Thank you for standing by. This is the conference operator. Welcome to the Martello Technologies Group Second Quarter Fiscal 2023 Investor Conference Call. Today's call will provide information and commentary on financial results for the three and six months ended September 30, 2022. You will hear from John Proctor, President and CEO of Martello, and Jim Clark, Martello's Chief Financial Officer. Following these remarks, John and Jim will take questions from analysts. If you have questions following the call, you can reach Martello at investoratmartellotech.com. First, here are a couple of housekeeping notices. All participants are in listen-only mode for the duration of the call. After the presentation, there will be an opportunity for analysts to ask questions. To join the question queue, you may press star, then one on your telephone keypad.
Should you need assistance during the conference call, you may signal an operator by pressing star and zero. This call is being recorded, and we expect that the recording will be available on Martello's website today. Remind that you that today's remarks will include forward-looking statements that are subject to important risks and uncertainties. For more information on these risks and uncertainties, please see the reader advisory at the bottom of Martello's news release, which is on their website and on SEDAR. Company's actual performance could differ materially from these statements. We'll begin with Martello's CEO, John Proctor. John.
Good morning, everyone. Thank you for joining us. I hope you and your families are all well and keeping well this fall. Before Jim and I review this quarter, I'd like to briefly touch on our growth strategy and the private placement announced last week. As you know, Vantage DX is the market-leading SaaS platform we launched just under a year ago. It consolidated several software products into a single solution to prioritize, resolve, and optimize Microsoft Teams performance. In under a year, it has become the Microsoft-recommended Teams monitoring solution, and I'll talk a bit more about that development of our partnership with Microsoft in a few moments. Our objective is to build a profitable business in the coming quarters, driven by this product, Vantage DX.
We are seeing progress in Vantage DX uptake with the number of users on the platform more than doubling in the first half of the 2023 fiscal year, and monthly recurring revenue increasing by 252%. To increase our share of 270 million user Microsoft Teams market, we are continuing to invest in our partnership with Microsoft to increase the size and velocity of our sales pipeline. Microsoft supports us on key sales deals and makes connections to enterprise customers with a need for our solution. They also champion our solution on webinars and in other marketing and sales activities. Similarly, our partnership with Orange is giving us access to large enterprise clients who can see a significant return on investment by adding Vantage DX to their Microsoft Teams deployment, avoiding downtime and productivity loss.
We won our first major client with Orange in Q2 and have several more deals in the pipeline with them. We also want to accelerate our lead to revenue cycle. We are implementing initiatives that simplify our sales process, such as reduction or elimination of Vantage DX trials. Other improvements we've made to the software have made it easier to show value to our clients rapidly and to accelerate the sale. Product stability and consistent feature releases are helping to drive more prospects into and through our funnel. I am pleased with the momentum we're seeing with Vantage DX. It is clearly solving a problem that a growing number of large organizations face. It helps IT professionals to identify when and where problems in their infrastructure will negatively impact Microsoft Teams users and disrupt their productivity. Our Co-Chairman, Terry Matthews, shares my excitement about our solution and market timing.
As we announced last week, he has provided an additional $2 million in capital through a private placement. This additional capital gives us excellent runway to manage lender obligations and grow our Vantage DX business to positive cash flow. We remain focused on achieving positive cash flow, and we took an important step towards this goal with a cost optimized exercise in August, reducing our annualized run rate cost by 20%. We will see the full benefit of these reductions in Q3 of this year, with operating expenses down 9% in Q2. Finally, I want to touch on our Mitel partnership and the hundreds of Mitel partners who use Mitel Performance Analytics, or MPA, the software we developed for Mitel's channel. We continue to nurture and sustain this important partnership. There is growing interest from Mitel channel partners in our Vantage DX solution.
Having relied on MPA for many years to monitor their Mitel solutions, we are a trusted software provider to bring these partners similar monitoring capabilities for Microsoft Teams. The Mitel business line remains a solid, long-term, recurring revenue base from which we can build sustained growth from our Vantage DX solution. I'll speak more about our focus and outlook shortly after Jim provides a more detailed review of our financial performance in the first quarter. Over to you, Jim.
Thanks, John. I will review the Q2 fiscal 2023 financials in some depth in a few moments. First, I would like to share my perspective on the company's performance and how we are driving customer and partner value, leading to shareholder value. Following the recent cost optimization exercise, management has increased its monitoring of performance through robust operational KPIs. As John discussed upfront, management has absolute focus on accelerating our sales and product feature release cycles. These actions, in tandem with careful decisions on spend and cash, will result in Martello achieving sustained profitable growth.
On to the financials for Q2. As always, we have posted our financials and the related press release to SEDAR, where you can review our financials in more detail at your convenience. Q2 revenues were CAD 3.8 million, representing a CAD 0.6 million decrease compared to CAD 4.4 million in Q2 fiscal 2022. The decrease is related to reductions in Sunsetting Legacy products, licenses, maintenance, and support. On a constant currency basis, revenue decreased by about 11%. While we are seeing strong, consistent quarter-over-quarter growth in Vantage DX revenue over the first 11 months since its launch, the cause of the decrease in our top-line revenue is the decline of revenue from some Sunsetting Legacy products. This decline is expected as Vantage DX scaling continues. One anomaly contributing to the decline is the off-boarding of a sizable customer, which had a material impact on revenue.
Management is organized to maximize the conversion of certain Legacy products and customers to Vantage DX. Gross margin was 87% in Q2 fiscal 2023, compared to 90% in the same period of fiscal 2022. The decrease is due to higher hosting costs associated with the growth in cloud-hosted environments led by Vantage DX. Management is taking actions that are expected to result in around a 50% decrease in the cost of hosting instances in the future. As we onboard new Vantage DX clients, the variable costs will continue to reduce. The recurring portion of total revenue is 99%, compared to 98% in Q2 of fiscal 2022. This is primarily attributable to the growing mix of subscription-based licenses. Modern workplace optimization continues to be Martello's dominant business line, with 55% of total revenues in Q2 of fiscal 2023.
Mitel Performance Analytics represented 45% of revenues in the quarter. The Mitel business line continues to provide a steady CAD 7 million annual revenue base that is 99% recurring, as we see strong growth rates from the new Vantage DX product targeted at the Microsoft ecosystem. Q2 monthly recurring revenue, or MRR, was CAD 1.26 million, compared to CAD 1.44 million in the same period last year. This decrease is attributable to declining license, maintenance, and support revenue, primarily on Sunsetting Legacy products, slight decrease in Mitel subscriptions, and unfavorable currency conversion. Just as a reminder, MRR is a non-IFRS measure representing the average monthly recurring revenues earned in a fiscal quarter.
We reached 474,000 Microsoft users on the Vantage DX platform, representing a 33% increase compared to Q1, and a 117% increase in the first half of fiscal 2023 vs Q4. The total number of Microsoft users on all Martello products totaled CAD 2.2 million, compared to CAD 2.9 million in Q2 of fiscal 2022. As discussed above, the decrease was led by the off-boarding of a Legacy GSX partner. The company is maintaining absolute focus on driving Vantage DX growth in partnership with Microsoft and our expanding sales channels. Operating expenses decreased 9% year-over-year to CAD 4.69 million in Q2 fiscal 2023 from CAD 5.14 million in Q2 of fiscal 2022.
The decrease is primarily attributable to the headcount reductions in the recent cost optimization exercise and decreased depreciation, amortization, and acquisition-related costs attributable to lower foreign currency conversion rates on euro to Canadian dollar. The Q2 net loss of CAD 2.42 million represented a 41% increase compared to a net loss of CAD 1.72 million in the same period of 2022. The Adjusted EBITDA loss in this period was CAD 0.85 compared to a loss of CAD 0.3 in Q2 of 2022, attributable to the higher operating losses, as discussed earlier. The company's cash and short-term investments balance was CAD 4.2 million at September 30th, 2022, compared to CAD 5 million at March 31st, 2022. Working capital now reflects the move of Vistara debt from long-term to current, plus the subordinate loan agreement signed with Wesley Clover in August.
This is the predominant reason for the CAD 12 million change in working capital. To close, I am confident that management is effectively responding to the strong and evolving market opportunity in our line of sight. I believe that our continued focus on accelerating sales through expanded sales channels, high-value product features, and improving our cost performance will result in achieving sustained profitable growth in the coming quarters. The recently announced $2 million private placement will help us manage our lender obligations and allow us to maintain focus on our objective to reach profitable growth driven by Vantage DX. I'll now hand it back to John to close with his perspective on Martello's outlook. John?
Thanks, Jim. As I mentioned earlier, we continue to be focused on the opportunity to optimize Microsoft Teams and Microsoft 365 user experience with Vantage DX, working closely with Microsoft and other key partners like Orange and Datacom. I'm really pleased with the momentum we're seeing with Vantage DX and remain very confident that we are in the right market at the right time. Microsoft Teams is a large and growing market of 270 million users, and IT teams globally are facing escalating pressure to manage Teams performance for a mix of remote and office-based users. We have recently won a few significant sales deals. One was a Fortune 100 food manufacturer with 80,000 users that wanted to create a 24/7 Teams monitoring service for VIPs or those whose calls are mission critical.
We also won a large U.K. government department with more than 120,000 users. What's been fantastic is that when these two customers deployed, our new Teams dashboard immediately showed them that they had more poor calls than they thought they did, which allowed them to address these problems right away. This allows them to see significant improvement in their team's productivity. We are excited by how these dashboards will accelerate our trial cycle so our time to revenue is faster. Overall, we are doing more with less. Achieving efficiencies and focused on continuous improvement to expand our sales pipeline and accelerate time to revenue. Our deepening partnerships with Microsoft, Orange and Mitel are an important differentiator and asset for Martello, one we will continue to nurture and develop.
Our plans to build a profitable business in the coming quarters are on track, and I am confident that Vantage DX revenue will help drive this growth. Jim and I are now here to answer your questions, and operator, would you please facilitate the Q&A part of this call?
We will now begin the question and answer session. Investors and analysts who wish to join the question queue may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw from the question queue, please press star then two. Once again, anyone on the conference call who wishes to ask a question may press star then one at this time. The first question comes from Christian Sgro from Eight Capital. Please go ahead.
Good morning, John and Jim.
Morning.
Morning, Christian.
Morning. To start, there were 1 million trials on DX last quarter. How does that cohort look in terms of conversions? Can you also comment on the broader health of the demand environment and the DX pipeline?
Sure. I'll start on the, on the conversions piece. If I look at sort of those wings we're bringing in trial, as a general rule of thumb, the bigger the company is, the longer the trial takes. I mentioned sort of some of the big, like the U.K. government department that we closed 120,000 users. From start of conversation to close was almost a year. Again, you know, these things are not swift with the big clients and they've got, you know, different departments and they all sort of want to plug into and everybody has a, has an opinion on the trial. It's the small ones that move quicker.
Really, you know, when I look at the conversions, generally once we get into trial, we are, you know, we're seeing a strong success in those pieces. They see the value. Particularly now with the dashboards and just sort of the dashboards only appeared in Q2. What we're seeing with the dashboards is not only are they sort of giving instant value to current new trials that are just starting, but, you know, when we've got clients already in the pipeline, suddenly we're going, you know, be able to say, "Hey, and these are the new upgrades to the product that you've already, you know, had a brief look at." We will see some accelerate there and I expect higher conversions.
The slight downside is that is a lot of things drift right, and that's, you know, to do with the primarily, I think, to do with the economy. Every enterprise at the moment is looking at their budgets, including their IT budget, and saying, you know, do I, you know, what do I need to spend? Can I move things slightly right? Can I keep more cash on hold? We're seeing a little bit of that as our challenge.
That's absolutely the fight at the moment is, you know, pulling those trials to a close, because even some who've trialed, they're now going into the procurement cycle. It's the procurement guys who say, "Yeah, well, maybe not this, you know, this quarter, maybe it's next quarter." We end up in a bit of a loop with the procurement guys, whether the IT guys have said yes. That's probably our biggest struggle at the moment. It's a manageable one, but certainly it's not easy at the moment to get some of these, you know, to get through some of the procurement processes when they're holding the purse strings quite tight.
Understood. Looking at the partnership channel with Orange and Datacom, how big are the wins that are usually led by them and, like, how are their sales cycles different to yours?
Yeah. I'll start with Datacom and then jump to Orange. Datacom is basically, yes, they're working on a couple of large opportunities with us, but their profiles are slightly smaller enterprise. you know, 2,000-3,000 users and below. The nice thing there is they can also take on much smaller clients and jam them all into a single instance. Whereas for each enterprise individual client, we run a single instance for those clients, which is expensive relatively. I'll come onto, you know, that's what we talked about in hosting costs. We're reducing that. Overall, it's still not that cheap, particularly for, you know, 200, 300 person business, you're not gonna do that.
What Datacom and we've set up is Datacom can onboard those guys, all these small guys into one instance under Datacom's management. That's part of it. Orange, you can expect they're giant enterprise, right? This is that Fortune 100 food manufacturer. I look at some of the, you know, some of the brand names they've currently talking to us about in the pipeline. These are all huge household name enterprises. You know, that's just the nature of their business. You know, they're a global telco. They're a global systems integrator in MSP. Them even for them to make their money is around these large enterprise. That's kind of important, and I'll touch on one example.
When we installed our product into this Fortune 100 food manufacturer, our dashboard showed they had a one in 10 poor call or call failure rate. I'll let that sort of you know, think about that from a, you know, if you're the CEO or CFO of that company, you've just been told that you've bought Office 365 and Teams, but one in 10 of your calls are poor, as in not overly productive, you're gonna want that fixed. They didn't know until they installed our product that that was their reality. Yes, they were getting help desk calls. Yes, they were seeing problems, but the severity of that problem was not apparent to the IT team. We give that transparency, and that's kind of key.
For Orange, they can look at that and say, now they're going to provide a service to fix those problems. They can provide a service to, you know, deliver a much higher level of productivity inside that company using our tool as sort of the guide and the benchmark to make sure they're doing it. Orange can immediately see their own revenue. That's kind of the point for all the partners is it's not just selling our tool, which is cool, I'll take a few points off the top. This is, can they wrap a service around it? Can they generate revenue, even recurring revenue, around the tool? The answer is yes. Orange have worked that out very quick.
We'll ask one more before passing the line, and more question for Jim here. Looking at costs, how do you expect COGS and S&M to trend as users on DX increase? Should we model a more gradual hike? Are there any scale benefits or upfront investments here to think of?
Sure, yeah. From a cost perspective, as John explained, and then I mentioned, we went through a cost optimization initiative to drive more focus onto the investment into Vantage DX. We're seeing all the momentum indicators pointing to the growth that we're that we were expecting. As we look at our cost base, I'll start first with cost of goods sold. There has been an increase in cost of goods sold within the hosting costs. That's attributable to the kind of the investment curve and where we are as we stand up instances and then we onboard clients. We're gonna see those costs, those costs vary and come down variably significantly as we onboard clients.
Secondly, as John mentioned, we've come up with a faster or accelerating our sales cycle, and part of that is also gonna be a reduction in the cost of hosting as we compress those cycles through trial, which is good news. From an operating expense perspective, we are carefully considering all the options on costs, both in terms of further investment in areas to make sure that we're leveraging and capitalizing on the opportunity in front of us. What we would see, and we've kinda drawn out, is as revenue accelerates, we do expect that we're gonna be increasing our operating expenses to support, but it'll be at a lot less trajectory than the actual growth line. We will carefully grow into our revenue line.
Great. Thanks for taking my question, guys. We'll pass the line now.
Thanks, Christian.
Once again, if you have a question, please press star then one. The next question comes from Daniel Rosenberg of Paradigm Capital. Please go ahead.
Hi, good morning. My first question was around the Legacy churn. I was wondering, when does this taper off, or when does this cycle out? Is this a one-time kind of in the quarter, and this is a new reset of levels, or is there more to go as you sunset?
Thanks, Daniel. Yeah, if I look at sort of our sort of Legacy piece, and again, you know, I've described this before as sort of we've got Vantage at the top, Mitel in the middle, and the Legacy sort of below that. A significant part of that Legacy is Gizmo, which is the tool we acquired from GSX, which is clearly a foundational part of Vantage as well. Still, you know, we're not doing much on Gizmo at the moment, if anything, but clients still renew. A large Asia bank just renewed, for example. One of the focus there on that Gizmo is to. They're the people or the clients we see as the simplest path to Vantage. Those are folks, when we talk about churn, we're hoping they don't churn.
We hope we want to transition those guys onto Vantage DX. Certainly, if you look at our initial Vantage DX customers, they were all Gizmo clients. Our first eight Vantage DX customers were all already clients of ours, already using Gizmo, and they transitioned onto Vantage. That's gonna be a focus. If I look at the other pieces, be it Live Maps, iQ, or the Domino software. Domino software, absolutely, that's decaying. The SCOM product, Live Maps, is also decaying. iQ, you know, we're not doing any work on that at all. However, one of our key partners, Paessler, and, you know, they're still growing that revenue stream with us because they white label it.
Much like sort of Mitel, we sustain the iQ product because, you know, Paessler need it for their PRTG Plus product line. They white label it in there. Certainly I would see sort of that one sustaining. As for the other two, Live Maps and the Domino, we're, there's no maintenance, there's no work going into it, you know, there's no customer success going on to it, so absolutely I see a decay. Again, in terms of timeline, like I said, sadly, and again, you know, you and I have spoken about this before, this is the complexity of Martello.
I see those two, Live Maps and Domino, to be honest, I'd like them to decay as fast as possible, you know, just keep decaying happily. The Gizmo advantage, and then iQ, we will just look after just because we need it to sustain Paessler. You know, financially, however, to your point, I see their impact decreasing certainly in so, you know, next calendar year, I would expect that Vantage will outgrow any sign of decay, or the impact of decay of any of those Legacy products.
Okay. Thanks for that. Then on the COGS, I was curious, you know, approximately what % COGS is hosting cost today?
What % of the total cost of goods sold is the hosting cost?
Yes.
As we look at it today, and I mentioned it upfront, we win a customer, we stand up an instance, and therefore that hosting cost is gonna be the majority component of the total cost of goods sold. As we've onboarded others, you can see the actual ratio of the hosting cost to the cost of goods sold is gonna decline. At this point, the hosting costs would represent about 50%-55% of the total cost of goods sold, and we're gonna see that come down. Your question is probably related to variables. The biggest variable is we're gonna accelerate VDX. VDX is on a hosted environment only. We're selling it as a cloud solution only.
That's gonna drive up the mix, of our VDX cost of goods sold within the total cost of goods sold. You can see where Mitel, for example, cost of goods sold are very, very low and the margins are high. That, that mix is probably gonna have the biggest impact on our overall cost of goods sold.
Lastly, on the sales channels, you know, as you implement the cost savings and turn the corner on profitability, when you think about, you know, how you wanna design your sales team going forward, would that include direct sales or really focusing more on establishing more partnerships? How are you guys thinking about that?
Yeah. I mean, great question. If I look at sort of where we are currently, it's 80% direct, 20% partner, and that's, you know, not unexpected if we spun up the partners. One of the things with Microsoft, and we've got a QBR today, is Microsoft have been really good at sitting with us on deals. We had a call with a large potential insurance partner in Asia this week. You know, five Microsoft people turned up to support us, which is great. What we need them to help also do, though, is generate pipeline. I'm a bit disappointed in that. They will get that message during the QBR today. I think, you know, there's still great potential. They're still learning about us.
You know, whereas Orange are certainly moving in terms of bringing deals to us. You know, they called us last week and put us into an RFP. They're moving, you know, certainly faster from a pure pipeline deals perspective. Again, the irony here is the big deal we closed with Orange, Microsoft supported. You know, Microsoft will be this balance of both support and pipeline. Orange will be pure pipeline. That being said, I want that to and, you know, started setting targets for next year. What I'd like to see next year is we're 60% direct and 40% partner. What that also means is I wanna keep the costs down in terms of our own sales folk, and we're making these partners.
We've got a bunch of new partners in the, in the pipeline. We've got paperwork out. You know, we're waiting for the big, you know, they're big entities, so grinding paperwork through them takes a while, but that's also where I see increasing that. I'm trying to, you know, focus. One of the things I think we've got to do better is, look at the U.S. more of the market. We haven't done that. If I look at sort of next year and if as we become sort of headed towards that, as we become profitable, one of the early areas where we might try and do more with more as opposed to less with more, is, you know, expand our sales presence in the States. We have some presence.
We have sales engineer, we have tech support in the States, and, but sales is done from Canada. Having somebody whose physical presence is in the States, I think will help. That was where we probably looked at that. Certainly from a partner perspective, I do see that pipeline expanding from the partners coming in, as Orange get their arms around us. That is absolutely true. That's exactly how this is happening. We're hoping Microsoft can make a bit of a shift from being supportive to more pipeline generation.
Okay. Thank you for taking my questions.
[crosstalk].
Okay. Thanks, Daniel.
This concludes the question and answer session. I would like to turn the conference back over to John Proctor for closing remarks.
Okay. On behalf of all of us, thank you all for your interest in Martello. As mentioned earlier, you can register to receive our upcoming newsletter in the interior section of our website. The recording of today's call will be available on our website later today. On another note, if you're looking to understand more about the Martello product line, please have a chance to look at any of our webinars. The links are posted on our website, and we'll give you some perspective. Particularly, if you wanna see what Microsoft and Orange think of us, they are on some of the webinars with us, and we'll give you their perspective. At the same time, you can reach out to our investor relations anytime by emailing investor@martellotech.com. Thank you all and have a great day.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.