which increased by 41% to $5.4 million. For the year to date, professional services and other revenue is up 48% over the same period in the prior year. The results were driven by several significant delivered professional services engagements, including new customer implementations and content development work for new and existing customers. I should remind listeners we will continue to see lumpiness in professional services revenue as big projects move through.
A highlight of the Q2 was continued steady expansion of our gross profit and gross profit margins. Gross profit increased by 13% to $ 26.6 million for Q2 and by 19% to $ 52.9 million for the year to date. The improvement reflects growth in revenue outpacing related increases in cost of revenue, in particular for subscription and support. Gross margin continues to trend toward our target operating model. Q2 gross margin was 64.6%, up from 63.9% last year. Gross profit margin for subscription and support was 68.2% in Q2 versus 68.8% last year.
The decrease for the period was attributable to growth in the cost of subscription and support revenues exceeding the growth in the related revenue as a result of increased headcount and related salaries and benefit expenses. Gross profit margin for professional services increased over the same period last year to 40.6%. The growth in services margins primarily reflects improving employee utilization compared to the prior period, which was caused by significant onboarding of service delivery teams. This has improved the revenue generation capabilities for our professional services team. Q2 operating expenses were $31.1 million, an increase of 23% over last year, mainly due to higher employee headcount and related costs in a tight labor market. With a strong balance sheet, healthy growth margin profile, and attractive long-term market dynamics, we are making measured investments for growth.
In terms of operating profitability, Q2 adjusted EBITDA was a loss of $ 1.5 million, or -3.6% margin, compared to a gain of $1 million or 2.6% margin in the same period last year. For the year to date, adjusted EBITDA loss was $3 million, trending significantly better than our previous guidance for fiscal 2023. Adjusted EBITDA was impacted by favorable foreign exchange fluctuations of $ 0.8 million and $ 0.9 million for the three- and six-month periods ended July 31st, 2022. We saw a predictable rebound in cash flow from Q1. Cash flow from operating activities reached $ 16.2 million this quarter versus $ 20.4 million in the same period in the prior year.
This was impacted by lower EBITDA as well as cash flow from operating activities being higher in last year's Q2 due to an out-of-period collection of a significant receivable. In an uncertain economic environment, our strong financial position provides important stability. We finished the quarter with $113.5 million in cash and no debt. With today's results, we updated our guidance for fiscal 2023 to reflect the factors John highlighted, which are expected to result in lower revenue growth and reduced adjusted EBITDA loss.
Specifically for fiscal 2023, we are now expecting total revenue in the range of $168 million-$170 million, implying growth of 11%-12% over the year ended January 31st, 2022, or 12%-14% on a constant currency basis rather than our previous guidance of total revenue in the range of $175 million-$178 million. We are now expecting a lower adjusted EBITDA loss in fiscal 2023, reflecting disciplined cost optimization and a measured prioritization of our investments, thereby putting us on an accelerated path to profitability. Our guidance now calls for adjusted EBITDA loss in the range of $6 million-$8 million rather than our previous guidance of adjusted EBITDA loss in the range of $9 million-$11 million.
In the current macroeconomic environment, we are evolving the target operating model, which reflects the operating levels we expect to achieve by the year ended January 31st, 2025. We are evolving the model towards one of balanced growth and profitability in response to interest rate uncertainty, resulting inflationary and foreign exchange impacts, and near-term pressures on new business growth as a result of our sales and marketing capacity challenges and buying pattern changes within areas of the markets we serve. There is extensive disclosure on the model, both in the press release and MD&A, including our key assumptions. Our medium-term model now includes revenue growth of 12%-15%, adjusted gross margin of 65%-70%, adjusted EBITDA margin of 13%-16%, and free cash flow margin of 16%-19%.
We appreciate this is a meaningful adjustment in how we are viewing the financial progression over the next several years. After thorough review, management and the board believe this achieves the right balance of growth and profitability in the current environment. The learning technology market remains strong, and we continue to capture market share. At the same time, the macroeconomic picture has changed, which gives us less visibility and therefore we are taking a more cautious approach to growth. We are confident we are well positioned to take advantage of this period of time. I will now turn it back to John for closing comments.
Thank you, Melissa. In summary, our business fundamentals remain strong, and we're addressing the sales and marketing capacity issue, which is the primary cause of the lower-than-expected revenue growth. We expect to continue generating solid organic revenue growth while pulling forward the timeline to profitability, and we're still making the investments to differentiate D2L from our competitors as we build the future of work and learning. We appreciate your interest and support, and with that, I'll be happy to take your questions. Back to you, operator.
Thank you. If you'd like to ask a question, please press star followed by one on your telephone keypad. If for any reason you'd like to remove your 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 comes from the line of Daniel Chan at TD Securities. Your line is now open. Please go ahead.
Hi. Good morning. Other than the macro uncertainty, are there any changes in the market dynamic that have caused you to change your midterm target operating model to focus more on margin?
That's a great question, Daniel. When we look at the short-term impact and also the, I guess, the medium-term model, it's primarily driven by the macro conditions, which, you know, in our case, the short-term impact for us. Is on really ramping up the sales and marketing capacity. That's something that we have largely done in Q2, which positions us well for the new model going forward. It did have an impact on this year. If I, you know, look at the investments that we're making still today, we're still making measured investments. We're still building the product to win. Those are things that we are still confident we can go off and do as we drive for this increased acceleration to profitability.
You know, we are well aware of the macro, but we're focused on the things that we can really control, which is why we've taken this route of balancing profitability with growth.
Thanks for that, John. Given that we seem to be in a high demand environment following the pandemic, why is now the right time to shift the model to be more balanced between growth and margin?
It's a good question, especially as our win rates in our core higher education market continue to go up. We've seen now both in North America and in Europe, our win rates are now over 50% of new implementations. You know, as we onboard new sales reps are just taking a more measured approach, as reps come up to speed, and as we lean into that healthy demand market, we should see continued growth. It's very hard for us to be able to forecast growth in excess of this model at this stage until those reps are fully ramped up and until we continue to demonstrate good execution in these uncertain times.
Thanks, John. Just one final one. Your original fiscal 25 target model seemed to have some growth from scaling the team built into it. What's being built into the current fiscal 25 growth target? In other words, can you achieve the new target with the current team, or does it also assume pipeline expansion from new hires?
Yeah. Right now we're still making measured investments, so we are still looking at adding a few more headcount, but none of that is going to be required to execute on the plan for the year. In the short term, you know, we have the people today, we have the capacity today to execute on the plan that we've got for the organization. If there's a silver lining with ramping up new folks, as they are fully onboarded, that gives us expanded capacity for the future as well too.
Thanks, John.
Thank you.
Thank you. Our next question comes from the line of Doug Taylor of Canaccord. Your line is now open. Please go ahead.
Yeah, thanks. Good morning. You said last quarter the pace of RFP activity in core education markets was still well below pre-pandemic levels. Does the change in your stance here today reflect the view that, you know, you think we're unlikely to get back to that prior form in the near and medium term?
Great question, Doug. Our position on that is still largely unchanged. We still have not seen the RFP activity that we saw pre-pandemic. We are seeing it climb. I think we said this last quarter too, you know, the H2 of the year is looking much better than the H1 of the year in terms of RFP activity, in terms of the build. The long-term market demands seems to be there.
This is sort of a, you know, situation where we've got to have the capacity on the sales and marketing side, something that we control, to be able to help prospects through their sales process so that we can get those sales processes wrapped up as fast as possible, so they can get to this new environment where they can support both students on campus and online at the same time. Nothing's changed on the long-term market demand, but we still have yet to drive the market demand that we would expect to be ramping up even faster than we are seeing today. I think the short of it is the demand, the need is there, the problem is there. We've got to do a better job in driving clients through that process.
Next question. Does the change in your forecast signal any shift in the emphasis back on core education versus, you know, the enterprise market?
If we look at where we're making our investments, we still see education being a great growth market for us. As I talked about earlier, our win rates there continue to go in a great direction. We have an opportunity to become the market leader. I feel we're at a stage where we could safely say that we're the emerging market leader, as we look at the new win rates for this year. We've got to demonstrate that over time as we pull away from the competition set.
That said, just the sheer size of the corporate market opportunity, our product market fit that we already have, our investments that we're making to continue to expand into other segments within corporate, that market is just so large that that will outpace our education market in the long term. I don't think this is a situation where education is a market we're moving away from. I want to make that very clear. We want to be the market leader in that space, but we do see corporate outpacing education.
Okay. Last question from me, maybe for Melissa. You've given us this updated guidance for this year and then reset the guidance for two years from now pretty materially. From this, should we assume that your prior view of crossing that breakeven threshold to profitability should happen. Perhaps even sooner than the last update. You know, I think you'd said some point next year. Or is there anything else you can give us to kinda help us connect the dots between these two guidance data points?
Yeah, that's right, Doug. Exactly. Like we said last year, we are looking for accelerating that path to profitability, and we would still see that happening. We're on our way. The guidance we've given for this year and then the medium-term model, it will be a step function getting there, and we would expect to cross that path in terms of the positive adjusted EBITDA to happen next year.
Thank you. I'll pass the line.
Thank you.
Thank you. Our next question comes from the line of Thanos Moschopoulos of BMO Capital Markets. Your line is now open. Please go ahead.
Hi, good morning. Hey, John, your comments around new implementation win rates over 50% in North America and Europe, just to be clear, is that for calendar 2022 year to date?
That's for calendar 2022 year to date. That's correct. Yeah.
Okay, great.
We've seen steady progress in increasing win rates in the prior three years as well. This has been a slow build. Today, the data that I've seen most recently is between 50%-60% of the new implementations so far in those two markets in higher education have gone to D2L, significantly outpacing our competitors.
Now in terms of where you're adjusting the hiring plans and pulling back, are there geographical nuances as we think about North America versus international? Like, are you kind of scaling back the plans equally in both areas or one more than the other?
No, we're still making the measured investments to go drive growth globally. There's, you know, opportunity both here in North America. You know, as you see in the numbers, our U.S. market in particular continues to be a really strong market for us this year. That said, you know, some of our international markets are growing even faster. I would anticipate international will still slightly outpace in terms of hiring North America, even though both markets seem to be growing fairly well. Corporate is another great example where I do expect corporate to outpace slightly education in terms of its investment, just given the sheer pace of growth that we're seeing in corporate relative to education right now.
Okay.
If you look at our roadmap. Oh, sorry. Go ahead.
No, go ahead. Sorry.
No, if you look at our roadmap, it's largely unchanged. I think as Stephen's come on board, I actually feel very confident in our ability to deliver on the product enhancements needed for both these markets. I feel we're in a better spot today than even six months ago in our ability to go off and deliver on those improvements that are gonna make a really big, meaningful impact on our clients, helping them stay very, very happy, and helping us really pull away from the competition and open up in these new markets, both globally as well as within corporate.
Great. If we look at ARR for the quarter, it was down a little bit sequentially. Just to be clear, is that really just FX, or was there any deterioration in terms of customer retention?
It was primarily new business bookings, followed by FX, followed by a small hit on churn. You know, from a logo retention perspective, we're doing really well there. It's primarily onboarding of new clients that, what impacted the ARR for the quarter.
Great. Thanks a lot. I'll pass the line.
Thanks, Thanos.
Thank you. Our next question comes from the line of Brian Peterson of Raymond James. Your line is now open. Please go ahead.
Hi. Thanks for taking the question. John, I wanted to maybe follow up on that last comment on retention. You know, as we're thinking about your logo retention in the different markets and, you know, maybe the upsell dynamic, has anything changed in the growth algorithm at all as it relates to retention? Would just be curious to get your thoughts there.
No. Logo retention remains very strong. I think this really speaks to the investments that we're making in the product and services. Some of you were actually at our users conference this summer. Our clients are very happy with the products, the services. We're well aligned on the roadmap for the future, and we see opportunity to pull away from the competitor set there, which gives us confidence in our logo retention going forward. That said, investing in sales marketing gives us the ability to do more upsell with existing customers, providing them with more services, more products. As we've grown that sales team this quarter, that will have a big impact on our ability to drive additional revenue with existing clients. I'm looking forward to that. You know, we're already seeing early signs of that holding true in the H2 of this year.
Good to hear. John, maybe a follow-up. I mean, you've been in this industry a long time. You know, it looks like we're in a little bit of a challenged macroeconomic cycle. You know, I'd love to get your thoughts maybe on just on customer conversations, you know, either on implementation or spending. I know this end market, at least on the education side, seems a little bit more, you know. Nothing's completely immune, but, you know, I'd just love to get your thoughts on kind of the status of your customer conversations and, you know, anything to call out as it relates to the broader macro, given your experience in the industry. Thanks.
Well, one great thing about holding our users conference in July is we have a really clear picture from clients in terms of feedback, that's pretty real time, if you will. The universities, they are happy. They all want to invest now to support this new strategy going forward in terms of both having students on campus and online, and a lot of students seeing the new normal as being both online courses being taken at the same time as on campus. Same thing for our corporate clients. They're seeing an opportunity for us to support an online learning experience for not only their employees, to do better onboarding, better leadership development, better upskilling, but also to support their clients in providing the education they need to run their businesses.
I've never seen, you know, healthier demand in the market both in corporate and in education. We have seen a bit of an elongated sales cycle in some of these markets, but I think that's largely due to the macroeconomic conditions where clients just have to reset and make sure that their, you know, their strategies align to the new macroeconomic conditions, just like we've done. I hope that shakes out fairly quickly, as you know, the early conversations that we're having with clients, you know, Q2 that have stretched into Q3 show that that is the case. I keep coming back to, I don't see any long-term demand issues here. I think this is a short-term hit.
Understood. Thanks, John.
Yep, you're welcome. Yeah, if I add something, Brian, like, I've also never seen better demand from our competitors' clients looking at our product as a better fit for their solutions for the future, and I think that is new. That's something that, as we look at our feedback from Fusion, really gives us a lot of good confidence that we can open up even more market in the future.
Thank you. Our next question comes from the line of Christian Sgro of Eight Capital. Your line is now open. Please go ahead.
Hi, good morning, and thanks for taking my questions. My first one is, you know, on the return to school. If students are, you know, more fully back in person learning, is there any change you're seeing to academic, you know, customer needs or types of usage on the platform? Are you thinking of your go-to-market or approach, you know, to the academic market differently at all post-COVID?
The quick answer is yes. We are seeing a difference. You know, the key difference being what was considered remote learning, which we did a little of, but that was primarily done through things like Zoom or Teams in the past. That is largely being pivoted away from when we go back to in person. There's gonna be a lot of students on campus, but at the same time, they're gonna be wanting to take an online offering, and the demand for remote is low in that scenario. That's why you're seeing an increase in our professional services. That's largely driven by clients looking to build new online programs. I know this is a bit of a nuance in language, but an online offering is largely not real time.
It's something that you can do at any time during the day, and so the need for the remote technologies like Zoom or Teams, while still gonna be there as part of the mix, it's gonna be less reliant, and that's gonna be a good thing long term. It requires our clients to make investments to build these online offerings, but at the same time, that provides a much better experience for the student and a much better experience for those that are teaching. I think, as clients invest in that, I think it'll make for a more positive experience long term.
That's helpful, John. You mentioned the professional services segment there. There was some positive commentary earlier from Melissa on the utilization and the gross margins in that segment were very strong in the quarter. I recognize it can be lumpy, but I was wondering if you think, you know, we could see some revenue strength or continued gross margin strength, from this quarter with the utilization, you know, with all the deployments going on, what your thoughts are there in the medium term?
Yeah, it's a great question. Like you said, there can be lumpiness in that depending on when things are being delivered. The increase that we had there was because we had some larger professional services engagements that were being implemented and delivered during the quarter. We had also some improvements in utilization. Now that we've got our team, we had a fair bit of hiring last year, and now that they're ramped, we're able to improve that efficiency and delivery within those teams. I really wanna thank our D2L team for their excellence in partnering with our clients in that delivery that happened. We do see some opportunity for ongoing strength in the margins, particularly in that line item, but with the caveat that we will still see some lumpiness.
That's great to hear and helpful color, Melissa. Thanks for taking my questions this morning.
Thank you, Christian.
Thank you. As a reminder, if you'd like to ask a question, it is star followed by one on your telephone keypad. Our final question comes from the line of John Shao of National Bank. Your line is now open. Please go ahead.
Hi, John. Hi, John, Melissa. Thanks for taking my question. The first one is, given the inflation environment everywhere we see today, are there any plans or any discussion with the clients about potentially increasing the solution price at all to mirror the inflation on your OpEx side?
I think the quick answer to that is yes, there is opportunity there. A number of our contracts already have put in place price escalators for inflation or for an annual price increase. I expect that conversation to be a lot easier with clients as we go from year to year or as we go from one renewal to the next. Yeah, that's certainly there.
Okay, thanks. My other question is more to Melissa. When you think about the 65%-75% midterm gross margin outlook, what do you think is the primary driver for that margin expansion in the midterm?
Sure. Great question. The medium term is 65%-70%. The real drivers there are optimization of our infrastructure and our cloud delivery. We have ongoing opportunities to continue optimizing there. In terms of optimizing how we support our clients in our customer support. Since we moved fully to the cloud, we've been on an ongoing journey of continuing to iterate on optimizations, and especially now in the new post-COVID world and the way that clients are operating. As that becomes more clear, that continues to present opportunities. It's an ongoing journey, and you can look back and see the progress we've made to date demonstrates that those opportunities are there and that we're working on them and achieving those gross margin improvements.
Okay, thanks. I'll pass the line.
Thanks, John.
Thank you.
Thank you. As there are no additional questions waiting at this time, I'd like to hand the conference back over to the management team for closing remarks.
Thank you very much, operator, and thank you for joining us on the call today, and thank you for the great questions. We're looking forward to updating you following our Q3 results. Have a great day, everybody.
That concludes today's conference. You may now disconnect your lines.