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Thank you for standing by. This is the conference operator. Welcome to the Martello Technologies Group Second Quarter Fiscal 2023 Investor Conference Call. Today's call will provide information and commentary on financial results for the 3 and 6 months ended September 30, 2022.
We will hear from John Proctor, President and CEO of Martello; and Jim Clark, Martello's Chief Financial Officer. Following these remarks, John and Jim will take questions from analysts. If you have questions following the call, you can reach Martello at investor@martellotech.com. [Operator Instructions] This call is being recorded, and we expect that the recording will be available on Martello's website today. We remind that you that today's remarks will include forward-looking statements that are subject to important risks and uncertainties. For more information on these risks and uncertainties, see the reader advisory at the bottom of Martello's press release, which is on their website and on SEDAR. The company's actual performance could differ materially from these statements.
We will begin with Martello's CEO, John Proctor. John?
Good morning, everyone, and thank you for joining us. I hope you and your families are all well and keeping well this fall. Before Jim and I review this quarter, I'd like to briefly touch on our growth strategy and the private placement announced last week. As you know, Vantage DX is the market-leading SaaS platform we launched just under a year ago. It consolidated several software products into a single solution to prioritize, resolve and optimize Microsoft team's performance. In under a year, it has become the Microsoft recommended teams monitoring solution, and I'll talk a little bit more about that development of our partnership with Microsoft in a few moments. Our objective is to build a profitable business in the coming quarters, driven by this product Vantage DX. We're seeing progress in VantageDX uptake with a number of users on the platform more than doubling in the first half of the 2023 fiscal year and monthly recurring revenue increasing by 252%.
To increase our share of 270 million user Microsoft Teams market, we're continuing to invest in our partnership with Microsoft to increase the size and velocity of our sales pipeline. Microsoft supports us on key sales deals and make connections to enterprise customers with a need for our solutions. They also champion our solution on webinars and in other marketing and sales activities. Similarly, our partnership with Roland is giving us access to large enterprise clients who can see a significant return on investment by adding Vantage DX to their Microsoft team deployment, avoiding downtime and productivity loss. We won our first major client with Orange in Q2 and have several more deals in the pipeline with them. We also want to accelerate our lead to revenue cycle. We are implementing initiatives that simplify our sales process, such as reduction or elimination of Vantage DX trials.
Other improvements we've made in software have made it easier to show value to our clients rapidly and to accelerate the sale. Product stability and consistent feature releases are helping to drive more prospects into and through our funnel. I am pleased with the momentum we're seeing with Vantage Dx. It is clearly solving a problem with a growing number of large organization space.
It helps IT professionals to identify when and where problems and their infrastructure will negatively impact Microsoft Teams users and disrupt their productivity. Our co-Chairman, Terry Matthews, shares my excitement about our solution and market timing. And as we announced last week, he has provided an additional USD 2 million in capital through a private placement. This additional capital gives us excellent runway to manage lender obligations and grow our Vantage DX business to positive cash flow.
We remain focused on achieving positive cash flow, and we took an important step towards this goal with a cost optimized exercise in August, reducing our annualized run rate cost by 20%. We will see the full benes reduction -- full benefit of these reductions in Q3 of this year with operating expenses down 9% in Q2. Finally, I want to touch on our Mitel partnership and the hundreds of Mitel partners who use Mitel Performance Analytics, or MPA, the software we develop for Mitel's channel. We continue to nurture and sustain this important partnership. There is growing interest from Mitel channel partners and our Vantage DX solution. Having relied on NPA for many years to monitor their Mitel solutions, we are a trusted software provider to bring these partners similar monitoring capabilities for Microsoft Teams. The Mitel business line remains a solid, long-term recurring revenue base from which we can build sustained growth of our Vantage Dx solution. I'll speak more about our focus and outlook shortly after Jim provides a more detailed review of our financial performance in the first quarter. Over to you, Jim.
Thanks, John. I will review the Q2 fiscal 2023 financials and some depth in a few moments. First, I would like to share my perspective on the company's performance and how we are driving customer and partner value leading to shareholder value. Following the recent cost optimization exercise, management has increased its monitoring of performance through robust operational KPIs.
As John discussed upfront, management has absolute focus on accelerating our sales and product feature release cycles. These actions, in tandem with careful decisions on spend and cash will result in Martello achieving sustained profitable growth. onto the financials for Q2. As always, we have posted our financials and the related press release to SEDAR, where you can review our financials in more detail at your convenience.
Q2 revenues were $3.8 million, representing a $0.6 million decrease compared to $4.4 million in Q2 fiscal 2022. The decrease is related to reductions in sunsetting legacy products, licenses, maintenance and support. On a constant currency basis, revenue decreased by about 11%. While we are seeing strong consistent quarter-over-quarter growth in Vantage DX revenue over the first 11 months since its launch, the cause of the decrease in our top line revenue is the decline of revenue from some sunsetting legacy products. This decline is expected as Vantage DX scaling continues. One anomaly contributing to the decline is the off-boarding of a sizable customer, which had a material impact on revenue.
Management is organized to maximize the conversion of certain legacy products and customers to Vantage Dx. Gross margin was 87% in Q2 fiscal 2023 compared to 90% in the same period of fiscal 2022. The decrease is due to higher hosting costs associated with the growth in cloud-hosted environments, led by Vantage Dx. Management is taking actions that are expected to result in around a 50% decrease in the cost of hosting instances in the future as we onboard new Vantage DX clients, the variable costs will continue to reduce.
The recurring portion of total revenue was 99% compared to 98% in Q2 of fiscal 2022. This is primarily attributable to the growing mix of subscription-based licenses. Modern workplace optimization continues to be Martello's dominant business line with 55% of total revenues in Q2 of fiscal 2023. Mitel Performance Analytics represented 45% of revenues in the quarter.
The Mitel business line continues to provide a steady $7 million annual revenue base that is 99% recurring as we see strong growth rates from the new Vantage Dx product targeted at the Microsoft ecosystem. Q2 monthly recurring revenue, or MRR, was $1.26 million compared to $1.44 million in the same period last year. This decrease is attributable to declining license, maintenance and support revenue, primarily on sunsetting legacy products, a slight decrease in Mitel subscriptions and unfavorable currency conversion. Just as a reminder, MRR is a non-IFRS measure, representing the average monthly recurring revenues earned in a fiscal quarter. We reached 474,000 Microsoft users on the Vantage Dx platform, representing a 33% increase compared to Q1 and a 117% increase in the first half of fiscal 2023 versus Q4. The total number of Microsoft users on all Martello products totaled $2.2 million compared to $2.9 million in Q2 of fiscal 2022. As discussed above, the decrease was led by the offboarding of a legacy GSX partner.
The company is maintaining absolute focus on driving Vantage DX growth in partnership with Microsoft and our expanding sales channels. Operating expenses decreased 9% year-over-year to $4.69 million in Q2 fiscal 2023 from $5.14 million in Q2 of fiscal 2022. The decrease is primarily attributable to the headcount reductions in the recent cost optimization exercise and decreased depreciation, amortization and acquisition-related costs attributable to lower foreign currency conversion rates on euro to Canadian dollar.
The Q2 net loss of $2.42 million represented a 41% increase compared to a net loss of $1.72 million in the same period of 2022. The adjusted EBITDA loss in this period was $0.85 compared to a loss of 0.3% in Q2 of 2022, attributable to the higher operating losses as discussed earlier. The company's cash and short-term investments balance was $4.2 million at September 30, 2022, compared to $5 million at March 31, 2022.
Working capital now reflects the move of Visterra debt from long term to current plus the subordinate loan agreement signed with Westlake over in August. This is the predominant reason for the $12 million change in working capital.
To close, I am confident that management is effectively responding to the strong and evolving market opportunity in our line of sight. I believe that our continued focus on accelerating sales through expanded sales channels, high-value product features and improving our cost performance will result in achieving sustained profitable growth in the coming quarters. The recently announced USD 2 million private placement will help us manage our lender obligations and allow us to maintain focus on our objective to reach profitable growth driven by Vantage Dx. I'll now hand it back to John to close with his perspective on Martello's outlook. John?
Thanks, Jim. As I mentioned earlier, we continue to be focused on the opportunity to optimize Microsoft Teams and Microsoft 365 user experience with Vantage Dx, working closely with Microsoft and other key partners like Orange and Datacom. I'm really pleased with the momentum we're seeing at Vantage DX remain very confident that we are in the right market at the right time.
Microsoft Teams is a large and growing market of 270 million users and IT teams globally are facing escalating pressure to manage team performance for a mix of remote and office-based users. We have recently won a few significant sales deals. One was a Fortune 100 food manufacturer with 80,000 users that wanted to create a 24/7 monitoring service for VIPs or those whose calls are mission-critical.
We also won a large U.K. government department with more than 120,000 users. What's been fantastic is that when these 2 customers deployed our new team's dashboard immediately showed them that they had more poll calls than they thought they did, which allowed them to address these problems right away. This allows them to see significant improvement in their team productivity. We are excited by how these dashboards will accelerate our trial cycle, so our time to revenue is faster.
Overall, we are doing more with less, achieving efficiencies and focused on continuous improvement to expand our sales pipeline and accelerate time to revenue. Our deepening partnerships with Microsoft, Orange and Mitel are an important differentiated asset for Martello. One, we will continue to nurture and develop. Our plans to build a profitable business in the coming quarters are on track, and I am confident that Vantage DX revenue will help drive this growth. Jim and I are now here to answer your questions. And operator, would you please facilitate the Q&A part of this call.
[Operator Instructions] The first question comes from Kiran Sritharan from Eight Capital.
So there were 1 million trials on DX last quarter. How does that cohort look in terms of conversions? And can you also comment on the broader health of the demand environment and the DX pipeline?
Sure. I'll start on the conversions piece. If I look at sort of those wings or bringing in a trial, the -- as a general rule of thumb, the bigger the company is, the longer the trial takes and I mentioned sort of some of the big -- like the U.K. government department that we closed, 120,000 users. -- from start of conversation to close with almost a year. So again, these things are not swift with the big clients and they've got different departments and they all sort of want to plug into and everybody has an opinion on the trial.
It's the small ones that move quicker. So really, when I look at the conversions, generally, once we get into trial, we are -- we're seeing strong success in those pieces. They see the value. And particularly now with the dashboards and just sort of the dashboards only appeared in Q2. So what we're seeing with the dashboards is not only are they sort of given instant value to current new trials that are just starting. But when we've got clients already in the pipeline, suddenly we're going -- be able to say, hey, and these are the new upgrades to the product that you've already had a brief look at.
So we will see some accelerate there and I expect higher conversions. The slight downside is that is a lot of things drift right, and that's to do with primarily, I think, to do with the economy. Every enterprise at the moment is looking at their budgets, including their IT budget and saying, do I -- what do I need to spend? Can I move things slightly right? Can I keep more cash on hold? So we're seeing a little bit of that is our challenge. That's absolutely the fight at the moment is pulling those trials to close because even some who've trialed, they're now going into the procurement cycle and some procurement guys who say, yes, well, maybe not this quarter, maybe it's next quarter, and we end up in a bit of a loop with the procurement guys where the IT guys have said yes.
So that's probably our biggest struggle at the moment. It's a manageable one. But certainly, it's not easy at the moment to soothe to get through some of the procurement processes when they're holding the per string is quite tight.
Understood. Looking at the partnership channel with Orange and Datacom, how big are the wins that are usually led by them? And like how are the sales cycles in to?
Yes. So I'll start with Datacom and then jump to Orange. Datacom is basically, yes, they're working on a couple of large opportunities with us, but their profiles are slightly smaller enterprise, 2,000 to 3,000 users and below. The nice thing there is they can also take on much smaller clients and jam them all into a single instance, whereas reach enterprise individual client, we run a single instance for those clients, which is expensive relatively. And I'll come on to -- that's why we talked about in hosting costs.
We're reducing that. But overall, it's still not that cheap, particularly for a 200-, 300-person business, you're not going to do that. But what Datacom and we've set up is Datacom can onboard those guys, all the small guys into one instance under Datacom's management. So that's part of it. At Orange can expect their giant enterprise, right? This is that Fortune 100 food manufacturer. I look at some of the brand names they're currently talking to us about in the pipeline. These are all huge household name enterprises. And that's just the nature of their business. They're a global telco. They're a global systems integrator in MSP. So even for them to make their money is around these large enterprises. But that's kind of important. And I I'll touch on one example when we installed our product into this new -- this Fortune 100 food manufacturer, our dashboard showed they had a 1 in 10 poor call or call failure rate. And I'll let that sort of think about that from a -- if you're the CEO or CFO of that company and you've just been told that you bought Office 365 and Teams, but 1 in 10 of your calls are poor as not overly productive.
You're going to want have fixed, and they didn't know until they installed our product, but that was their reality. Yes, they were getting help desk calls, Yes, they were seeing problems, but the severity of that problem was not apparent to the IT team. So we give that transparency, and that's kind of key. Now for Orange, they can look at that and say, now they're going to provide a service to fix those problems.
Now they can provide a service to deliver a much higher level of productivity inside that company. using our tool as sort of the guide and the benchmark to make sure they're doing it. So Orange can immediately see their own revenue. And that's kind of the point for all the partners is it's not just selling our tool, which is cool. I'll take a few points off the top. This is can they wrap the service around it? Can they generate revenue, even recurring revenue around the tool? And the answer is yes, and Orange have worked that out very quick.
Well last one more before passing the line and more question for Jim here. Looking at costs, how do you expect COGS and S&M to trend as users on DX increase? Would we -- should we model a more gradual hike? Are there any scale benefits or upfront investment here to think of?
Yes. So from a cost perspective, as John explained and I mentioned, we went through a cost optimization initiative to drive more focus on to the investment into Vantage DX we're seeing all the momentum indicators pointing to the growth that we were expecting. As we look at our cost base, so I'll start first with cost of goods sold, there is a -- there has been an increase in cost of goods sold within the hosting cost. That's attributable to the kind of the investment curve and where we are as we stand up instances and then we onboard clients.
We're going to see those costs those costs vary and come down variably significantly as we onboard clients. Secondly, we've -- as John mentioned, we've come up with a faster or accelerating our sales cycle and part of that is also going to be a reduction in the cost of hosting as we compress those cycles through trial, which is good news. From an operating expense perspective, we are carefully considering all the options on costs, both in terms of further investment in areas to make sure that we're leveraging and capitalizing on the opportunity in front of us.
So what we would see, and we've kind of drawn out as revenue accelerates, we do expect that we're going to be increasing our operating expenses to support, but it will be a lot less trajectory than the actual growth line. So we will carefully grow into our revenue line.
[Operator Instructions] The next question comes from Daniel Rosenberg of Paradigm Capital.
My first question was around the legacy churn. I was wondering when does this taper off? Or when does this cycle out? Is this a onetime kind of in the quarter and this is a new reset of levels? Or is there more to go as you said?
So thanks, Daniel. And yes, if I look at sort of legacy piece, and again, I've described this before as sort of we've got Vantage at the top, Mitel in the middle and the Legacy sort of below that. A significant part of that Legacy is Gizmo, which is the tool we acquired from GSX, which is clearly a foundational part of Vantage as well.
But still we're not doing much on Gizmo at the moment, if anything, but clients still renew a large Asian bank just renewed, for example. One of the focus there on that Gizmo is to they're the people or the clients we see the simplest part of Vantage. So those are folks when we talk about churn, we're hoping they don't churn. We hope we want to transition those guys on to Vantage DX. And certainly, if you look at our initial Vantage DX customers, they were all Gizmo clients.
So our first 8 Vantage DX customers were already clients of ours already using Gizmo and they transitioned onto Vantage. So that's going to be a focus. If I look at the other pieces, be it live maps, IQ or the Domino's software. Domino's software, absolutely, that's decaying. The Sconproduct, live Maps is also decaying. IQ, we're not doing any work on that at all. However, one of our key partners, Paslasand are -- they're still growing that revenue stream with us because they white label it.
So much like sort of Mitel, we sustain the IQ product because payer needed for their PRTG product line. They white labeled it in there. So certainly, I would see sort of that one sustaining. But as for the other 2 live maps and the Domino, we -- there's no maintenance, there's no work going into it. There's no customer success going on to it. So absolutely, I see it decay.
But again, in terms of time line, like I said, is this is the -- sadly -- and again, you and I have spoken about before. This is the complexity of Martello. I see those 2 live maps and Domino, to be honest, I'd like them to decay as fast as possible, just keep decaying happily. The Gizmo advantage and then IQ, we will just look after just because we needed to sustain Paisle. So again, financially, however, to your point, I see their impact decreasing certainly into next calendar year, I would expect that Vantage will outgrow any sign of decay or the impact of decay of any of those legacy products.
Okay. And then on the COGS, I was curious, approximately what percentage of COGS is hosting costs today?
What percentage of the total cost of goods sold is the hosting cost?
Yes.
Yes. Okay. So as we look at it today, the -- and I mentioned it upfront, we win a customer, we stand up an instance and therefore, that hosting cost is going to be the majority component of the total cost to get sold. As we've onboarded others, you can see the actual ratio of the hosting cost to the cost of goods sold is going to decline. At this point, the hosting costs would represent about 55% of the total cost of goods sold, and we're going to see that come down. So your question is probably related to variables. On the biggest variable is we're going to accelerate VDX. VDX is on a hosted environment only. We're selling it as a cloud solution only. That's going to drive up the mix of our VDX cost of goods sold within the total cost of goods sold. And you can see where Mitel, for example, cost of goods sold are very, very low and the margins are high. So that mix is probably going to have the biggest impact on our overall cost to get sold.
And lastly, on the sales channels. As you implement the cost savings and turn the corner on profitability, when you think about how you want to design your sales team going forward, would that include direct sales or really focusing more on establishing more partnerships? How are you guys thinking about that?
Yes. I mean, great question. If I look at sort of where we are currently, it's 80% direct, 20% partner, and that's not unexpected to be spun up the partners. One of the things with Microsoft and we've got a QBR today is Microsoft has been really good at sitting with us on deals. We had a call with a large potential insurance partner in Asia this week, 5 Microsoft people turned up to support us, which is great. What we need them to help also do though is generic pipeline.
And that's a bit -- I'm a bit disappointed in that. They will get that message during the QBR today. But I think there's still great potential. They're still learning about us. So whereas Orange are certainly moving in terms of bringing deals to us, we -- they called us last week and put us into an RFP. They're moving certainly faster from a pure pipeline deal perspective. But again, the irony as is the big deal we closed with Orange, Microsoft supported.
So Microsoft will be this balance of both support and pipeline. Orange will be pure pipeline. That being said, I want that to -- what are we setting -- started setting targets for next year. What I'd like to see next year is we're 60% direct and 40% partner. And what that also means is I want to keep the costs down in terms of our own sales folks, and we're making these partners.
We've got a bunch of new partners in the pipeline. We've got paperwork out. We're waiting for the big -- their big entities. So grinding paperwork through them takes a while. But that's also where I see increasing that. So I'm trying to focus. One of the things I think we've got to do better is look at the U.S. more of the market. We haven't done that. If I look at sort of next year and as we become sort of headed towards that as we become profitable, one of the early areas where we might try and do more with more as opposed to less with more is expand our sales presence in the states.
We have some presence. We have sales engineer. We have tech support in the States, but sales is done from Canada but having somebody whose physical presence and states, I think, will help. So that was where we'd probably look at that. But certainly from a partner perspective, I do see that pipeline expanding from the partners coming in as Orange get our arms around is that is absolutely true. That's exactly how this is happening. And we're hoping Microsoft can make a bit of a shift from being supportive to more pipeline generation.
This concludes the question-and-answer session. I would like to turn the conference back over to John Proctor for closing remarks.
Okay. On behalf of all of us, thank you all for your interest in Martello. As mentioned earlier, you can register to receive our upcoming newsletter in the Interior section of our website and the recording of today's call will be available on our website later today. On another note, if you're looking to understand more about the Martello product line, please have a chance to look at any of our webinars. The links are posted on our website, and we'll give you some perspective. And particularly, if you want to see what Microsoft and Orange think of us, they are on some of the webinars with us and we'll give you their perspective. At the same time, you can reach out to our Investor Relations any time by e-mailing investor@martellotech.com. Thank you all, and have a great day.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.