Instructure Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to Instructure's fourth quarter and fiscal year 2021 earnings call. At this time, all participants are in a listen-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 now like to turn the conference over to our first speaker, Denise Garcia, Investor Relations. Denise, please go ahead.

Thank you, Mel. Good afternoon and welcome to Instructure's fourth quarter and full year 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 Daly, and Chief Financial Officer, Gail 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 a discussion of factors that could affect our future financial results and 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 statement. 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 our website. With that, let me turn the call over to Steve.

Thank you, Denise, and good afternoon, everyone. Thank you all for joining us for our fourth quarter and full year 2021 earnings call. During today's call, Dale and I will provide details on our fourth quarter results and provide first quarter and full year 2022 guidance. Instructure delivered another strong quarter in Q4, exceeding our previously communicated guidance ranges across all of our guidance metrics. Fourth quarter gap revenue was $110.6 million of 26% year-over-year, while allocated combined receipts, or ACR, was $111.4 million of 23% year-over-year. We had our best fourth quarter bookings in the history of the company as we continued to execute on the go-to-market strategy we introduced last fall. Full year 2021 gap revenue was $405.4 million of 34% year-over-year. while ACR was $414.7 million, a 28% year-over-year. We think ACR, which adds back the impact of fair value adjustments to acquired unearned revenue, gives investors better visibility into the underlying growth of our business. Thanks to our focused investment approach, fourth quarter adjusted EBITDA grew 57% year-over-year to a $41.7 million, a 37% margin. Full year 2021 adjusted EBITDA more than doubled to $146.7 million, and we converted 115% of full year adjusted EBITDA to adjusted unlevered free cash flow. Total customers grew 14% year-over-year to nearly 7,000 at the end of Q4, as Canvas gained share across each of our key markets. Net revenue retention was 109% in 2021, which highlights the continued growth opportunity in our customer base. Our strong fourth quarter financial performance capped off a truly outstanding year for Instructure. We look forward to building on our success in 2022 and beyond as we continue to enhance our Instructure learning platform while remaining focused on driving profitable growth and maintaining our industry-leading margins. I now want to talk about five key highlights for the quarter. First, in Q4, we once again saw strength in each of our key markets, U.S. higher education, K-12, and international. In higher education, our cloud-native and extendable platform continued to display legacy systems. During the quarter, Walden University selected Canvas for its 40,000 student population because of its superior user interface and flexibility at scale, while providing data access and a robust API. The deal also included impacts to help accelerate Walden's transition from Blackboard to Canvas, while providing continuity with previous functionality. We are seeing strong uptake of impact in higher education as well as K-12 as educational institutions seek to better understand how ed tech tools are being used in their environment. We have also been very pleased by how impact has been received in the K-12 markets since we announced the availability of the solution last fall, and we expect impact to further differentiate us from our K-12 competitors while expanding our total addressable market. In K-12 more broadly, we continue to take share from both unpaid and paid legacy LMS systems during the quarter. In Q4, Hartford County Public Schools selected Canvas LMS and Canvas Studio after the incumbent, a paid LMS vendor, terminated its legacy system. Hartford chose us because of our strong product features and our expertise in migrations and change management services. International remained our fastest growing part of the business in Q4, and we continue to believe international can be as large as our U.S. business over time. In Australia, we signed a deal with Australian Catholic University, or ACU, to replace their Moodle system. After a comprehensive competitive tender process, ACU selected Canvas and Impact as the foundation for the next generation digital ecosystem to underpin ACU Online, the university's recently launched fully online education portfolio. Second, our focused go-to-market and expanded set of offerings are resulting in higher penetration of products across our customer base through both cross-sell opportunities and new logo deals. In 2021, 43% of new wins involved more than one product, up from 33% in 2020. During the quarter, Newport News Public Schools took advantage of the statewide virtual Virginia contract, which allows districts to use Canvas as a procurement vehicle to purchase Mastery Connect, our K-12 student assessment management system. Armed with better sales tools, our dedicated K-12 assessment sales team is having great success cross-selling our suite of assessment management solutions, including Mastery Connect and Certica, into our customer and Canvas installed base. Third, we are making disciplined investments to expand our platform and drive long-term growth. Our high gross margins, strong sales execution, productive R&D investment, and low capital requirements allow us to reinvest in the business, pursue strategic M&A, and deleverage while maintaining industry-leading margins. For example, the full-year 2022 guidance we are providing today, which Dale will discuss in greater detail later in the call, takes into account meaningful increases in R&D and sales headcount, expanding our sales capacity while delivering expected 36% adjusted EBITDA margin, well ahead of consensus 2022 estimates for our edtech peers. Fourth, we have a strong track record of value creation through M&A. With Canvas at our core, we are uniquely capable of improving the performance, accessibility, and reach of acquired software solutions. Our technical integrations have gone smoothly and ahead of schedule, which has allowed our sales teams to rapidly incorporate newly acquired products into their conversations. As a result, we've been very successful in adding products we acquired over the last 12 months to our existing Canvas base. Fifth, as our international business continues to grow rapidly and gain market share, we are looking at ways to turbocharge growth. Last month, we announced the launch of a new channel partner program, which is expected to spur growth in APAC, EMEA, and LATAM markets. The new program offers potential partners additional ways to generate revenue beyond reselling products with opportunities such as implementation, training, and support services. Early feedback has been positive, and we are optimistic about the cost-effective expansion of our international footprint through Channel Partners. Turning to stimulus funding, last month the Department of Education announced that every state education agency received approval of their American Rescue Plan Elementary and Secondary School Emergency Relief, or ESSER, plan before the end of 2021, resulting in the distribution of $41 billion of additional funding, which had been contingent on state plan approval. With only $26 billion of the $190 billion of ESSER funds used as of November 2021, we expect the funding environment to remain favorable for years to come. Looking to the remainder of 2022 and beyond, we believe the Instructure Learning Platform is uniquely positioned to help educational institutions and developers solve the complex challenges presented by the proliferation of edtech tools. For educational institutions, these challenges include a fragmented user experience, siloed data, unclear ROI, security risks, and difficulties in evaluating, implementing, and managing applications. For EdTech tool developers, accessing education markets and navigating procurement processes are significant hurdles. Our 2022 product roadmap includes investments to expand the capabilities of our platform as we address an even larger share of our $30 billion total market opportunity. In our core North American higher education business, we expect the number of RFP opportunities to significantly increase in 2022 relative to 2021 as universities look to upgrade their infrastructures. Our growing pipeline includes large universities with legacy LMS systems, which simply cannot scale to meet the demands of millions of concurrent users. We are highly confident in our competitive position and look forward to continued momentum in the coming years. In summary, I couldn't be more excited to lead Instructure through our evolution into the most comprehensive teaching and learning platform worldwide. I would like to thank our customers, our partners, our employees, and shareholders for your ongoing support. With that, I will now turn the call over to Gail to talk about our financial results and the ongoing momentum we're seeing in the business. Thank you, Steve, and thank you again to everyone for joining us today. Before discussing our detailed financial results, I'd like to point out that in addition to our GAAP results, I will 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 fourth quarter, we continue to show a combination of strong top-line growth and expanding adjusted EBITDA margins. For the full year, we expanded adjusted EBITDA margin by 1,350 basis points. We expect to maintain our industry-leading margins as we deliver durable, profitable growth in the years ahead. As Steve mentioned, we generated fourth quarter 2021 total GAAP revenue of $110.6 million, up 26% year-over-year, and HCR of $111.4 million, up 23% year-over-year. Subscription and support ACR accounted for 91% of our fourth quarter revenue at $101 million, up 27% year-over-year, primarily as a result of the continued momentum within our core Canvas LMS product, both domestically and internationally, in addition to the strong upsell and cross-sell of our other products, especially assessment. Professional services and other revenue accounted for 9% of our fourth quarter revenue at $9.6 million, up 22% year over year, driven by strong implementation and training services delivery in our K-12 business. Deferred revenue at the end of the fourth quarter was $255.7 million, up 25% year over year. Retaining performance obligations for RPO were $698 million at the end of the fourth quarter, up 60% year-over-year. We expect to recognize revenue on approximately 76% 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 count are on a non-GAAP basis. Please note that when I refer to margins in the upcoming comments, I'm referring to margins calculated as a percentage of ACR. Our strong gross margin profile is supported by our optimized cloud architecture and flexible support model that scales to meet seasonal customer demands. In the fourth quarter, gross profit was $86 million, representing a 77.1% gross margin, up from 68.3% in the fourth quarter of 2020. We couldn't be more pleased with our enhanced operating model and continued operating leverage on the gross margin line. Turning now to operating expenses. Sales and marketing expenses for the fourth quarter were $21.4 million, or 19.2% of ACR, down from 22.1% in the fourth quarter of 2020. Research and development expenses for the fourth quarter were $13.4 million, or 12% of ACR, compared to 11.5% in the fourth quarter of 2020. as we invested in engineering headcount to pursue our ambitious product roadmap general administrative expenses for the fourth quarter were 10.5 million dollars or 9.4 percent of acr up from 6.7 in the fourth quarter of 2020 driven largely by the addition of public company costs in the second half of 2021 Non-GAAP operating income for the fourth quarter was $40.7 million, representing a 36.5% operating margin, up from 27.9% in the fourth quarter of 2020. Fourth quarter adjusted EBITDA was $41.7 million, representing a 37.4% adjusted EBITDA margin, up from 29.3% in the fourth quarter of 2020. Non-GAAP net income for the fourth quarter was $48.2 million, or $0.34 per share, compared to $17 million for $0.13 per share a year ago. Turning to the balance sheet and cash flow statement, we ended the fourth quarter with $159.2 million in cash, cash equivalents and restricted cash, and $493.3 million of long-term debt net of discounts, resulting in a 2.2 times net debt to trailing 12 months adjusted EBITDA ratio. Full year 2021 GAAP operating cash flow was $105.1 million compared to negative $20.2 million in the prior year. Full year free cash flow was $100.9 million compared to negative $22.4 million in the prior year. Full year 2021 unlevered free cash flow was $156.6 million, a 124% year-over-year increase. from $69.9 million in 2020, while adjusted leverage for cash flow, which adjusts for the impact of restructuring, transaction, and sponsor-related costs paid in cash, was $168.7 million, a 69% year-over-year increase from $99.7 million in 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 tax shield for the next several years. I will now conclude the call by providing guidance for Q1 and for the full year of 2022 for ACR, adjusted EBITDA, and adjusted unlevered free cash flow. We have provided additional guidance details in our earnings press release. For the first quarter of fiscal 2022, we expect ACR in the range of $109.1 million to $110.1 million. Normalizing for the bridge divestiture, our first quarter ACR guidance growth rate is 16% at the midpoint. For the full year, we expect ACR in the range of $456.7 million to $460.7 million. Normalizing for the Bridge Investiture, our full year ACR guidance growth rate is 12% at the midpoint. As a reminder, in February of 2021, we sold Bridge, our corporate LMS business. Bridge contributed approximately $4 million of ACR during the first quarter of 2021. We expect first quarter adjusted EBITDA in the range of $37.9 million to $38.9 million, representing an adjusted EBITDA margin of 35% at the midpoint of the range. For the full year, we expect adjusted EBITDA in the range of $162.1 million to $166.1 million, representing an adjusted EBITDA margin of 35.8% at the midpoint of the range. We anticipate full year 2022 adjusted unlevered free cash flow to be between $183 and $187 million. Please note that moving forward, we plan to use adjusted unlevered free cash flow as our primary free cash flow metric because it provides a better measure of our ongoing cash generation. A couple of quick points on seasonality. First, as a reminder, ACR is typically roughly flat between our first and second quarters, and we expect this trend to repeat itself this year. Second, we expect our adjusted, unlevered free cash flow seasonality to look a little different this year. By leveraging our scale and strong balance sheet, we've been able to secure favorable terms with our vendors, thereby reducing our cost structure and improving our gross margins over time. We're able to do this by making incremental prepayments to vendors in the order of $25 to $30 million, which will impact adjusted unlevered free cash flow year-over-year comparisons for the first quarter. In summary, 2021 was an incredible year for Instructure. We reentered the public market and executed at a very high level. exceeding our guidance in every quarter. From our position at the Center of Teaching and Learning, we are leading the digital transformation of education. And financially, we offer a rare combination of double-digit growth and best-in-class margins. We couldn't be more pleased about our momentum in the marketplace and look forward to updating you on our progress throughout 2022. With that, Steve and I are happy to take any of your questions.