Udemy, Inc. (NASDAQ:UDMY) Q3 2023 Earnings Call Transcript November 5, 2023
Operator: Good day, and welcome to the Udemy’s Third Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note that this event is being recorded today. I would now like to turn the conference over to Dennis Walsh, Vice President, Investor Relations. Please go ahead.
Dennis Walsh: Thank you, Joe. Joining me today are Udemy’s Chief Executive Officer, Greg Brown; and Chief Financial Officer, Sarah Blanchard. During this conference call, we will make forward-looking statements within the meaning of federal securities laws. These statements involve assumptions and are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed or anticipated. For a complete discussion of risks associated with these forward-looking statements, we encourage you to refer to our most recent Form 10-K and Form 10-Q filings with the Securities and Exchange Commission. All forward-looking statements are based upon information currently available to us.
We caution you to not place undue reliance on forward-looking statements and we do not undertake or expressly disclaim any duty or obligation to update or alter our forward-looking statements, except as required by applicable law. In addition, during this call, certain financial performance measures may be discussed that differ from comparable measures contained in our financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles referred to by the Securities and Exchange Commission as non-GAAP financial measures. We believe these non-GAAP financial measures assist management and investors in evaluating our performance and comparing period-to-period results of operations in a more meaningful and consistent manner as discussed in greater detail in the supplemental schedules into our financial earnings release.
A reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our earnings press release. These reconciliations together with additional supplemental information are available on the Investor Relations section of our website. A replay of today’s call will also be posted on the website. With that, I will now turn the call over to Greg.
Greg Brown: Thank you, Dennis, and good afternoon to everyone on the call. Udemy once again delivered results that exceeded our expectations for both revenue and adjusted EBITDA. On a year-over-year basis, Udemy Business revenue increased 30%, while consumer revenue increased 1%. We also raised our outlook, which now projects our first full year of positive adjusted EBITDA well ahead of plan. During the quarter, Udemy Business customers remain highly engaged with our platform as demonstrated by the 14% year-over-year increase in logos and the 114% large customer net dollar retention rate. We added new or expanded existing relationships with global customers, including Assurant, Deutsche Telekom, Schlumberger USA, Shell and Walmart Chile to name a few.
We closed many six-figure deals during the quarter, including three $1 million-plus deals, contributing to Udemy Business ARR growth of 26% year-over-year. Compared to the prior quarter, deal velocity improved, our win rates increased, and we’re seeing higher average enterprise plan contract values. Given these results, we are very encouraged by the demand on both sides of our business. While still too soon to call a bottom, we are seeing customers beginning to ease their budgetary constraints, although still below historic norms. As customers plan for 2024, it is clear that investments in upskilling and reskilling are a key focus. Our conversations with CLOs across the globe suggest that developing skills-based practices will be a top priority for the foreseeable future.
This gives us confidence in the significant opportunity for long-term growth. With that in mind, today, I wanted to share some insights into: first, what is driving the transformative shift that is reshaping companies approach to skills-based practices; and second, the strategic investments Udemy is making now in order to capitalize on this opportunity and drive long-term profitable growth. Let’s start with the market trends. The current environment is characterized by an accelerated pace of innovation, driven by digital transformation, the emergence of generative AI and the widespread adoption of hybrid work. These profound forces are reshaping the way we work and redefining the skills needed to drive future growth and success. A study from Mackenzie underscored the urgency of this situation, revealing that 87% of executives are already identifying skills gaps within their organizations.
In addition, the World Economic Forum found that 60% of all workers will need retraining before 2027 as skills rapidly evolve or become obsolete due to automation. It is abundantly clear that we are in the early innings of a dramatic global transformation, one that businesses must fully embrace to enhance productivity, foster innovation and create sustainable value. This new reality demands the immediate and ongoing attention of all organizations and workers. Many forward-thinking companies are already responding to this challenge by recognizing skills as the new currency within their organizations. Global enterprises such as IBM, Bank of America, Kellogg’s and Walmart as well as multiple U.S. state governments are leading the way by prioritizing skills proficiency, including implementing credentialing programs and easing degree requirements for certain roles.
Having a clear skills-based transformation strategy is critical for a company’s future success. It ensures talent decisions are based on what workers actually are capable of achieving. A study by Deloitte reinforces this, revealing that organizations embracing skills first practices are 107% more likely to place talent effectively, 52% more likely to foster innovation, and 57% more adept at anticipating and navigating change. We firmly believe that companies aiming to stay ahead of the pace of change must invest in talent mobility to support career growth and the attraction and retention of top-tier talent. In today’s world, people are as vital as technology in creating sustainable differentiation. For example, a prominent global airline partnered with Udemy Business this quarter to enhance the digital skills of its employees.
The company chose Udemy as its learning partner to increase digital literacy, improve productivity, bridge skills gaps and retain talented staff. Udemy Business was chosen over an incumbent because of our demonstrated ability to develop and implement a skilling strategy, the breadth of our skills content and skills validation capabilities. Layering on to that, AI continues to reshape industries across all geographies. Organizations and professionals must understand how generative AI will impact individual roles and how it can be integrated into transformation strategies to foster agility, resilience and competitiveness. During the quarter, a large global pharmaceutical company doubled its seat count with us in a multiyear expansion deal to address the full extent of the AI opportunity.
The CEO set a mandate for upscaling the entire workforce on this technology in order to increase the speed to market for its pipeline of drug candidates, drive efficiencies throughout the entire company and protect its data with enhanced compliance. Udemy is supporting our customers’ efforts to achieve these critical business objectives by providing its employees access to relevant AI content, curated learning paths and certifications. The demand for generative AI-related content on the Udemy platform is remarkable. Currently, we offer an extensive selection of over 1,500 courses, which have collectively garnered more than 2.5 million learner enrollments. The organic creation of content in response to demand reaffirms the effectiveness of our marketplace model, which seamlessly adapts to evolving technology and learner needs.
It’s important to note that as technology continues to advance and new demands arise, our platform organically fosters the creation of fresh, relevant content. Gen AI is a prime example of this dynamic process. And looking ahead, with further technological advancements on the horizon, we are confident in Udemy’s ability to lead by providing relevant, high-quality content that will continue to attract a growing number of learners and customers. As demand for creating skills in digital transformation strategies increases, we will align our own strategy as well as our investments in product innovation, brand and go-to-market to capture that demand. Heading into the New Year, you can expect to hear more about our investments and new campaigns that we believe will have the potential to dramatically increase Udemy brand awareness globally.
As part of those efforts, we plan to bolster our go-to-market engine and lean into strategic partnerships that extend our reach more rapidly and into new markets. We recently announced a partnership with Docker, a leading provider of development tools, and have more exciting collaborations with technology leaders to announce over the next few months. These partnerships will allow us to expand and introduce Udemy to millions of new learners. For example, we are already seeing significant traction with our AWS partnership. During Q3, total contract value of bookings through AWS increased 214% quarter-over-quarter, and we grew the number of deals transacted by more than 5x year-over-year. Over time, we anticipate our strategic partnerships will become even more impactful.
In addition, we remain bullish on the opportunities that generative AI brings to our business and have built a robust product road map that will supercharge the Udemy experience. We are building highly relevant generative AI-enabled capabilities for three distinct personas: our enterprise customers, learners and instructors. In response to the evolving needs of our enterprise customers, Udemy is committed to delivering tailored solutions. With industries undergoing rapid transformations, organizations are turning to Udemy to address their specific upskilling requirements. To serve them better, we’re developing a cutting-edge generative AI-powered skills mapping system. This innovative solution when integrated with our extensive course catalog of more than 210,000 courses, positions us at the forefront of addressing each customer’s precise skills demands.
Leveraging generative AI, we will automate the creation of personalized learning paths and guidance, ensuring that every professional skill development need is met. For learners, we are focused on enhancing the experience on our platform. We are harnessing the power of gen AI to guide learners directly to content that aligns precisely with their unique needs to optimize their personalized experience. For example, we recently introduced smart search capabilities that enable learners to access bite-sized micro learning opportunities within our vast course catalog. This not only streamlines the experience, but it also enhances engagement and optimizes time spent on our platform. Finally, we are committed to empowering instructors with tools that supercharge their ability to create high-quality content more efficiently and effectively.
Instructors often spend substantial time responding to learner inquiries, with some even hiring teaching assistants. We will leverage AI to automate responses for leaner questions, saving instructors’ valuable time. Learners too will benefit from a more responsive and engaging experience. Instructors also dedicate significant time developing practice tests and quizzes. We will apply generative AI to automatically create interactive materials for instructors. These enhancements will be applicable to all new and existing courses and will be available to all 75,000 Udemy instructors. The synergy between generative AI, coupled with the depth and breadth of Udemy’s content, will further enable us to deliver learning and skill development solutions to the market at scale.
In order to properly fund these initiatives, we announced to our instructor partners today that we will be adjusting our instructor revenue share. Our plan is to gradually lower the rate for our subscription programs over the next few years, which will reduce costs as a percentage of revenue. We believe that our investments in brand and product will be a net positive over time for instructors. Sarah will share more details on this in a moment. Finally, our commitment to innovation extends beyond our customer offerings. We are actively leveraging the power of AI to transform our internal operations, ultimately enhancing the service we provide to our valued customers. Our recent investment in cutting-edge technology is leading to the launch of a generative AI-powered chatbot that can efficiently handle over 70% of our incoming requests, streamlining our support processes and providing quicker resolutions for our customers.
Enchanted with this development, we’re equally committed to upscaling our customer support teams, underscoring our dedication to becoming a premier center for generative AI support. In conclusion, we are committed to helping individuals and organizations navigate this exciting period of rapid change. Udemy is prioritizing skills, embracing the potential of AI, adapting to the hybrid future of work and fostering a culture of agility and resilience. These strategic pillars will guide us as we continue to lead the transformation to a skills-based economy and innovate in this ever-evolving landscape. Now I’ll turn the call over to Sarah for a financial review.
Sarah Blanchard: Thank you, Greg. I’ll focus my comments on the key financial highlights and then provide our outlook for Q4 and full year 2023. You can find the complete set of financial tables in our news release, which is available on our Investor Relations website. We had a strong third quarter as we exceeded expectations on both the top and bottom line. Revenue increased 17% year-over-year to $185 million or nearly $5 million above the high end of our guidance range. The year-over-year growth included a negative impact from foreign exchange, or FX, of 1 percentage point. The contribution from regions outside of North America was 60% of total revenue and increased from 58% in Q3 of the prior year as we continue to expand our geographic footprint.
Udemy Business revenue increased 30% year-over-year to $109 million. Included in net growth was a 2 percentage point headwind from changes in FX rates. We ended the quarter with annual recurring revenue, or ARR, of $443 million, up 26% from a year ago. Our consolidated net dollar retention rate for Q3 was 106%, a 2-point decrease from the prior quarter. The rate was 114% for large customers or those with 1,000 or more employees, just 1 point lower than the prior quarter. It is encouraging to see the pressure on net dollar retention soften, which gives us confidence that we will continue to deliver net dollar retention above 100% as customers recognize the value of our platform. On top of that, gross dollar retention remains stable, which is impressive considering the current macroeconomic environment.
In aggregate, we grew our customer base by 14% year-over-year or 432 net adds to more than 15,000 customers globally. The number of customers spending more than $100,000 in ARR is up 37% from a year ago. From a geographic perspective, the strongest demand during the quarter came from our North America and Asia Pacific regions. Our consumer marketplace continues to be vibrant. Although traffic was flat year-over-year at 34 million average monthly unique visitors, we added nearly 3 million learners to the platform, ending the quarter with 67 million or an 18% year-over-year increase. Course creation and refresh are strong with more than 5,000 new courses added each month and 60% of our top courses were updated in the past 90 days. This further demonstrates the power of the marketplace model to keep up with the pace of change.
As a result, we were pleased to deliver year-over-year segment revenue growth for the first time in 6 quarters of more than 1%, including the negative impact of a 0.5 percentage point from FX. We also achieved an exciting milestone with our consumer subscription, which we call Personal Plan. We have been testing Personal Plan in several markets and now have more than 100,000 monthly and annual paid subscribers. Consumers are responding well to these plans, and we look forward to providing more updates as the program evolves. As we move down the P&L, note that all financial metrics are non-GAAP unless stated otherwise. Q3 gross margin was 60%, a 200 basis point improvement from Q3 2022, driven by the continued revenue mix shift to Udemy Business, which accounted for 59% of total revenue in Q3.
Total operating expense was $107 million or 58% of revenue and 1,100 basis points lower than Q3 of last year thanks to our focus on company-wide cost efficiency. Sales and marketing expense represented 37% of revenue, down 600 basis points. R&D expense was 13%, down 100 basis points and G&A expense was 8%, down 400 basis points. On the bottom line, we delivered positive net income of approximately $8 million or 4% of revenue. Adjusted EBITDA was positive for the second consecutive quarter at approximately $8 million or 4% of revenue, which represents a 1,200 basis point expansion year-over-year and nearly 300 basis points better than the high end of our guidance range. The better-than-expected adjusted EBITDA result was primarily driven by revenue outperformance and our disciplined approach to driving operational efficiency throughout the organization.
Moving on to key cash flow and balance sheet items. We ended the quarter with $483 million of cash, cash equivalents, restricted cash and marketable securities. Free cash flow for the quarter was positive $9 million, driven by collections timing and lower expenses. Now turning to our outlook for Q4 and full year 2023. We expect Q4 revenue to be between $184 million and $187 million. Assuming foreign currency exchange rates remain constant, FX is expected to negatively impact Q4 year-over-year total revenue growth by approximately 2 percentage points. On the bottom line, we anticipate Q4 adjusted EBITDA margin of breakeven to positive 1%. For the full year, we are raising our outlook. We now expect revenue to be within a range of $723 million and $726 million or 15% year-over-year growth at the midpoint, including an estimated 3 percentage point negative impact from FX, assuming no further changes in rates.
On the bottom line, we are committing to our first full year of positive adjusted EBITDA, well ahead of plan. We expect full year 2023 adjusted EBITDA margin to be positive between 50 and 100 basis points or a nearly 900 basis point expansion at the midpoint compared to 2022. Although we expect to end the year strong, we remain cautiously optimistic going into 2024. We’ve continued to see delays in decision-making from new and existing customers, the effects of which will flow into next year. We’re also seeing some softness in EMEA as geopolitical tensions rise in that region. Therefore, we are exercising caution until we start to see green shoots to materialize and have more visibility into next year. With that said, the long-term opportunity is significant.
Given our efforts to focus on operational excellence through these turbulent times, we are well positioned to capitalize on the opportunity in front of us. Before taking questions, we wanted to address an update. Earlier today, we shared with Udemy’s instructor partners that we will be adjusting our instructor revenue share. Under the current payment structure, instructors earn 37% of revenue for individual course purchases on Udemy’s marketplace. Instructors earn 25% for Udemy Business in our Personal Plan subscription offerings, which is allocated pro rata based on consumption of their content. Due to the rapid growth of the Udemy Business, our instructor payment pool has grown at a significantly faster rate than our marketplace revenue since 2020, with the total instructor earnings expected to be more than $200 million for 2023.
As we continue to scale, the cost of acquiring, on boarding and servicing customers has risen as well. Now it’s the right time for Udemy to further lean into capitalizing on the massive long-term opportunity available to us as we lead the transformation to the skills-based economy. As Greg shared, we have an exciting product road map that leverages generative AI and will accelerate our growth. We believe that these new products will drive greater customer adoption and engagement, ultimately increasing LTV over time as customers grow with us. We also plan to invest in brand-building initiatives to increase awareness and expand our global customer base, which will help grow instructors’ businesses by connecting them to more learners. Under the new structure, the revenue share for the marketplace will remain unchanged, but we will be gradually reducing the instructor share of subscription revenue.
Our first adjustment to 20% will be effective January 1, 2024, followed by 17.5% in 2025 and 15% in 2026. Considering the growth potential we see for our enterprise and subscription products, we will expand the instructor payment pool over time while optimizing the revenue share structure. The positive impact on gross margin from the revenue share adjustment is expected to be meaningful, allowing us to continue to grow sustainably, make the necessary investments to capitalize on the opportunity and expand our bottom line. Let me take a minute to walk you through some of our preliminary assumptions to illustrate how we’re thinking about margin expansion as we progress toward our long-term targets. Starting with the baseline estimated gross margin for 2023 of 50% to 59%, we expect an approximate 300 basis point improvement on average annually from 2024 to 2026.
By the end of 2026, we expect gross margin to be approaching 70%, and for 2027, we expect to exceed 70%. The majority of gross margin expansion will be driven by the instructor revenue share change, and to a lesser extent, the continued mix shift to Udemy Business and other leverage as we scale the business globally. During that time, we will make opportunistic investments that will support the long-term growth of our business. As a result, while it won’t be a straight line, we are confident that we will achieve our adjusted EBITDA target range of 15% to 20% by 2027. In closing, 2023 has so far been a transformative year for Udemy. We significantly strengthened our leadership team, strategically navigated a very challenging macroeconomic environment, and we delivered positive adjusted EBITDA well ahead of plan.
As we approach the end of 2023, we remain focused on consistently balancing strong top line growth and profitability on an annual basis. We look forward to keeping you updated as we progress toward that goal. So with that, we’ll open up the call for your questions. Moderator?
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Q&A Session
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Operator: We will now begin the question-and-answer session. [Operator Instructions] At this time we will take our first question, which will come from Ryan MacDonald with Needham. Please go ahead.
Ryan MacDonald : Hi, thanks for taking my question. And congrats on a great quarter. Maybe just starting with the instructor revenue share adjustments. As you think about what — as this is rolling out, is this going to be rolled out on January 1 to all Udemy Business consumer subscription content or only net new content that is created after Jan 1? And then as you think about the savings that this is going to generate on gross margin and the cost of revenues line, how much of that do you expect to reinvest below the gross margin line? Or how much of that you expect that should fall down to the bottom line as we look over the next couple of years here?
Greg Brown : Hi, Ryan. Thanks for the question. I’ll answer the first part and then turn it over to Sarah to answer the second. Yeah, as of Jan 1, the changes in instructor payment fees will apply to all courses that are subscription-based, Personal Plan as well as Team Plan and Enterprise Plan. And we surely are going to be reinvesting these funds to grow the business in significant ways. But I’ll let Sarah add a little bit more color in terms of the balance between gross margin impact and bottom line EBITDA margin. Sarah?
Sarah Blanchard : Yeah, hi, Ryan. Thanks for the question. So from a gross margin perspective, as we talked about, we expect about 300 basis points expansion on average, which is a combination of the instructor revenue share, which starts impacting immediately. As Greg just spoke about, we are making that change effective January 1 for all of our subscription courses. And then in addition to that, the revenue mix shift to Udemy Business over time also contributes to that gross margin expansion. From an EBITDA perspective, for next year, we expect just modest expansion because we are going to be reinvesting some of those dollars in some of the things you heard us talking about, around brand, around product and around go-to-market as we see green shoots in different areas.
We’re really focused in capturing this massive opportunity that is in front of us. So from a longer-term perspective, that means we expect to deliver meaningful bottom line expansion in 2025 and 2026 as a result of these investments. And we’re confident we’re going to reach our long-term EBITDA target in 2027.
Ryan MacDonald: Excellent. Thanks for color and really appreciate it. Maybe just one more, Greg, for you on just the environment within B2B. We’ve seen recently from one of the largest HCM surveys in the industry that net new dollars in sort of HR broadly are expected to be down, I think, 10%, 11% next year, but learning remains and training remains the top spend priority. So I’m curious, given the sort of shift towards skills-based training within enterprises, how are those conversations? And where are you seeing the most demand? Are you seeing a healthy mix of net new versus existing? Or is it more weighted towards existing customers? Thanks.
Greg Brown: That’s a really good question, Ryan. So as we mentioned, we saw — in the quarter, we saw improvement in sales cycle velocity, win rates, average deal sizes, improvement in deals over $100,000. And so from the perspective of the leading indicators we’re looking at, that give us confidence in the opportunity not just today, but tomorrow. We feel really good about the momentum and feel really good about our team’s ability to execute. We are seeing a balance of net new — a really healthy balance of net new customers as well as existing customer upsells. And I’ll tell you — I’ll give you an example of net new that is exciting for us. A large Fortune 500 financial services company signed a $2 million three-year contract with us for the specific purpose of developing and transitioning to a skills-based organization, so developing skills capability across the entire organization.
And they’re leveraging all products, not just our core, but Udemy Business Pro, professional services, as well as badging and certification. And the nature of those conversations, which I had an opportunity to take part of, what was really exciting is the strategic nature of the partnership and the way that they were looking at it. They’ve got goals to drive revenue, reduce costs, improve productivity and support their business community as a result of the investments they’re making in upskilling across the organization. So we’ve talked a bit in the past that this transition to a skills-based org and skills-based economy is gaining steam, and now it’s starting to manifest in large multiyear contracts, net new customers coming in, in addition to a healthy dose of expansion that we continue to see.
I’ll just add. I recently — over the last six weeks, I had an opportunity to go visit both Europe and India and spend time with a number of our larger customers. And I can tell you after meeting with the CLOs and heads of people in these organizations, that they’re under immense pressure by their CEOs to develop a strategy and a capability to upskill across the organization with respect to AI. Well, how are they going to internally leverage this transformational technology, right, to get operating leverage with respect to how they’re running their business, and at the same time, leverage AI into the products and services they’re developing to provide competitive advantage for their customers. And this is unlike anything I’ve seen before in my career in terms of the consistency.
Every customer we talked to, this was the number one topic of conversation. And we — and the conversations we were in were all about us being a primary partner and strategic partner in helping them through this endeavor of transitioning to, not just a skills-based organization, but an organization that truly understands how to leverage AI to get operating leverage internally as well as extend that externally. So we’re at the front end of a transformational shift, and we’re going to see more and more of this as we move forward.
