D2L Inc
TSX:DTOL
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Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the D2L Inc. Fiscal 2023 First Quarter Results Conference Call. [Operator Instructions].
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 forecast 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 IRFS 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 3 months ended April 30, 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 9, 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 30, 2022. You can find this information on the Investors section of our website at d2l.com. Please note that the results we're discussing today are in U.S. 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, up 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 the look hard for evidence. For example, Statistics Canada recently reported that on-field 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 require 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've 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 and our platform enhancements. Our new implementation win rates in markets like higher education continue to decline 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 K-12 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. And we're working hard to efficiently onboard one of our largest customers, British Columbia's Ministry of Education, 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 outlook.
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.
And on the product side, we recently introduced BrightSpace Creator Plus as an early access program. Creator Plus makes it easy for subject matter experts to build highly engaging learning experiences. It includes a package of beautifully designed templates drag-and-drop interactive, 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 the 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 9 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 the 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 $95,000 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 negative $16.2 million compared with negative $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 to $178 million, implying growth of 15% to 17% over fiscal 2022, and adjusted EBITDA loss in the range of $9 million to $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 U.S. dollar. Recall that roughly 45% of our revenue is from outside the U.S.
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; and 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.
[Operator Instructions] Our first question today comes from Daniel Chan from TD Securities.
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?
Dan, thanks for the question. So we have -- it's really a mix of both of those. So there is some FX and some of those slower hiring. So it's not one that's more predominant than the other. It's a combination of both.
Okay. And then 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?
So we're tracking well on our gross margin improvement, 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 is -- this year will be our first return to an in-person conference, which we believe is actually going to be really helpful with building pipeline and solidifying customer and prospect relationships. And it will take some time for some of the operation efficiencies to scale in the back half of the year. So in general, EBITDA losses will be lower in the back half of the year.
Okay. And then finally, is your fiscal '25 targets still valid?
It is. The medium-term model is still valid.
The next question today comes from Thanos Moschopoulos from BMO Capital Markets.
Just maybe expanding on that last point. So if the fiscal '25 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. And we do think that 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 '24, and that's what will help them keep the model in effect.
Great. And in terms of the delayed hiring, is it impacting a particular segment or geography more than others, corporate versus higher ed versus K-12, international versus North America? Or is it kind of across the board?
Great question, Thanos. It's across the board. So our corporate team is doing a fairly good job in terms of staying at capacity across education, our global groups, we're definitely seeing pressure on the war for talent.
Okay. And on the macro side, I mean, I think it stands the reason that education customers are going to be met for resilience. But just to clarify, on the corporate market as well, are you seeing any signs of the slowdown or the kind of business as usual, given all the networks that happening?
Another great question, Thanos. So I've spent some time traveling visiting with to the different CEOs of companies, visiting with our clients in different regions. And it's very clear that we're not seeing any slowdown. But the opposite, we're seeing more demand for a 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. And we've seen the same thing in higher education. So 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. So very clearly seeing a mix of both on-campus and online in the academic space as well, too.
So 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 confidence in the model and the confidence in the fundamentals of the business.
The next line today comes from Christian Sgro from Capital.
I wanted to talk about the visibility into bookings kind of growing into the back half of the year and D2L always had good visibility with the subscription model. So just wondering, my question is, do you see the bookings strength coming from some of the recently announced customers and their plans to get on to a 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?
That's a great question, Christian. The 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 in our core markets globally. And then if you -- yes, no, I think that's probably the quick answer.
Okay. That's helpful. And 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, how hiring is going across different teams. I mean if I understood more so correctly, it sounds like the plan is still to hire aggressively into all areas, maybe through the year. Like how's your, let's say, ultimate plans for sales team headcount changed into the year? Or is that all maybe just pushed out, it's still the same?
So we've largely kept the headcount in terms of openings in terms of job for those things you mean, Christian. And if so, yes, we've largely kept that intact. There's no change there. We've just been slower to acquire capacity that we need to support the growth that we're looking for.
And just to add, our focus there is really on that quota carrying capacity as well as that -- but those that help build pipeline.
Okay. Perfect. I'll ask just one more question today, a rounded $100 million of cash on the balance sheet. I'm wondering any thoughts on M&A? Has your perspective there changed? Or for organic initiatives, we'll see the focus through the next bit here?
So 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. So we are still taking a look at that strategically, Christian. Good question.
The next question today comes from Doug Taylor from Canaccord.
You've spoken to an accelerated path back to profitability with these results. I think you said the medium-term targets, fiscal 2025 remain intact. So I guess I'm asking you to be more -- can you quantify or detail what you mean by that accelerated path back to profitability? Is the breakeven timetable been moved forward? Or are you signaling just a shallower kind of trough before you kind of arc back up towards breakeven? That would be helpful.
Sure. So our current view is that we will achieve breakeven sooner in fiscal year '24 and more importantly, that we will be cash flow positive.
That's helpful. Let me ask a couple of questions, I guess, about the very strong professional services. You detailed that, 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 Proserve line to remain at these elevated levels over the next couple of quarters?
So for this quarter, that does reflect some significant growth in new customer implementations and content development work for both some new and existing customers. And but there is always some lumpiness to that kind of work based on the implementations that are going through and so 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.
Go ahead.
Well, sorry, Doug. 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 folks might not be working as hard on this over the summer or they may be working harder. I'm not sure yet. But that lumpiness is certainly there, but the general trend is more investment in building online programs. Both in education and in corporate.
Okay. So one final question for 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. So should we be expecting given the mix shift from Proserve to subscription for that to continue to trend higher towards the back of the year? And all of the investment that you're making in sales and marketing and other will be focused more on the operating expense line rather than gross profit or cost of goods sold?
I think there's a couple of parts to that. I think on the mix of professional services versus software. No, I think we're going to probably trend back to where we were previously, Doug, on that front. We definitely are investing heavily into making sure that we're growing our software business. So the 90-10 rule should be something that we're trending back to Q1, a bit of an anomaly there. And then I don't know, Melissa, if you want to take the other part of that question? Or did that answer the question, Doug?
Yes. And I guess there was just one follow-up on the permanence of some of the gains you've made in gross margins this quarter year-over-year?
Yes, we do expect 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 mid-term model.
Yes. And Doug, just building on that again, 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 only guided.
The next question today comes from Brian Peterson from Raymond James.
John, first one for you. Just if we kind of step away from the fiscal year '23 or fiscal year '24 dynamics, because it's kind of hard to call the timing for -- particularly for your higher ed or K-12 customers. What does that pipeline look like? And if you're thinking about the display or replacement of some of the legacy solutions like what does the pace of change look like there over the next, let's call it, 3 to 5 years?
Great question, Brian. The pipeline today looks very healthy. I don't think that's out of time where we've seen more large deals flowing into the pipeline for future implementations. We're just looking at it yesterday, again, 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 -- in the education space, many of the institutions were in a bit of a lock-in 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. And so we see a great opportunity to replace legacy technology, I think data and technology that doesn't support mobile very well, doesn't -- still have 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 going to 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 come out of this pandemic.
We see similar on the corporate side, Brian. For many of the CEOs that I'm talking to, talent attraction and retention is the #1 priority. And 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, millions of dollars as they roll out our technology to support that better experience because they're not churning as many individuals.
And then on the tight labor market, I think you're going to 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. So 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. And maybe just kind of double clicking on some of the go-to-market questions. Has there been any change to sales force retention, I'd be curious, is it more about net new hires? Or has there been any change in 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 as the calendar year. But any help on understanding the contribution that partners may mean to the go-to-market going forward?
Yes. That's a great question a couple of questions there. So on the partner side, we are definitely leading in with our partners to drive acceleration in partner-driven revenue. So we -- we've talked about that incorporating that into a bit of 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. So just being very transparent there. That's -- that to us is really important, and we're addressing both of those strategies.
[Operator Instructions]. Next question today comes from John Shao from National Bank.
I just have one question regarding the professional services, which is obviously very strong this quarter. So my question is to what extent can we think that PS revenue is a leading indicator of future growth in ARR?
So that's a great question. So 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.
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 want to 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 lines.