Instructure Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to Instructure's third quarter 2021 earnings call. At this time, all participants are in a lesson-only mode. After the speaker's presentation, there will be a question and answer session. Please be advised that this conference is being recorded. I would like to turn the conference over to your first speaker, April See, Investor Relations.

April, please go ahead. Good afternoon and welcome to Instructure's third quarter of 2021 earnings call. We will be discussing the results announced in our press release issued after the market closed today. With me are Instructure's Chief Executive Officer, Steve Daley, and Chief Financial Officer, Dale Bowen. Before we begin, I'd like to remind you that today's conference call will include forward-looking statements based on the company's current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For discussion of factors that could affect our future financial results in business, please refer to the disclosure in today's earnings release and other reports and filings we file from time to time with the Securities and Exchange Commission. All of our statements are made as of today based on information available to us today, and except as required by law, we assume no obligation to update any such statements. During the call, we will also refer to both GAAP and non-GAAP financial measures. You can find the reconciliation of our GAAP to non-GAAP measures included in our press release, which is posted to the investor relations section of the website. All of our non-revenue financial measures we discussed today are non-GAAP, unless we state that the measure is a GAAP measure. With that, let me turn the call over to Steve.

Thank you, April. And good afternoon, everyone. Thank you all for joining us for our third quarter 2021 earnings call. During today's call, Dale and I will provide details on our third quarter results and provide an update on 2021 guidance. As you can see, Instructure exhibited strong performance in Q3, which exceeded our previously communicated guidance. Third quarter gap revenue was $107.2 million of 31% year over year, while allocated combined receipts, or ACR, was $108.6 million up 24% year over year. As a reminder, we think ACR, which adds back the impact of fair value adjustments to acquired unearned revenue is a better representation of the business as it gives investors better visibility into the underlying health of our business. We delivered this growth while continuing to demonstrate the strength of our business model with 38% adjusted EBITDA margins in the quarter and strong unlevered free cashflow conversion Q3 was another strong quarter for Instructure, and I'm excited about the company's bright future. Our strong Q3 results were fueled by new local wins and the ongoing expansion of existing customer relationships. I couldn't be prouder of these results, which showcased our commitment to growth while maintaining best-in-class margins. We have a diversified business in higher ed, K-12, and international, with leading share in North America and growing share across the world. Our strong growth trajectory is underpinned by the powerful trend of digital transformation in education, very favorable and durable federal funding dynamics, and our mission-critical platform that facilitates teaching and learning for over 30 million Canvas users. I now want to talk about five key highlights from the quarter today. First, our products continue to see high usage, even after most North American K-12 and higher ed students return to the classroom this fall. In Q3, users of Canvas continued to utilize the platform at levels that are significantly higher than pre-pandemic levels. This strong usage reinforces our assessment that the LMS continues to be a core platform for teaching and learning, even as students and teachers return to the classroom and is a cornerstone in the digital transformation of education. Second, in Q3, we saw strength in each of our markets, given strong tailwinds from digital transformation projects and our key differentiators. usability, reliability, scalability, and broad open platform. We continue to win new logos in higher education, replacing incumbent legacy LMS solutions. In the third quarter, Johns Hopkins University announced that it will replace Blackboard with Canvas as the university's learning management system in advance of the 2022-2023 academic school year. Miami Dade College also announced that they are moving from Blackboard to Canvas for the 2022 school year. In each case, ease of use, modern user interface, superior mobile experience, and powerful ability to integrate with third-party tools were key differentiators. Higher education institutions continue to see Instructure and Canvas as the next generation solution as they re-platform for the future. On the K-12 side, we continue to see strong momentum, including securing greenfield wins in districts that are not already using a paid LMS. The value of an enterprise-grade LMS has become increasingly clear as districts recognize the importance of features, uptime, and scalability amidst accelerated digital transformation. For example, a top 10 school district in the U.S. with over 200,000 students chose Canvas as their paid LMS in Q3, even though they had access to a competitor's LMS for no cost. Despite this and their usage of the competitor's student information system, known as the SIS, they chose Canvas because of our demonstrated success in large districts, our superior functionality, and the appeal of our new and well-received Canvas K-5 offering. This is a great example of the continued traction that we are seeing in the K-12 market and a great proof point of how we continue to invest for innovation. We also continue to see outstanding growth in our international markets, with revenue growth in excess of 30% during the third quarter. Third, we continue to see demand building for our products, and this was very evident in our successful InstructureCon customer event last month. We had attendees from over 5,000 institutions join us at InstructureCon, more than five times pre-pandemic levels. At the conference, we introduced new commercial partnerships and several significant new features to our learning platform, including mastery via simplified assessments, which utilize scoring algorithms that enable shorter, more effective assessments, and Canvas for K-5, which add age-appropriate features to Canvas for our youngest learners. More than half of these attendees will meet prospects, highlighting the magnitude of the opportunity ahead of us. Our existing customers continue to adopt additional products beyond just the LMS, demonstrating that we have a large opportunity in our installed base and our platform strategy is working. As a result, a growing percentage of new bookings continues to come from cross-sell opportunities, and a growing percentage of new logo wins include more than one product. One area we see success in cross-selling is our assessment management solutions, or AMS. For example, the Vermont Virtual Learning Cooperative, one of our existing statewide deals, purchased our assessment product this quarter. A key factor in their decision was the integration of the learning management system with the assessment management system. This is not a singular event. In another example, a large district in Tennessee chose our AMS for the same reasons. The need to address the significant learning loss created by the pandemic and a more iterative approach to assessments will continue to fuel the digital transformation of assessment solutions. We believe we are well positioned to help our customers address this very serious issue, and our platform will continue to drive enduring growth through cross-sell, especially as we add more products through organic and inorganic innovation and integrate them within the learning platform. Finally, we continue to use strategic M&A to increase our TAM and rapidly expand our learning platform capabilities. I'm very excited to say that earlier today we announced the acquisition of Kimono, the leading cloud-based provider of education data integration solutions and one of our key partners. Kimono's integration platform enables different applications used in the classroom to share data with, and connect to the school's applications. We believe the value of our platform increases as our partners and customers seamlessly share data between disconnected applications. I'm also excited to mention that the EasySoft integration, now called Impact, is on track and performing well. Earlier this month, we announced the availability of Impact for the K-12 market, opening up the addressable market for a solution previously only available in higher ed. Both EasySoft and Kimono are great examples of our ability to use strategic M&A to accelerate our product roadmap and expand the addressable market to drive durable growth. As we look forward, our M&A pipeline remains strong, and we continue to focus on acquiring companies that will expand our TAM, enhance our platform, and create opportunities for cross-sell into our expansive customer base. In summary, I am confident and optimistic about our business. We believe we are well positioned for durable growth and expanding profitability as a leading platform for teaching and learning in both higher education and K-12. I will now turn the call over to Dale to talk about our financial results and the exciting momentum we are seeing in the business. Thank you, Steve. And thanks again to everyone for joining us today. Before discussing detailed financial results, I'd like to point out that in addition to our GAAP results, I'll be discussing certain non-GAAP results. Our GAAP financial results, along with the reconciliation between GAAP and non-GAAP results, can be found in our earnings release, which is posted in the investor relations section of our website. In the third quarter, we continue to show a combination of durable top-line growth, expanding adjusted EBITDA margins, and strong unlevered free cash flow conversion. Year-to-date, we remain a rule of 60-plus company, with 30% ACR growth and 35% adjusted EBITDA margins. further validating the underlying quality of our business. As Steve mentioned, we generated third quarter 2021 total gap revenue of $107.2 million, up 31% year over year, and ACR of $108.6 million, up 24% year over year. Subscription and support revenue accounted for 90% of our third quarter revenue at $96.2 million, up 31% year over year. primarily as a result of the continued momentum within our core Canvas LMS product, both domestically and internationally, in addition to strong upsell and cross-sell of our other products, especially assessments. Professional services and other revenue accounted for 10% of our third quarter revenue at $11.1 million, up 31% year over year, driven by strong implementation and training services delivery across both our K-12 and higher ed businesses. Deferred revenue at the end of the third quarter was $287.1 million, up 38% from the third quarter of 2020. Remaining performance obligations, or RPO, were $684 million in the third quarter, up 16% year over year. And we expect to recognize revenue on approximately 77% of our RPO over the next 24 months. In discussing the remainder of the income statement, please note that unless otherwise stated, all references to our expenses, operating results, and share counts are on a non-GAAP basis. Please note that when I refer to margins in the upcoming comments, we calculate our margins based upon ACR. Our gross margin profile is very strong, and we maintain healthy margins through our optimized cloud architecture and flexible support structure that is designed to scale and meet customer demands. In the third quarter, our gross profit was $83.5 million, representing a gross margin of 76.9%. This is compared to a gross margin of 71.1% in the third quarter of 2020. Turning now to operating expenses. Sales and marketing expenses for the third quarter were $20.3 million, or 18.7% of ACR, down from 21.9% in the third quarter of 2020. Bookings per rep and the average size of cross-sale deals continue to improve as we build upon the efficiencies we introduced into our go-to-market efforts last fall. Research and development expenses for the third quarter were $13.3 million, or 12.3% of ACR, down from 13% in the third quarter of 2020, even though we have more engineers focusing on the development of our product roadmap than we did a year ago. General and administrative expenses for the third quarter were $9.5 million, or 8.8% of ACR, up from 7.2% in the third quarter of 2020, driven largely by the addition of public company costs in the second half of 2021. Non-GAAP operating income for the third quarter was $40.4 million, representing a 37.2% operating margin, up from 29% margin in the third quarter of 2020. In the third quarter, adjusted EBITDA was $41.3 million, representing a 38% adjusted EBITDA margin up from 30% in the third quarter of 2020. This result was better than our expectations and reflective of both our strong top-line growth and disciplined management of our cost structure. We were pleased with the over 820 basis point and over 800 basis point improvement in operating margins and adjusted EBITDA margins respectively, demonstrating the power and efficiency of our model. Non-GAAP net income for the third quarter was $33.7 million, or net income of 25 cents per share, compared to $24.8 million, or 20 cents per share, a year ago. Turning to the balance sheet and cash flow statement, we ended the third quarter with $231.8 million in cash, cash equivalents, and restricted cash. This is up $157.3 million from the end of the second quarter, The entirety of the $233.1 million of IPO net proceeds were used to pay down debt, so the increase was driven largely by cash collections, which was the highest collection quarter in the company's history. Last week, our strong financial performance enabled us to refinance our outstanding debt facility with a new facility that has highly attractive terms. As part of this refinancing, we paid down approximately $31 million of principal and now have total outstanding debt of $500 million. As a result, we expect that our annual interest expense will be reduced by approximately $18 million per year going forward. Operating cash flow in the third quarter was $161.2 million compared to $100.3 million in the third quarter of 2020. Free cash flow was $160 million in the third quarter compared to $99.5 million in the third quarter of 2020. Our unlevered free cash flow was $172.2 million in the third quarter compared to $120.7 million in the third quarter of 2020. As a reminder, our strong free cash flow conversion is driven by our favorable billing terms, low capital expenditures, and our accumulated tax assets, which we believe will act as a shield for the next several years. I will now conclude the call by providing guidance for Q4 and for the full year of 2021 for ACR, unlevered free cash flow, and adjusted EBITDA. We have provided additional guidance details in our earnings press release. For the fourth quarter of fiscal 2021, we expect ACR in the range of $107.5 million to $108.5 million or a growth rate of 19.1% at the midpoint of the range. I want to make one additional point specific to ACR and Q4. We expect subscription and support revenue to increase sequentially from Q3 to Q4 and professional services revenue to decrease sequentially from Q3 to Q4. This is consistent with the historical trends where we see higher services revenue in Q3 We expect adjusted EBITDA in the range of $38.5 million to $39.5 million, representing an adjusted EBITDA margin of 36.1% at the midpoint of the range. For the full fiscal year 2021, we expect ACR in the range of $410.7 million to $411.7 million, or a growth rate of 26.6% at the midpoint of the range. We expect adjusted EBITDA in the range of $143.6 million to $144.6 million, representing an adjusted EBITDA margin of 35% at the midpoint of the range. We anticipate unlevered free cash flow to be roughly $152 million for the year and adjusted unlevered free cash flow of roughly $164 million. which adjusts for the impact of restructuring transaction and sponsor costs paid in cash. With that, Steve and I are happy to take any of your questions.