Good day, and welcome to the Udemy Second Quarter 2024 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Dennis Walsh, Vice President of Investor Relations. Please go ahead.

Thank you, David. Joining me today are Udemy's Chief Executive Officer, Greg Brown; and Chief Financial Officer, Sarah Blanchard. During this conference call, we'll 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. Our 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 and 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 SEC as non-GAAP financial measures. We believe that these non-GAAP financial measures support management and investors in evaluating our performance and comparing period-to-period results of operations in a more meaningful and consistent manner. 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 website. Please note, we have provided a supplemental deck with tables and charts with details on some of the initiatives announced today. The deck can be found for download on the quarterly results section of our Investor Relations 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.

Thank you, Dennis, and good afternoon to everyone on the call. I'm pleased to report that for the second quarter of 2024, our revenue came in at the high end of our guidance range, and we significantly exceeded the range for adjusted EBITDA margin. Udemy's business revenue increased 19% including the negative impact of 2 percentage points from changes in FX rates, while ARR grew to nearly $500 million, up 17% compared to the same period last year. As a result, total revenue increased 9% year-over-year, including a negative 2-point impact from FX to $194 million for the quarter. The growth was primarily driven by Udemy business, and was somewhat offset by an anticipated year-over-year decline in consumer revenue. On the bottom line, we overdelivered on our expectations for adjusted EBITDA as we continue to drive operational efficiencies throughout the business. This quarter, we also surpassed a monumental milestone of 1 billion course enrollment since inception. This remarkable achievement underscores our unwavering commitment to transforming lives to learning and highlights the profound impact we made on individuals and organizations around the world. I'm extremely proud of our team's performance and can't thank our employees enough for their hard work and dedication. Now that we're more than halfway through the year, I wanted to provide an update on the current state of the market and several strategic initiatives that we're implementing to more effectively position Udemy for long-term success. The global workforce skill gap is widening as generative AI accelerates the pace of change across all industries and geographies. By 2030, it is estimated that there could be 85 million jobs on fill due to a shortage of workers with the right skills, leading to $8.5 trillion in lost annual revenues. Companies and individuals need to adapt to a rapidly evolving…

Thank you, Greg. I'll start with comments on the key financial highlights and then provide our outlook. You can find a complete set of financial tables in our news release, which is available on our Investor Relations website. Revenue increased 9% year-over-year to $194 million. With more than 60% of our total revenue coming from outside the U.S., we have a negative impact from FX to our year-over-year growth rate of 2 percentage points. Absent the higher-than-anticipated FX headwind, we would have exceeded the high end of our guidance range for Q2. Udemy business revenue for the quarter was $121 million, an increase of 19% year-over-year, including a 2-percentage point headwind from changes in FX rates. We ended the quarter with annual recurring revenue, or ARR, of $493 million, up 17% from a year ago. Professional services, financial services, manufacturing, tech and retail continue to be the strongest verticals contributing to ARR growth. Our consolidated net dollar retention rate, or NDRR, at quarter end, was 101%. The rate was 108% for large customers or those with 1,000 or more employees. As expected, upsells are taking longer than historical norms in this environment, so we are still seeing some pressure on net dollar retention. Gross salary retention has remained stable. In aggregate, we grew our global customer base by 11% year-over-year to nearly 16,600. Gross margin for our Udemy business segment came in at 72% for the second quarter, up 500 basis points from the prior year primarily due to the instructor revenue share change that went into effect on January 1 of this year. As expected, second quarter consumer revenue of $74 million was down 4% on a year-over-year basis. Including a negative 3 percentage point impact from FX. Within that, personal plan subscriptions contributed more than 10% of the…

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Brett Knoblauch with Cantor Fitzgerald. Please go ahead.

This is Thomas Shinske on for Brett. I guess on the consumer weakness. Last quarter, we kind of pointed out the North American weakness, but strength outside of North America, I guess, any update to the trends there? Are we seeing continued consumer weakness? And any idea when you think this might pick up?

Tom, thanks for the question. So, a few things. I think the first is just a reminder that what we focus on most when it comes to consumer is our consumer vibrancy metrics. So really making sure that we are seeing the course creation updating that makes our solution and our platform is so powerful. And we continue to see 5,000-plus courses updated and created each month, which we're really happy to see. That being said, we did have a strong Q1 from a conversion perspective. We saw softness across Q2. And there wasn't really any area which is really broadly just consumer spending. We have also, as you probably know, have been pulling back on marketing spend over the past few years. One other thing I will add is we did implement some new low-cost marketing initiatives in the quarter. So, you saw traffic jump up quite a bit to about $41 million, over 20% up year-over-year. So, there's some puts and takes within consumer. Traffic is up, we've got some low-cost long-term marketing initiatives, but we did see softer conversion across the board from both a category of learning and from a regional perspective.

I'll just add real quick that from a strategic standpoint, our focus is on investing into the enterprise and deploying resources to scale and take advantage of the massive opportunity in the enterprise. So as Sarah just alluded to, we've been pretty clear that we're not investing in the consumer business in a material way to see significant growth it's really about vibrancy. So, you should expect as we go forward, the investment and where we apply our resources is going to largely be into the large enterprise.

Awesome. And then one more, if I may. On the enterprise shift, I guess, how will the shift affect existing SMB customers in terms of service continuity or changes in contracts? And I guess, how will that also affect like as we're looking at the NRR delta between the 2 NRRs that you guys disclosed, should we start to see those go into directions here, should we start to see the 108 kind of stick and the lower one kind of drive further down? Or what are we seeing there?

I'll take the first part of the question and Sarah, I'll let you take the second. So, I'm just going to broadly state that we've taken a very deliberate and data-driven approach to the decision of now reshaping our strategy to focus upmarket into the enterprise in a more concerted way. Now that really is about us moderating, I would say, and adjusting to the headwinds and the tailwinds that we're seeing in our business. But by no stretch, are we divesting and not going to serve the SMB opportunity to your customers. That's absolutely still going to be an important component of our overall strategy. So please take that away that we're going to take care of our SMB customers just as efficiently and ideally more effectively going forward than we have in the past. But the investment into our growth and the expansion opportunity is going to be in the enterprise. So, SMB customers are going to be well taken care of. Go ahead, Sarah.

Yes. I would just add to that. In thinking about net dollar retention, we are going to still continue to support our SMB customers. Where we're moderating our spend is in things like generating pipeline and regions and segments on the SMB side, where that pipeline is inefficient to generate, it's inefficient to capture. So, from a moderation perspective, a lot of it is in landing those new SMBs. But of course, we're always going to take good care of our customers.

And our next question comes from Stephen Sheldon with William Blair. Please go ahead.

You've got Pat [indiscernible] on today. My first question, just quickly wanted to ask. So, as we're seemingly on the cusp of hopefully improving macro environment. Can you just talk a bit more about the decision to strategically refocus on larger enterprise customers now versus down the road?

Yes, it's a good question. Happy to take that. So based on our assessment of the environmental conditions we're operating in today as well as projecting forward, and then coupling that with the assessment of all of the unit economic data that we have access to and our ability to build pipeline and everything we just mentioned in the release, with respect to higher win rates and what have you, all data points for us lead to the decision that we've made to invest into the large enterprise. And that is something that has not been taken lightly, obviously. It's got a lot of thought and data has supports the decisions we've made. So, the macroeconomic conditions, I would say, place some factor, but this is really about us playing to our strengths. And allocating resources and really getting focused as an organization on what we can control. And what we can control is the investment into this segment, which we have historically had a disproportionate amount of revenue growth, win rates, and we compete very, very well in this segment. And that's also going to enable us to deliver what we talked about on the bottom line. Which has accelerated -- material acceleration and expansion of our bottom line, which again is very much within our control. So that's a little bit of color around the decision process and we'll let us here.

Right. Okay. And then just now that it's been a couple of quarters since you implemented the change to the instructor payouts. Can you just provide an update on how that has gone with instructors, how retention has held up and particularly with those instructors in the higher end?

Yes. We are very pleased to say we continue to have had no top instructors opt out, and we expect that to continue. We are and constant communication with our instructors. Most recently, our Chief Product Officer, had a session with them going more deeply into the product capabilities that we're going to be releasing, that we're moving into beta right now with and the sentiment coming out of that meeting was extremely positive. And the comments and the dialogue continue to be very much upbeat. So really happy with the work our teams have done to bear hug and wrap our arms around our structures, which are the lifeblood of our business and making sure that the vibrancy of the conversation we're having with them continues to remain very, very positive.

And our next question comes from Ryan MacDonald with Needham & Company. Please go ahead.

Greg, maybe first one for you on one of the areas of strategic focus in terms of increasing that focus on penetrating the existing large customer base. I think you noted that it was about $1.5 billion revenue opportunity if you get to over 50% penetration there. What specifically can you do in the current environment to increase that penetration with those that you're obviously already embedded with an, obviously, there's been some volatility in the market with some competitors struggling? Is there any way you can use that to your advantage in the near term to help continue to consolidate share or maybe accelerate that consolidation of share reoccurring?

Yes. Good question, Ryan. I appreciate it. I'll touch on a couple of things. One is we continue to get strong data points from a variety of different sources that give us confidence that this shift to a skills-based economy and focus on learning and development continues to gain steam. Most recently, our own report, Workplace 2.0 report, saw 84% of our customers are focused on developing a skills-based infrastructure. And most recently, over the last week, Insight published a report that investment by leaders and prioritization and learning and development is up from 29% in 2023 to 50% in 2024. So, we continue to see momentum in the direction of developing a capability around skills. And that also manifests in customer wins. We had a number of nice customer wins. One in particular, I'll just call out is it's a large consumer products company that came to us needing a platform, a broad platform to consolidate onto is us against the usual suspects from a competitive perspective, and the requirements were much broader than just IT. Including business skills, professional skills, management leadership skills, very much playing into our favor and that's exactly what we've developed, the capability of platform that will serve an entire enterprise and their endeavor to transition to a skills-based organization. And so that ended up manifesting in a nice win for us, and this is a nice global partner. We've got a number of those that we could speak to. And that momentum continues to gain steam. So, and then to your question around maybe one of the folks in our category that has maybe had a difficult time I believe. There's no question that we're very focused on taking advantage and maximizing those types of opportunities and I won't go into great detail on that, but we've seen a number of wins this last quarter consolidation wins, if you will, or takeaways as a result of those exact type of opportunities. And just one of the other many data points that gives us a lot of confidence in our ability to continue to win a disproportionate amount of the time in the large enterprise.

Super helpful color there. I appreciate it. Sarah, maybe as a follow-up for you. As we think about this pathway now to $130 million to $150 million of adjusted EBITDA in fiscal '26. Can you just help us understand maybe what the assumptions are around the sort of operating environment or maybe growth environment to as you kind of work towards those targets, do we need sort of the end markets across consumer and UB to just sort of remain relatively constant with where they're at today? Do you require an improvement slowdown? Just kind of curious of maybe the environment or framework as you think about your pathway towards these targets?

Thanks for the question, Ryan. So how we're thinking about it is, first, on the UB side, UB, we believe, is going to continue to be a very durable double-digit growth segment for us. And as we focus on the enterprise, the unit economics on that side of the business are already much stronger than on the SMB side. The retention is stronger, the ability to upsell and sell in. Greg just spoke about it. The pipeline has been building path that is going to be our fastest-growing segment. The consumer side, there's a little bit less visibility. Ideally, we've spoken about over time running that flat to up a few points. That could take some time, right? We're going to be exiting this year in the low down probably 10% to 11% as we saw -- that's our expectation as we saw those conversion rates in the second half. So, we think that going forward, we're going to be able to stabilize that consumer business somewhat. Drive the UB and continue to delivering double digit and really expand on that bottom line aggressively because we're focused on controlling the controllables. And we have continued to overdeliver on EBITDA quarter after quarter after quarter as a public company. And so that's where our focus is. And I know there's a lot of different scenarios from a top line perspective, when you think about our EBITDA targets and getting there faster, but just that's how we're thinking about it and the margin expansion is going to come from about 650 basis points is going to be gross margin improvement. The majority, the vast majority of that is in structure revenue share change mix shift. And then we've got these operating efficiency initiatives that we're undergoing right now that will deliver another 3 points. And then another 7.5 of operating leverage -- 750 basis points of operating leverage over the next few years. So that's how we're thinking about it, and we're just really focused on this new strategic focus.

Excellent. I appreciate the additional context there.

The next question comes from Terry Tillman with Truist Securities. Please go ahead.

This is Dominique Manansala on for Terry. So, as we think about reacceleration for you to meet business in the back half of the year, how should we think about growth on quarterly breakdown? And what factors are driving the growth rate in each period?

Yes, I'll take that question. So, what we're looking at with our updated guidance is exiting the year with UB in the low double digits. And from a net new ARR incremental ARR, that is what we will see in the fourth quarter step up a bit. But with this shift in our focus and with the changes we're going to be making to our go-to-market organization, that reacceleration of UB is going to take a little more time.

Great. And could you also provide an update on international operations in the APAC region? I'm just curious as to how the demand and execution queue [indiscernible] Japan also held up.

Yes, happy to take that. So, we talked in prior announcements that we did have some softness in that region. We've shored up leadership, feel good about the leadership we have in that region. And we continue to work through the execution aspect of what's happening in both Korea, Vietnam and then, of course, Japan, which has been operating and executing well for some time. Nothing specific to call out. I feel good about what we're seeing. Rob now, our new CRO, is in the saddle, has been to Japan, spent a full week, I believe, 10 days over there with customers and partners. Came back with a lot of optimism around the upside potential there. So, nothing material to call out with respect to APAC other than what I just mentioned.

And the next question comes from Josh Baer with Morgan Stanley.

I was wondering if you could maybe help appreciate the bridge that we have. But as far as like the annual margin expansion from 2024, either out to the 2026 EBITDA dollar guide or the 20% in '27. Like any help in thinking about the path there?

Yes, Josh, thanks for the question. In this focus on pulling our margin expansion forward, you should expect to see significant margin expansion in both 2025 and 2026. And so, you can think about the gross margin, you know what that looks like in that expansion. And you could expect not perfectly, but roughly linear expansion over those few years.

Okay. Got it. And then a follow-up, like with that in mind, so kind of talking about maybe 550 basis points of annual expansion or something like that to just get from 3.5 in '24 to 20% in '27. You're like 14%, 15% in 2026, you have an EBITDA range there 130 to 150. At the high end, that's over $1 billion in revenue, which is like a 15% growth CAGR, but Q4 is exiting at 3% growth. So, I was just hoping you could talk a little bit more about what it's going to take to really accelerate from 3% exiting this year to 15% over the next couple of years?

Yes. So, we're not putting any targets out for our revenue growth rates in '25 and '26 right now, '25 will happen at the end of this year. And there is a wide variety of potential revenue growth rates that will allow us to get to that $130 million to $150 million EBITDA. And so, when you're thinking about the growth for us, again, UB is going to remain a double-digit growth. But we are exiting this year about 12% growth rate. So just thinking about that and that accelerating over some period of time, but not quickly, multiple scenarios for consumer, we're focused on the bottom line. We have a clear path to it and we'll be providing more detail on '25 to '26 in the upcoming quarters.

And the next question comes from Jeff Mueller with Baird. Please go ahead.

Steven Pawlak for Jeff. Under the new strategic plan, I guess, what can you do differently under the new model that you are already doing to drive upsell at existing clients besides just increased capacity?

A good question. So, I think a lot of it has to do with the focus we're going to apply and the process and the rigor that we're going to implement under Rob's leadership. In terms of how we're landing and expanding into our class of enterprise customers. And we now have a broad platform. And the vast majority of our revenue to date has been through seat expansion. It will -- landing with our core product and then expanding core product seats. We're going to get much better at selling our additional products and capabilities allow Udemy Business Pro, Udemy Leadership Academy as well as the new set of products, AI products that are coming online in the back half of the year. So, we're going to have more to sell. We're going to get really good at selling those products through our enterprise customers as well as accelerating seat expansion. Remember, we're less than 10% penetrated in the 5,000-plus customers we have in that segment. So, there's tremendous opportunity for both seat expansion and new product expansion into this class of customers. And with the focus that we're going to be applying with Rob's experience and expertise, having done this for 25 years at high-growth companies like Adobe and SAP, I've got a lot of confidence. We have a lot of confidence in our ability to do just that. So, focus is a great thing, and we're applying focus now. And with the win rates that we've seen in our enterprise customer segment. Keep in mind, right now, we're growing at more than twice the rate at over-place the scale of any of our public peers. And we're adding more customers every quarter into that segment than any of those folks in a material way. So we've got a position of strength that we're building off of, and we expect to extend that.

Understood. And then with the reallocation of resources upmarket, is there a retraining that's involved there? And sort of what's the time line to maybe how those people reach full capacity, if that's the case?

We've already got a strong contingent of account executives selling into our enterprise and strategic accounts. Is there some additional training around sales process that Rob and team are going to be layering in? Yes, there is. But that's going to be on the fly and continuing to improve how we engage, land and expand and sell value up to the C-suite as we continue to move through the months and quarters ahead. So, yes, I mean, there's no doubt there's an investment there, and that will be ongoing. But I've done this a long time and let go to market teams for a long time, and that's always an ongoing process, right? So that's always an evolution that organizations are going to continue to have.

[Operator Instructions] our next question comes from Noah Herman with JPMorgan. Please go ahead.

So just on the point about optimizing the go-to-market organization. Can you just elaborate if maybe you have to hire additional sales leadership to really execute the new go-to-market playbook as you're sort of reshuffling the deck a little bit? And if so, what is really the time line for the transformation?

It's a good question. We don't expect material changes in leadership on the sales side to be able to execute our plan. Are we going to be reshaping promotion and augmenting processes to be able to execute and do what I've alluded to now, which is land and expand more efficiently and effectively into this segment? Yes, we surely will. And so, I mean, there may be some small changes that we make as we move forward from a personnel standpoint, leadership. But really, it's about focus for us and not trying to sell equally into all segments but getting really, really good and focusing on and executing well into the enterprise segment. So, Rob is in process of working with our teams to determine, if we need to shift some heads from one segment to the other, and that will be an ongoing process, and that's always an ongoing process. Where we see opportunity, we're going to layer heads in. We're going to lay our account executives. And we're going to do that as aggressively as we can where the opportunity presents itself. And that's just a process that will unfold over the next quarters and months ahead.

Yes, that's really helpful. And just maybe for Sarah. Just on the guidance, understanding everything happening with the consumer segment, but for the large customer cohort, what exactly are you embedding in the guidance that's really changing on a sequential basis outside of the key initiatives that you're implementing. Was there any change that you saw in terms of pipeline? Or impact from macro that's really been baked into the guidance now?

Yes. Thanks for the question. We have continued to see the macro be a challenging environment. And by that, I mean, we have continued to see deals take longer to close. Some of them are a little bit smaller than they have been historically, it's taken a little bit longer to upsell. And so, we have factored that into the guidance as well as the impact of this strategic shift of market. So, both of those have been taken into consideration. And we're really focused on driving that growth efficiently. You heard Greg talk about the LTV and the retention and the efficiencies of that enterprise segment. And so, we're really focused on capturing that market really efficiently.

Our next question comes from Devin Au with Keybanc. Please go ahead.

Just wanted to get more clarity on the conversion -- free-to-pay conversion slowdown in consumer. When did you see kind of that conversion slowdown in the quarter? And like thus far this quarter, has it deteriorated? I just want to get more clarity on kind of what happened there just because you guys pick up the guide last quarter, but now you're seeing slowdown there. So just maybe help us bridge what happened there.

Yes. Thanks for the question, Devin. So, we really did see Q1 was strong as we stated, and we did bring up our expectations on consumer for the year. April was I'm going to say, okay. And then we saw that deceleration or suppression of the conversion rates in May and June. We continue to see a few tough and our expectation for the rest of the year is that it's going to remain tough that the consumer environment is going to be hard. One thing I will mention is we do have a new head of consumer. And he pulled together his plan along with the team. And so, we're going to be launching some new strategic initiatives, but we don't want to press the pedal on spend. We've been pulling back that marketing spend. We're operating that business pretty thoughtfully until some of these strategic initiatives allow us to have an LTV that we feel comfortable spending into. But again, our focus right now is keeping consumers stable, that marketplace vibrancy and really focusing on our new strategic initiatives.

Helpful. And then just one quick follow-up on the enterprise side. I think you alluded to the recovery time line of enterprise ARR growth is going to get pushed out. I mean how much of that extend the time line is driven by the changes that you're making on the go-to-market side? And how much of that is really just the step down that you're seeing in the macro environment?

Yes. So, we're not going to break down between those two categories. But what I will say is, in the last call, we did say that we expect our incremental ARR to be pretty flat in Q2 and Q3. And then step up a bit in Q4, and that is still our expectation, a little more muted with this focus on the focus upmarket, but this is consistent with how we were seeing net new ARR throughout this year.

This concludes our question-and-answer session. I would like to turn the conference back over to Greg Brown for any closing remarks.

Yes, I'd like to thank everybody for joining the call today, and we look forward to the next update for Q3 in November. Thanks so much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.