Instructure Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to Instructure's first quarter 2022 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 your first speaker, Denise Garcia, Investor Relations. Denise, please go ahead.

Thank you. Good afternoon and welcome to Instructure's first quarter 2022 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 Bailey 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 a 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 accepted as required by law we assume no obligation to update 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 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 first quarter 2022 earnings call. During today's call, Dale and I will provide details on our first quarter results and provide second quarter and updated full year 2022 guidance. Instructure delivered another strong quarter in Q1, exceeding our previously communicated guidance ranges across all of our guidance metrics. First quarter gap revenue was $113.5 million, up 21% year over year, while allocated combined receipts where ACR was $114 million, up 15% year over year. Normalizing for the bridge divestiture, gap revenue and ACR were up 26% and 20% year over year respectively. 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. We achieved a record non-gap gross margin of 78.4% in Q1, up 580 basis points year over year, as we continue to improve the efficiency of our IT infrastructure and support operations. First quarter adjusted EBITDA grew 34% year over year to $43.6 million, a 38% margin as we further demonstrated operating leverage on both the gross margin and adjusted EBITDA lines. Canvas continues to displace legacy LMS competitors in the United States and across our major international markets. Beyond the LMS, our instructor learning platform strategy gained further traction during the quarter as we continued to land large deals and grew ACR from our assessments product at a strong double-digit rate. We expect to continue investing in the platform through organic development and strategic M&A as we strive to connect every aspect of teaching and learning and capture an increasing share of our $30 billion market opportunity. I now want to talk about five key highlights from the quarter. First, in Q1, we once again saw strength in each of our key markets, U.S. higher education, K-12, and international. Higher education institutions across the country continue to choose Canvas for its ease of use, scalability, flexibility, and superior UX. Our highly engaged Canvas community of 1.6 million users is also often cited as a key deciding factor when institutions select Instructure as their long-term strategic partner. Higher education institutions collaborate and share best practices, especially within the same school system. And we find that wins within a school system tend to beget more wins. For example, our first Canvas adoption in the California State University system was in 2013. Since then, more and more CSU universities have adopted Canvas. We couldn't be more pleased to announce that as of Q1, all 23 CSU universities with a combined enrollment of over 485,000 students are contracted with Instructure. Beyond Canvas LMS, CSU universities use a number of other instructor learning platform solutions, including Studio, Impact, and Pathways. As the only provider with significant higher education and K-12 LMS market share, Canvas benefits from network effects as purchasing decisions increasingly factor in the continuity of teaching and learning experience. In addition to collaborating amongst themselves, higher education institutions, especially community colleges, collaborate with K-12 schools to better understand the needs and preferences of the incoming student population. Last quarter, Prince George's Community College, or PGCC in Maryland, selected Instructure over the legacy incumbent in a four-product deal. Instructure had been on PGCC's radar since Prince George's K-12 district joined the Canvas community 18 months ago, PGCC wanted to ensure a seamless transition for students first entering college, especially first-generation students. As the largest provider of K-12 and higher education offerings, Canvas was uniquely positioned to serve PGCC's needs. As more K-12 districts adopt enterprise class solutions and the digital transformation of K-12 education experience continues, We expect our competitive advantage to increase as a network effect created by offering an LMS solution to both the higher education and K-12 markets grows even stronger. This network effect works both ways as evidenced by the competitive win last quarter with Spring Branch Independent School District in Houston. Spring Branch ISD chose Canvas to serve the 33,000 plus K-12 students enrolled across its 47 school district. For Spring Branch ISD, continuity with regional higher education institutions, as well as Canvas' strong reputation in the wider Texas education community, were key factors in its decision to go with Canvas. In addition to Canvas LMS, Spring Branch ISD purchased Canvas Studio, which allows teachers to integrate asynchronous video content into their lesson plans to modernize the teaching and learning experience across their district. International remained the fastest growing part of the business in Q1, and we continue to believe international can be at least as large as our U.S. business over time. During the quarter, we signed an agreement with UCAM, a private university in Spain, to replace their open source system. After a rigorous multi-year review, UCAM selected Canvas over a competitive product priced at a steep discount. With 90% of the time in the classroom spent on instructional workflows enabled by the LMS, Educational institutions understand the fundamental importance of selecting the right LMS partner. They chose Canvas because we offer a superior LMS solution, a strong product portfolio and ecosystem of over 650 partners, an exceptional level of customer support, and a host of other factors. The decision rarely comes down to price alone. 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. During the quarter, Nebo School District, an existing Canvas LMS customer, selected our Mastery Connect Assessment Management System and the Navigate Item Bank formative assessment content we acquired with Certica over competitive solutions. We are helping K-12 districts like Nebo School District transition to a teaching model based on more frequent benchmark digital assessments, which proactively identify learning loss and enable earlier interventions. Addressing learning loss is a key social priority, with 20% of the $122 billion of ESSER III funds appropriated under the American Rescue Plan earmarked for pandemic-related learning loss. Assessments represent a significant customer-level growth opportunity for Instructure as the ARCU of our K-12 assessment solutions is two to three times greater than the ARCU of our K-12 LMS solution. 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. Our updated 2022 guidance, which Dale will discuss in greater detail later in the call, reflects our expectation for further adjusted EBITDA margin expansion this year. Our higher full year 2022 adjusted EBITDA margin outlook is driven by faster ACR growth and stronger gross margins than previously expected without any change to our planned increases in R&D and sales headcount. We will continue to invest in our business to drive long-term profitable growth. Fourth, we continue to use strategic M&A with the goal of increasing our TAM and expanding our instructor learning platform capabilities. On April 14th, we announced the acquisition of Concentric Sky, whose Badger technology serves as the default micro-credentialing tool within Canvas LMS. Badger's stackable digital credentialing technology enables millions of non-traditional learners to demonstrate to potential employers the skills and achievements they have earned from over 25,000 organizations in 160 countries. We expect our rebranded Canvas badges and Canvas credentials offering to advance our strategy to address the $5 billion non-traditional online market opportunity. We are excited to support our higher education customers in their efforts to serve this rapidly growing segment of their student populations. Our M&A pipeline remains strong, and we will continue to pursue strategic acquisitions with the goal of expanding our TAM and enhancing the value of the instructor learning platform to educational institutions and their students. Fifth, our international business continues to grow rapidly and gain market share. International remained our fastest growing segment in Q1 with strength in each of our major regions. With international higher education LMS market share in the mid single digits, we expect international to remain our fastest growing segment in the years ahead. Last quarter, we discussed our strategy to cost-effectively expand our international footprint through a new channel partner program. While still early, the program is off to a strong start with bookings and pipeline ahead of plan. We have signed 72 new value-added resellers and have distribution coverage in 100% of emerging markets globally. We are thrilled to announce that Tech Data, the world's largest IT distributor, will be supporting us across all of Latin America in an APAC. We look forward to expanding and deepening our relationships with channel partners as we seek to turbocharge international growth. Turning to stimulus funding, the vast majority of $190 billion appropriated for the K-12 schools under the American Rescue Plan Elementary and Secondary School Emergency Relief Fund remains unspent. According to Capstone, a leading government policy and regulatory consulting firm, As of the start of Q2, roughly $150 billion of ESSER funds had yet to be invested, which assuming the funds are deployed over a three to five year period, represents a roughly 50% average annual increase in K-12 discretionary spending. This is because approximately 90% of K-12 district spending, which totaled $769 billion in fiscal year 2019, according to the National Center for Education Statistics, consists of recurring non-discretionary expenditures such as salaries, benefits, janitorial services, and capital outlays, which are seldom considered to be appropriate use of stimulus funds. We continue to expect ESSER funds to drive significant incremental demand in our K-12 segment in coming years. Looking to a remainder of 22 and beyond, our pipeline of North American higher education RFP opportunities continues to build, as many universities which delayed major purchasing decisions during the pandemic look to upgrade their infrastructures. With competitive win rates in the 70% range, market share gains represent a substantial ongoing growth driver for Instructure. Our M&A pipeline remains robust, and we continue to explore ways to leverage our strong balance sheet and free cash flows to accelerate our structured learning platform strategy. We are highly confident in our strategic vision and the ability to execute and look forward to continued momentum in the coming years. In summary, I am encouraged by our strong first quarter financial results, which exceeded our guidance range on all metrics. We expect the favorable trends that drove our first quarter outperformance to continue for the balance of the year, which is reflected in our revised 2022 guidance. I would once again like to thank our customers, partners, employees, and shareholders for your ongoing support. With that, I will now turn the call over to Dale to talk about our financial results and the ongoing momentum we are seeing in the business. Thank you, Steve, and thanks 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 first quarter, we continue to show a combination of strong top line growth and expanding adjusted EBITDA margins. Building on the consistent gross margin improvement we have delivered in recent quarters, first quarter non-GAAP gross margin exceeded 78%, a new record for Instructure. As Steve mentioned, we generated first quarter 2022 total GAAP revenue of $113.5 million, up 21% year-over-year, and ACR of $114 million, up 15% year-over-year. Normalizing for the bridge divestiture, first quarter gap revenue and ACR grew 26% and 20% year over year, respectively. Subscription and support ACR accounted for 91% of our first quarter revenue at $104 million, up 14% year over year, or 20% normalizing for the bridge divestiture. 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 ACR accounted for 9% of our first quarter revenue at $10 million, up 29% year-over-year, or 35% normalizing for the bridge divestiture. driven by strong implementation and training services delivery in our K-12 business. Deferred revenue at the end of the first quarter was $189 million, up 22% year-over-year. Remaining performance obligations, or RPO, were $668.6 million at the end of the first quarter, up 17% year-over-year, and we expect to recognize revenue on approximately 75% 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 first quarter, gross profit was $89.4 million, representing a 78.4% gross margin, up from 72.6% in the first quarter of 2021. 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 first quarter were $22.4 million or 19.7% of ACR compared to 19.7% in the first quarter of 2021. Research and development expenses for the first quarter were $14.4 million or 12.6% of ACR, down from 13% in the first quarter of 2021. We continue to invest in engineering headcount to pursue our ambitious product roadmap while leveraging offshore talent to drive ongoing R&D efficiency. General and administrative expenses for the first quarter were $10.1 million, or 8.8% of ACR, up from 7.2% in the first quarter of 2021, driven largely by the addition of public company costs. Non-GAAP operating income for the first quarter was $42.5 million, representing a 37.3% operating margin, up from 32.6% in the first quarter of 2021. First quarter adjusted EBITDA was $43.6 million, representing a 38.2% adjusted EBITDA margin, up from 33% in the first quarter of 2021. Non-GAAP net income for the first quarter was $40.3 million, or $0.28 per share, on a fully diluted basis compared to $23.7 million, or $0.19 per share, a year ago. Turning to the balance sheet and cash flow statement, we ended the first quarter with $105.3 million in cash, cash equivalents, and restricted cash. and $493.5 million of long-term debt, net of discount, resulting in a 2.46 times net debt to trailing 12 months adjusted EBITDA ratio. As a reminder, the timing of cash collections is highly seasonal in our business, with the vast majority of annual license fees invoiced and collected during the third and fourth quarters at contract renewal or inception. As a result, our cash balances and cash flows are lower during the first half of the year and build significantly during the second half of the year. Operating cash flow was negative $65.9 million during the first quarter and $97.9 million over the last 12 months. Free cash flow was negative $67.3 million during the first quarter and $92.8 million over the last 12 months. Adjusted unlevered free cash flow was negative $60.3 million during the first quarter Over the last 12 months, adjusted unlevered free cash flow was $143.1 million, a 25% year-over-year increase. 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 Q2 and revised guidance for the full year of 2022 for ACR, adjusted EBITDA, and adjusted unlevered free cash flow. For the second quarter of fiscal 2022, we expect ACR in the range of $110.5 million to $111.5 million, consistent with typical Q2 seasonality. We are raising our fiscal 2022 ACR guidance, and now we expect ACR in the range of $461.8 million to $465.8 million. Normalizing for the Bridge Investiture, our full-year ACR guidance growth rate is 13% at the midpoint. As a reminder, on February 26, 2021, we sold Bridge, our corporate LMS business. Bridge contributed approximately $4 million of ACR during the first quarter of 2021. We expect second quarter adjusted EBITDA in the range of $37 million to $38 million, representing an adjusted EBITDA margin of 33.8% at the midpoint of the range. For the full year, We now expect adjusted EBITDA in the range of $164.8 million to $168.8 million, representing an adjusted EBITDA margin of 36% at the midpoint in the range. Our increased fiscal year 2022 adjusted EBITDA guidance reflects higher ACR growth and stronger gross margin as we continue to optimize our third-party technology costs. We are also increasing our full year 2022 adjusted unlevered free cash flow guidance by $2 million. And we now expect adjusted unlevered free cash flow in the range of $185 million to $189 million. A couple of quick points on adjusted unlevered free cash flow. First, as a reminder, during Q1, we made incremental prepayments to vendors of approximately $25 to $30 million to secure more favorable terms which impacted year-over-year comparisons for the quarter. These pre-payments will reduce our cost structure and improve our gross margins over time. Second, in the earnings release and 8K we filed today, we have provided a quarterly reconciliation of adjusted unlimited free cash flow for the first nine quarters, for the last nine quarters to facilitate historical financial comparisons of this metric. In summary, we are pleased to have exceeded our first quarter guidance ranges and to be raising our full year 2022 guidance ranges across all metrics. We are executing at a very high level as we continue to displace legacy LMS competitors and gain wallet share with our instruction learning platform solutions. There's no company better positioned than Instructure to lead the digital transformation of education, and we've only scratched the surface of this $30 billion market opportunity. Our financial profile is compelling with double-digit top-line growth, best-in-class margins, and superior adjusted unlevered free cash flow conversion. We look forward to updating you on our progress throughout the remainder of 2022. With that, Steve and I are happy to take any of your questions.