D2L Inc. (DTOL) Earnings Call Transcript & Summary

Hello, everyone. Thank you for joining us, and welcome to D2L Inc. Second Quarter 2027 Financial Results Digital Conferencing Call. After today's prepared remarks, we will host a question-and-answer session. [Operator Instructions] I will now hand the conference over to Craig Armitage, Investor Relations. Craig, please go ahead.

Good morning. Thank you. 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 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 company's annual and interim management's discussion and analysis and the most recently filed annual information form, in each case as filed under the company's profile on SEDAR+. In addition, during the call, reference will be made to various non-IFRS financial measures, including adjusted EBITDA, adjusted EBITDA margin, adjusted gross profit, adjusted gross margin 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 quarter ended July 31, 2026, 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. I'd now like to turn the call over to Mr. John Baker, Chief Executive Officer of D2L. Please go ahead, John.

Thank you, Craig, and good morning, everyone. Thank you for joining us for our second quarter fiscal 2027 earnings call. We released our financial results after market close yesterday, and you can find those materials in the Investor Relations section of our website. Please note that all amounts discussed today are in U.S. dollars unless otherwise stated. I'm pleased to be joined this morning by Josh Huff, our CFO. Our second quarter results reflect both strong bookings quarter and the anticipated impact of the previously disclosed U.S. K-12 customer churn. While this affected our headline growth metrics for Q2, the underlying performance of our core business remains solid. And with this headwind now behind us, we expect improved revenue growth and profitability as we move through the second half of fiscal 2027. For the second quarter, subscription and support revenue increased 2% to $50.9 million. Annual recurring revenue, or ARR, increased 5% to $223.4 million. Adjusted EBITDA was $6.5 million, and we repurchased approximately 2 million subordinate voting shares during this quarter, while maintaining a strong balance sheet with $106.4 million of cash and no debt. As you will see in our Q2 disclosure, we have adjusted revenue guidance for the full year based upon softness in our advisory services and the delayed launch of a new customer. Josh will get into this in more detail shortly. Importantly, excluding the K-12 market, ARR grew more than 10% year-over-year, our fourth consecutive quarter of double-digit ARR growth across our core higher education and corporate markets, which account for more than 90% of our revenue. This performance reflects healthy bookings, strong competitive win rates and our success in expanding customer relationships through the broader D2L platform. In our largest market, higher education, our competitive position continues to strengthen. We continue to displace each of our major competitors as institutions globally look to modernize their learning environments and prepare for the future of learning. In North America Higher Education, our new customers in the quarter included the School of Professional Studies at Brown University, a member of the Ivy League, as well as Golden Gate University and Southwestern Michigan College. These wins reinforce the importance of our platform and product road map among institutions as they make big long-term decisions about their learning technology. Internationally, our momentum continues to build in key markets. During the quarter, we added customers, including the Continuing Professional Development unit at the University of Leeds in the United Kingdom, Van Lang University in Vietnam and IESB in Brazil. And subsequent to quarter end, UNSW Sydney selected D2L Brightspace as its next-generation learning platform. UNSW is one of the top 20 ranked universities globally. This is a flagship win for D2L as we start Q3. We see a significant long-term opportunity internationally as institutions around the world modernize their learning platforms. Before moving on, I'd like to briefly touch on the K-12 market. This has been a challenging last 12 months with the U.S. K-12 market, where we've experienced significantly more churn than normal. We don't take that lightly, and we're committed to delivering better results moving forward. Beginning in Q3 of this fiscal year, we expect the retention and growth trends to continue to normalize in K-12, and we're pleased to report that our remaining K-12 customer portfolio is strong. Engagement remains healthy, and we're seeing encouraging new opportunities and new logos emerge. Beyond education, we further expanded our presence in the corporate market. New customers this quarter included the American Society of Safety Professionals, the Royal College of Anaesthetists in the United Kingdom and the Public Service Alliance of Canada, one of the Canada's largest unions representing close to 250,000 workers. These wins highlight our ability to support workforce development, professional education and member learning at scale. New customer acquisition remains an important growth driver, and we're also creating value through the expansion of the D2L platform with our existing customer base. Creator+ continues to gain traction as customers look to create more engaging, interactive and accessible learning experiences, highlighted by an adoption rate of more than 35% among existing customers. We're also seeing increasing momentum for our AI offering, D2L Lumi. During the quarter, D2L Lumi surpassed $5 million of ARR and is attached on greater than 40% of new customer deployments within global higher education. And we're working hard to broaden adoption with existing customers as well. This demonstrates that AI is contributing to both sides of our growth strategy and strengthening the value proposition for new customers while creating additional opportunity to expand relationships with existing customers. We also see evidence that educators are moving beyond the initial exploration and discussions about AI to now focusing on practical implementation. In research conducted by our team earlier this year, educators consistently emphasized the importance of AI tools that improve learning outcomes, enhance teaching effectiveness and are deployed in a trusted and responsible manner. We believe this feedback validates our strategy of embedding AI in ways that help educators and learners achieve better outcomes while maintaining strong foundations of trust, privacy and accessibility. These themes were reinforced at Fusion 2026, our annual customer conference, where we welcomed more than 1,100 attendees from all around the world. One of the clearest messages from our customer conversations was that institutions are looking for a practical path forward as AI continues to reshape learning. Customers recognize the potential of AI, but they want to move forward thoughtfully. They're focused on responsible implementations, protecting institutional and learner data and ensuring that technology contributes to meaningful learning outcome improvement. More broadly, institutions are looking for a trusted partner that can provide both stability and innovation as they navigate this evolving learning landscape. At Fusion, we introduced new AI-powered innovations and platform enhancements across D2L Brightspace, Lumi, Creator+ and H5P. These included new capabilities designed to help customers transform existing learning content to be more engaging and to improve outcomes, translate content into new languages and provide learners with Lumi Learner Mode for more personalized support and embedded knowledge checks. Overall, we're encouraged by the performance across our core markets. And while our current growth profile has been affected by the previously disclosed U.S. K-12 attrition, we continue to see strength in bookings, customer expansion and AI adoption. We are well positioned for improved revenue growth and profitability through the balance of fiscal 2027 and into fiscal 2028. With that, I'll turn the call over to Josh to review the financial results and to talk about the outlook in more detail.

Thanks, John, and good morning, everyone. As John noted, our second quarter results reflect continued growth across our core markets, together with the anticipated impact of the previously disclosed U.S. K-12 customer churn. As expected, Q2 represented the period of greatest impact on our reported growth rates. While these factors affected our near-term financial performance, the underlying performance across our core higher education and corporate markets remained solid. Total revenue increased 2% to $55.6 million. Subscription and support revenue increased 2% to $50.9 million, reflecting growth from new customers and expansion with existing customers, partially offset by higher than typical U.S. K-12 churn experienced over the past 12 months. In addition, the current quarter was affected by the delayed go-live of a new customer deployment, resulting in approximately $0.8 million impact to subscription and support revenue in the quarter and is anticipated to be live by the end of this fiscal year. Annual recurring revenue increased 5% to $223.4 million and in constant currency increased 6%. Reported ARR in Q2 was impacted by the final major component of U.S. K-12 churn as previously disclosed and in line with our expectations. As John highlighted, excluding the K-12 market, ARR increased 10% year-over-year and on a constant currency basis increased 11% year-over-year. Professional services and other revenue was $4.7 million, consistent with the prior year. We continue to see a softer demand environment for advisory engagements within our professional services practice, while remaining confident in the value these services can provide to clients. Turning to margins and profitability. Adjusted gross margin was 70.4% compared with 70.6% in the prior year period. As previously disclosed, the database technology work was completed during the second quarter, concluding the associated incremental costs incurred over the past 12 months. This positions us to report improved gross margins in the second half of fiscal '27 and moving forward. Adjusted EBITDA was $6.5 million or 11.6% of revenue compared with $7.5 million or 13.7% of revenue in the same period last year. Adjusted EBITDA reflected the previously discussed revenue impacts as well as planned investments in sales and marketing, including our annual Fusion customer conference held in Q2. Importantly, the broader progression of our business remains consistent with the first half, second half framework we outlined at the beginning of this fiscal year. As we move through the second half of fiscal ' 27, we continue to expect higher revenue growth, expanding gross margins and meaningful adjusted EBITDA margin expansion. The midpoint of our updated guidance implies approximately 7% subscription and support revenue growth and a 16% adjusted EBITDA margin in the second half of the year, a significant improvement relative to our Q2 results. Moving to net income. We reported a net loss of $3.1 million in the second quarter compared with net income of $2.7 million earned in the prior year period. The primary driver of this change was a noncash fair value loss of $4.8 million related to the loan receivable from SkillsWave. As required under IFRS, the loan is measured at fair value each quarter. Updated assumptions reflecting SkillsWave operating results, financing environment and credit risk resulted in the fair value being reduced to 0 as at July 31. This fair value adjustment does not change the underlying loan, which remains in place and secured. Turning to cash flow. Cash flows from operating activities were $28.8 million in the second quarter compared with $15 million in the prior year period. And free cash flow was $28.5 million in the second quarter compared with $15.2 million for the same period last year. The year-over-year increases primarily reflect working capital movements, including strong customer collections during the quarter. We believe the trailing 12-month period provides a more representative view of the underlying cash generation as it normalizes working capital movements between quarters. For the 12 months ended July 31, free cash flow was $42.7 million versus $24.1 million in the comparable trailing 12-month period, showing significant progress in scale. Our financial position remains strong as we ended the quarter with $106.4 million of cash and cash equivalents and no debt on our balance sheet. In terms of capital allocation, we completed our previously announced substantial issuer bid during the quarter, repurchasing approximately 1.9 million subordinate voting shares. We also repurchased about 131,000 shares under our normal course issuer bid during the period. As a result, we repurchased a total of approximately 2 million shares during Q2, and we'll continue using the NCIB over the balance of this year. Looking across a longer period, we have now repurchased more than 3 million subordinate voting shares through the SIB and NCIB combined over the trailing 12 months. This represents 11% of the opening subordinate voting shares outstanding during that period. We believe our use of these programs reflect a disciplined approach to capital allocation. We have been able to meaningfully reduce our share count and return capital to shareholders while maintaining a debt-free balance sheet and significant financial flexibility to continue investing in our organic and inorganic growth opportunities. Turning to our outlook. We have revised our revenue guidance for fiscal '27. We now expect subscription and support revenue of $211 million to $213 million, representing growth of 6% to 7% over fiscal '26 compared with our previous range of $212 million to $214 million and total revenue of $228 million to $231 million, representing total growth of 5% to 6% over fiscal '26 compared with our previous range of $231 million to $234 million. The revised revenue outlook reflects softer demand within our advisory professional services practice as well as the delayed go-live of a new customer deployment and the corresponding impact on subscription and support revenue in the current fiscal year. Ongoing optimization of our cost of goods sold and operating efficiencies is offsetting the impact of the lower revenue outlook, allowing us to maintain our adjusted EBITDA guidance of $33 million to $35 million, representing an adjusted EBITDA margin of approximately 15% at the midpoint. As John highlighted, we continue to expect meaningful improvement in our financial profile during the second half of fiscal '27. Looking beyond the current year, our fiscal '28 target operating model remains unchanged. We continue to target revenue growth of 10% to 15% and an adjusted EBITDA margin of 18% to 20%. We recognize that achieving these targets requires a meaningful step-up from our fiscal '27 performance to date. Our confidence is grounded in 4 consecutive quarters of double-digit ARR growth in our core markets, a strengthening competitive position, continued international expansion, increasing customer value through products such as Creator+ and D2L Lumi and the diminishing impact of the churn and COGS headwinds that have affected our reported results the past few quarters. These targets remain a clear priority for the team, and our focus is squarely on executing the plan to deliver higher revenue growth, expanding margins and increased cash generation. With that, we'll open the call to questions.

[Operator Instructions] Your first question comes from the line of Erin Kyle with CIBC.

I guess first one here is just on the K-12 churn in the quarter. I'd say that the magnitude of the churn was larger than what we had anticipated. So maybe if you can kind of comment on the size of the contract there or average contract size across K-12 in your broader markets? And then maybe just as a follow-on, do you have any other large contracts that are similar in size to this one that could be up for renewal in the next few quarters here?

Yes. As we had discussed in previous quarters, Q2 effectively had that sort of final tranche of churn during this sort of 12-month period where we've had higher levels of churn than normal. And so the amount of churn from K-12 in the quarter was actually in line with our expectations and plans. We are pleased to report that go forward, we do expect K-12 to return to normal retention and growth effective Q3 and sort of have this ARR headwind behind us. I think the other sort of mechanical thing within ARR is always FX as well. So in the quarter, just to be clear, there was a $2 million haircut on ARR from FX. And so when you sort of reconcile each of those data points, we actually added net $6 million of ARR from our core business in the quarter, which is a decent Q2.

And then, Erin, just to add a little color to the K-12 market. I spent a lot of time visiting them with our clients over the course of the last 12 months as well. And by and large, the rest of the client base is very solid. So there are other large clients. For example, most of Canada uses D2L as a learning platform, New Zealand, New York City, many others. And so there are still large clients, but the clients that are -- that remain are very solid, growing and engaging heavily in terms of new technologies to support a better learning experience. So very confident in our go-forward strategy with K-12. And keep in mind, this is now less than 10% of our overall revenue.

Maybe just a follow-up to that, John. Just on the differences in the U.S. K-12 market and Canada and international, is there anything you can call out more specifically on why you have the confidence that this is contained to U.S. -- like the nuances of the U.S. K-12 market, I imagine, are different than Canada, for example. So maybe if you could just put some color around that.

Yes. I think just generally speaking, there's no secret that the overall U.S. K-12 EdTech spend is down significantly year-over-year. In our case, what we're seeing in markets like Canada, Canada is ranked #3 in the world, for example, in education for K-12. There's a real investment in making sure that their students have the best technology to support a really great learning experience that helps them achieve even better results year-over-year. So there is a real investment in cutting-edge technology to support student learning. And we're seeing that in other markets around the world. It's not to say that that's not existing in the U.S. I just want to be clear on that. There's just been a general pullback on technology spend across the U.S. in the course of the last 2 years. And at some point, we hope that, that will bounce back. And in the meantime, we're digging in deeply with the clients that really care deeply about improving educational outcomes for their students.

That's helpful. And then maybe I'll just ask one more on the deferred implementation that you called out. Can you expand a bit more on the reason behind that deferral? And then in your view, is the delayed implementation, do you feel it's company-specific or customer specific to that particular account? Or is it -- do you think it could be expanded to other contracts as well?

No, this is very specific to one individual account. It's a very large one, as you can tell by the change in guidance for the year. It's just sliding the go-live into end of Q3 from where we expected it to be much earlier. And it's just a very large complex implementation that required custom software development, and there was a fairly significant change of scope of that software development. So until that implementation is done, it's very hard to sort of go live with all this, in this case, close to 1 million users. And so when that does go live later this quarter, we're quite excited to start to recognize the revenue after that point forward, which is part of why we're seeing the confidence in the revenue acceleration in the back half of the year.

Your next question is from the line of Doug Taylor with National Bank.

John, I'll ask you to maybe comment on the pipeline. You obviously had a strong Q2 for core higher education growth. Can you talk about the momentum and the conversion rates that you think about and what's required to get to your refreshed guidance now for this year and as we think about next?

Yes. The guidance change for this year really has very little to do with the pipeline. It's really just recognizing revenue in year. What I'm excited about is actually the pipeline. Even in a tough macro market with RFP volume down, we're seeing our win rates continue to climb in our core higher education market in particular. We're seeing flagship wins like UNSW Sydney is a great example. It's a top 20 university globally. And it's not just in one region. We're seeing wins in many different regions around the world. And so I'm very bullish on the team's work on the pipeline. We're not done yet, Doug. There's a big effort ahead of us to really fire up a replacement cycle to encourage clients to move to an AI-first learning platform. But I'm confident over the course of the next few months, we'll get that really started to fire up because what we're seeing now with our clients is close to an order of magnitude improvement. So the combination of our learning services with Lumi, with Creator+ is really having a major impact on improving educational outcomes. So completion rates are going really high up, which for a university, for example, if they can improve completion rates for retention of students by 10%, that's tens of millions, possibly hundreds of millions for some of our bigger clients. And so that's compelling just by itself, but we're also saving a tremendous amount of money in terms of development of high-quality learning experiences. And at the same time, what we have is an environment where students are really desperate to have a better learning experience because they're up against students that may be using other technologies to sort of write an essay or to do some of the work, and they want better learning experiences to actually have a better outcome for their own career, for their own progression in life. And so all these, I think, are going to turn into a tailwind for us as we look ahead. And that's starting to show up in the pipeline. We're seeing healthy pipeline generation, but the work is still being done to really start this replacement cycle in the market. That will drive our RFP volume with our high win rates, that will be a very compelling event.

You've talked about these high win rates and a lot of the success you've had has come, I guess, at the expense of some of your legacy competitors. But as you use Lumi and AI as a competitive differentiator in future new wins, can you maybe talk about whether there's been a change here in the budget that some of these institutions are willing to allocate towards investment in that technology versus just replacing legacy systems?

I think that's the part that we have to unlock in the back half of this year is really helping these institutions understand the value that can come from these technologies. I would imagine most don't realize they can get an order of magnitude improvement by implementing these technologies to support a better learning experience. They just don't have that connection yet. So we have a big education effort ahead of us. But I think it is very compelling. I don't think there's any budget issue from all the clients that I'm speaking to. They have budget for AI. They have -- there's no sticker price issue with our technology. Key now is trying to figure out the unlocks to get them to buy it as quickly as possible. We're seeing good attach with new clients, which is very encouraging, over 40% buying it right out of the gate. We're seeing the attach rate for existing clients ticking up, but we want to see it tick up much, much faster. We might -- I know it sounds strange, but we're happy with the growth that we've seen so far in the first half of the year with Lumi. But the back half, we're hoping to really start to accelerate the growth.

Okay. And one more for me. Maybe this one is better suited for Josh. I think you've done a good job articulating the short-term headwinds that you faced in recent quarters. You also did, in your prepared remarks, reiterate the 10% to 15% growth objective as we think about next year. You do have some lingering stubs you'll be lapping from K-12, FX and perhaps the PS, professional services setup. Can I maybe just get you to talk through some of those things, the puts and takes as we think about the growth profile into next year?

Yes, absolutely. Appreciate the question. In Q2, as we mentioned, sort of always had a bit of this trough dynamic. And so as we look forward, into the second half of the year, we'll start to see some accelerant this back half. In the -- implicit in the guidance, you kind of can math into a 7% subscription growth in the second half and a 16% EBITDA margin in the second half. But also, as you mentioned, those headwinds abating on the K-12 front, we'll see that most readily in ARR starting Q3 and beyond. It will effectively be a sort of clean representation of adds. And then on the margin front, the COGS work has actually sort of exceeded our expectations slightly. And so we start to see in the back half of this year already a bit of a step-up in our margin profile, and that will continue into next fiscal. And I'd say more importantly, it really comes down to looking at sort of that core business performance. We look at that ex K-12 ARR growth being low double digit the past 4 quarters, 11% this past quarter. Win rates are strong. International continues to tick at about a 15% growth profile. As John mentioned, we continue to see a really good opportunity with Creator+ and Lumi. So all of those things are sort of getting us comfortable with our plans to step up into that F28 operating model. And certainly, we're committed and focused as a management team to getting there.

Your next question from the line of Gavin Fairweather with Cormark.

Maybe just to start on Australia. I think you've added some sales investments in recent quarters and nice to see the UNSW win coming through subsequent to quarter end. So maybe you can just refresh us on your view of the market structure in Australia and your ambitions in that market in the years ahead.

Yes. It's not just Australia. Australia is one of many markets which are now really coming to life for us as a company. What's interesting in Australia is up until recently, we did not have a lot of wins in that region in higher education. We had great clients, great proof points. The market was largely Canvas and Moodle. And we're now starting to see the momentum shift in that market to us with almost 2 big wins. UNSW is a fantastic one, a great school, very committed to really having a big impact on improving the student learning experience, a very prestigious institution, and I think they're going to be a great partner. University of Otago, another great example of New Zealand. There's some fantastic new wins in that region, really great clients. And I think it's also a good example where all these institutions are also using H5P in that region as well, too. And so you get this cross-pollination of great experiences. But that institution, in particular, did a very detailed diligence review of our platform and us as a company to make that decision. And I think it's going to be hopefully an example for many other prestigious institutions from around the world to make similar choices in the year ahead. I think that market dynamic is playing out, whether it's in Singapore or Netherlands or South Africa or many, many other countries around the world. There's not just an isolated spot or example, if you will.

That's great. And then maybe just turning to the corporate side, further momentum this quarter on the membership side. I know that a goal of the company is to push more into employee training. Maybe just you could provide us with an update there. I know there's been a lot of product work underway, and you've hired some new leadership. I know it's probably not going to impact the back half of this fiscal year, but maybe just update us on the strategy and progress heading into fiscal '28.

No, I think you're still seeing fantastic growth there, especially for training organizations, where their members need a fantastic learning experience to support those training organizations continue to support their mandates and drive additional revenue for those organizations. So that's a very strong part of our business and growing quite quickly. We continue to invest across all of our markets in terms of developing new product, new technologies to really support us making sure that we can continually expand the market opportunity that's in front of us. And I remain very bullish on corporate being a critical market for us because as you can imagine, any time that all these industries are going through this big transformation, they're going to need upskilling and learning. And we're the best platform for them to deliver that to their members. And we're quite excited to see the new clients coming on board this past quarter and very bullish on the opportunities in front of us with the new leadership and also the expanded team.

Your next question is from the line of John Shao, TD Cowen.

So in terms of the Lumi ARR, it's good to see that 40% growth in just 2 quarters. And I understand the attach rate for new customers is relatively high. So my question is, how do you plan to drive a higher attach rate among your existing cohort? Is more of a conversation at renewal? Or is this -- or the conversation already happened?

The conversation is typical for renewal. That said, the impact that Lumi has now with clients is so significant, they should be embracing it today. They shouldn't be waiting. And so I'm actually personally sitting down with the team to understand all the key objections that get in the way of people trying to buy Lumi today and see if we can figure out how to knock them back as quickly as possible. John, like this is a technology where if they implement it, all of a sudden, you can do things like translate this content into different languages. You can automatically take a Word document and convert it into a beautifully engaging interactive learning experience with interactives and flash cards and quick knowledge checks on the bottom of every page. It just makes learning so much better for students. We now have closing in on 10 different efficacy studies that demonstrate the impact that it has in terms of improving educational outcomes. And then our learning services team has actually figured out ways to really drive down the cost of developing all of these courses as well. So the combination of those 2 things is so compelling for clients. It's literally almost 10x better than the way that they've been doing it so far to date. And any time you get a product to the point where it's 10x, that's compelling enough to put in place the purchase today. There's little to no risk attached to these clients putting this technology. The clients that have embraced it have had a tremendous impact on their businesses, and we just need to get the word out, I think.

Got it. And in terms of your PS revenue guidance this quarter, I'm just curious, is the weakness largely discretionary or cyclical? Does it reflect a structural change in how customer purchase your PS services? My understanding is that you have shortened the deployment cycle. So what is the implication maybe for your future PS revenue going forward?