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spk08: Ladies and gentlemen, thank you for standing by and welcome to Instructure's second 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.
spk01: Thank you. Good afternoon and welcome to Instructure's second 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 Daly, 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 risks, 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, 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 our website. With that, let me turn the call over to Steve.
spk11: Thank you, Denise, and good afternoon, everyone. Thank you all for joining us for our second quarter 2022 earnings call. During today's call, Dale and I will provide details on our second quarter results and provide third quarter and updated full year 2022 guidance. It has been a little over a year since Instructure reentered the public markets, and before discussing our second quarter results, I would like to take the opportunity to reflect on our progress over the last 12 months. We have exceeded our financial guidance every quarter since our IPO, and the four-year 2022 financial metrics we will be guiding to today are all significantly higher than consensus estimates were when we went public. We have advanced our structured learning platform strategy through record R&D investment and three acquisitions, and our K-12 assessment solutions are growing significantly faster than the corporate average. Our focused international strategy has resulted in profitable growth across all of our major regions, and the channel partner program we implemented this year is enabling us to cost-effectively enter new international markets. We have deleveraged significantly and continue to generate robust free cash flow, which leaves us with many options to create further shareholder value going forward. Looking ahead, we are confident in the resilience of our financial model, including solid top line growth and strong margins. Turning to Q2 results, Instructure delivered another strong quarter, exceeding our previously communicated guidance ranges across all metrics. Second quarter GAAP revenue was $114.6 million, up 22% year-over-year, while allocated combined receipts for ACR was $114.9 million, up 20% 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. We achieved non-GAAP gross margins of 77.6% in Q2, up 390 basis points year-over-year. This demonstrates our ability to continuously expand our gross margins as we scale and focus on operational efficiencies. Second quarter adjusted EBITDA grew 28% year-over-year to $39.8 million, a 35% margin, as we demonstrated further operating leverage on both the gross margin and adjusted EBITDA lines. Higher education and K-12 institutions in the United States and across our major international markets continue to choose Canvas as their next-generation LMS solution. Beyond the LMS, our instruction learning platform strategy gained further traction during the quarter as we continued to land large deals and grew ATR from assessments products 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 four key highlights from the quarter. First, in Q2, we saw again 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 ease of use, scalability, flexibility, and superior UX. According to a recent report from Edutechnica, Canvas continued to gain share in the U.S. higher education LMS market over the past year. As of this spring, 42% of U.S. higher education institutions used Canvas, up from 39% last year. The data also show that over 40% of US higher education institutions continue to run on legacy LMS systems, which provides us with a significant growth opportunity in the coming years. During the quarter, Northern Arizona University, or NAU, selected Canvas to replace its incumbent LMS provider after a rigorous 10-month evaluation process. The results of NAU's review and selection process, which are available on the university's website, demonstrate a clear preference among NAU's students and instructors for Canvas over the competition. NAU's purchase included three instructor learning platform products, Canvas LMS, Studio, and Catalog. Catalog will support NAU's online programs by enabling the university to quickly and efficiently publish any Canvas course to an online catalog. Instructors' focus on innovation and ability to creatively address opportunities in the online sphere are clearly resonating with U.S. higher education institutions. As we build out the Instruction Learning Platform, we expect our competitive differentiation in this market to increase further. K-12 districts are also excited by our Instruction Learning Platform product and vision. Demand for a portfolio of high-value assessment solutions remains robust, as educators seek to support the increasing need for innovative, standard-aligned interim and formative assessments to improve learning outcomes and mitigate pandemic-related learning loss. With an average revenue per user of two to three times the K-12 LMS, our assessment solutions also represent a significant growth opportunity for Instructure. During the quarter, Neenah Joint School District, which serves over 6,700 students across 14 schools in Wisconsin, chose Instructure as its next generation LMS solution. In the case of Neenah JSD, our unique ability to bundle our leading mastery connect assessment management system with Canvas LMS, as well as tight integration between the two solutions, drove the district's decision to partner with Instructure. LinaJSD also based its decision on the excellence of our support organization, which is a hallmark of Instructure's culture and a key competitive advantage. International remained the fastest growing part of our business in Q2. During the quarter, we signed an agreement with Brazilian College of Radiology and Diagnostic Imaging, or CBR, to power their digital transformation. CBR selected Instructure because we were able to offer them a tightly integrated solution which included Canvas LMS, Studio, and Catalog. Catalog proved to be an especially strategic asset in the deal as CBR, like many higher education institutions worldwide, looks to expand its course offerings online. Catalog not only provides a customizable storefront for institutions' online force and program offerings, but it integrates into most payment systems. Our ability to provide TBR with a payment gateway solution for the Latin American region was a key factor in winning the business. In addition, we continue to build out our channel program, to cost-effectively expand our international footprint. With our international higher education LMS market share in the single digits, we expect this segment to remain our fastest-growing segment in the years ahead. 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, DeKalb County Schools, an existing Canvas LMS customer, purchased Studio Impact and Services to improve the adoption of technology in the classroom and advance digital learning across its 94,000 student districts. As a reminder, Impact helps administrators evaluate the impact of educational technology while helping faculty and students seamlessly navigate new platforms. 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 enterprise software business model and vertical focus provide us with excellent visibility into our near-term revenues due to our long-term, non-cancellable contracts and the educational vertical's minimal sensitivity to macroeconomic volatility. We expect a rule of 50 outcome for the full year on an adjusted EBITDA basis, driven by our double-digit revenue growth and continued strong margins. In spite of the deteriorating macroeconomic environment, we continue to invest in R&D and sales headcount this year, and our appetite and capacity for creative M&A opportunities remains unchanged. We expect to continue investing in our business to drive consistent long-term profitable growth. Fourth, we continue to use strategic M&A with the goal of increasing our TAM and expanding our structured learning platform capabilities. During the second quarter, we advanced our instruction learning platform strategy through the acquisition of Concentric Sky and the rollout of Canvas badges and Canvas credentials to the market. Canvas Credentials enables higher education institutions to use digital badging to increase student enrollment and retention rates while providing a seamless way for learners to record and share their validated skills and achievements with future employers. We look forward to partnering with higher education institutions to establish and grow their non-traditional online programs using foundational technologies from Instructure, a significant TAM expansion opportunity. With our strong free cash flows and conservatively capitalized balance sheet, we believe we are in an excellent position to take advantage of inorganic growth opportunities that may arise as seller expectations adjust to the current market environment. Our M&A pipeline remains robust, and we expect to continue to pursue strategic acquisitions with the goal of expanding our TAM and enhancing the value of the instructional learning platform to educational institutions and their students. Turning to stimulus funding, the vast majority of $190 billion appropriated for K-12 schools under the Elementary and Secondary School Emergency Relief or ESSER Fund remains unspent. According to the Department of Education, as of the end of May, $141 billion or 74% of ESSER Funds have yet to be invested. Burbio, a data aggregator, reports that over 25% of ESSER III funds have been earmarked for technology spending. The Cal County Schools, a cross-sell example I mentioned earlier, utilized ESSER funds to help finance its additional investment in the Instructure Learning Platform. We expect many other forward-thinking Canvas LMS customers, like the Cal County Schools, to generate significant incremental demand in our K-12 segment using ESSER funds over the next few years. Last month, we were thrilled to host over 12,000 registrants at InstructureCon 2022 North America. Many of our 600-plus Instructure EdTech collective partners hosted virtual booths with partners such as Google, Microsoft, and Zoom, delivering virtual sessions at the conference. During the event, we unveiled our updated brand architecture supported by four brand pillars, Canvas for learning management solutions, Mastery for assessment and tools and content, Elevate for Data and Analytics and Impact for EdTech Adoption Engagement. We also highlighted product improvements that make the Instructure Learning Platform even more powerful in 2022. We look forward to hosting the three additional Instructure Cons later this year for Latin America, EMEA, and the Asia-Pacific regions. looking to the remainder of 2022 and beyond our pipeline for north american higher education rfb opportunities continues to build as many institutions which delayed major purchasing decisions during the pandemic look to upgrade their infrastructures in summary i'm encouraged by our strong second quarter financial results which exceeded our guidance ranges in all metrics We expect the favorable trends that drove our second quarter outperformance to continue for the balance of the year, which was 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'll be discussing certain non-GAAP results. The 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 second quarter, we continue to show a combination of strong top line growth and expanding adjusted EBITDA margins. Moving on the consistent gross margin improvement we have delivered in recent quarters, Q2 non-GAAP gross margin expanded by 390 basis points year-over-year to 77.6%. As Steve mentioned, we generated second quarter 2022 total GAAP revenue of $114.6 million, up 22% year-over-year, and ACR of $114.9 million, up 20% year-over-year. Subscription and support ACR accounted for 90% of our second quarter revenue at $103.2 million, up 19% 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 crossover of our other products, especially assessments. Professional services and other ACR accounted for 10% of our second quarter revenue, at $11.7 million, up 24% year-over-year, driven by strong implementation and training services delivery in our high-ed business. Deferred revenue at the end of the second quarter was $283.3 million, up 13% year-over-year. Remaining performance obligations, or RPO, were $783.7 million at the end of the second quarter, up 17% year-over-year. And we expect to recognize revenue on approximately 74% of our RPO over the next 24 months. 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 second quarter, gross profit was $89.2 million, representing a 77.6% gross margin, up from 73.7% in the second quarter of 2021. We couldn't be more pleased with our enhanced operating model and continued operating leverage on this gross margin line. Turning now to operating expenses. Sales and marketing expenses for the second quarter were $24.7 million or 21.5% of ACR compared to 20.7% in the second quarter of 2021. Research and development expenses for the second quarter were $15.5 million or 13.5% of ACR, down from 13.8% in the second 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 efficiencies. General and administrative expenses for the second quarter were $10.4 million, or 9% of ACR, up from 7.5% in the second quarter of 2021, driven largely by the addition of public company costs. Non-GAAP operating income for the second quarter was $38.7 million, representing a 33.7% operating margin, up from 31.7% in the second quarter of 2021. Second quarter adjusted EBITDA was $39.8 million, representing a 34.6% adjusted EBITDA margin, up from 32.5% in the second quarter of 2021. Non-GAAP net income for the second quarter is $35.9 million, or 25 cents per share, on a fully diluted basis, compared to $20.7 million, or 16 cents per share, a year ago. Turning to the balance sheet and cash flow statement. We ended the second quarter with $87.6 million in cash, cash equivalents, and restricted cash, and $492.5 million of long-term debt, net of discounts, resulting in a 2.44 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 in the second and third quarters and collected during the third and fourth quarters. 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 $8.6 million during the second quarter and $100.2 million over the last 12 months. Free cash flow was $6.6 million during the second quarter and $94.2 million over the last 12 months. Adjusted unlevered free cash flow was $16.2 million during the second quarter. Over the last 12 months, adjusted unlevered free cash flow was $134.2 million. 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 Q3 and revised guidance for the full year of 2022 for ACR, adjusted EBITDA, and adjusted unlevered free cash flow. For the third quarter of fiscal 2022, we expect ACR in the range of $118.5 million to $119.5 million. We are raising our fiscal 2022 ACR guidance by $4 million. And we now expect ACR in the range of $465.8 million to $469.8 million. Normalizing for the bridge divestiture, our full year ACR guidance growth rate is 14% at the midpoint. As a reminder, on February 26, 2021, we sold bridge, our corporate LMS business. Bridge contributed approximately $4 million ACR during the first quarter of 2021. We expect third quarter adjusted EBITDA in the range of $42.1 million to $43.1 million, representing an adjusted EBITDA margin of 35.8% at the midpoint of the range. For the full year, we now expect adjusted EBITDA in the range of $167.5 million to $171.5 million, representing an adjusted EBITDA margin of 36.2% at the midpoint of the range. Our increased fiscal year 2022 adjusted EBITDA guidance reflects higher ACR growth and stronger gross margins as we continue to optimize our third-party technology costs. We are also increasing our full year 2022 adjusted unlevered free cash flow guidance, and we now expect adjusted unlevered free cash flow in the range of $185.5 million to $189.5 million. In summary, we are pleased to have exceeded our second quarter guidance ranges and to be raising our full year 2022 guidance ranges across all metrics. We are executing at a high level as we continue to display legacy LMS competitors and gain wallet share with our instructor learning platform solutions. We believe that there is no other company that's 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 solid 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.
spk08: At this time, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Your first question comes from the line of Josh Thayer with Morgan Stanley. Your line is open.
spk00: Great. Thanks for the question and congrats on a really strong quarter. So we're now, I think almost two and a half years post the onset of COVID really changed the landscape and the opportunity in K-12. So I was hoping to get an update on the competitive environment. What portion of K-12 do you see as penetrated as far as a paid LMS perspective? Where do you see that going over the next several years? And what's the latest on your competitive momentum versus the alternatives in K-12.
spk11: Yeah, thanks, Josh. And, yeah, I think you're right when you talked about the change that happened with the pandemic and K-12 recognizing the need for a digital transformation strategy. We still see a lot of interest. You know, as we mentioned on our last call, the K-12 system has been under a lot of pressure, particularly administrators with teacher shortages. You know, I think they were happy to go into this summer and get a little bit of a break, but the strategic priority remains high for digital transformation and the recognition that an enterprise class LMS is needed in order to really be a foundation for that. So we continue to see the good demand in our K-12, the pipeline demand. continues to build. We've had some, you know, really, you know, we mentioned a couple of cross-sell opportunities, so it's not just the LMS, but also the other products that make up the Instructure Learning Platform. We don't have an update on the, you know, the breakout between paid or unpaid. Our last data says that still there's about 40% to 45% of the market that's unpaid, and we expect that while the pace Over the last year since we've come out of the pandemic in some sense, it's slower than it was during the pandemic. We expect it to continue to kind of march forward at that, you know, increased penetration of a paid-for LMS. Our win rates are still, you know, world-class. We continue to win more than our fair share of the deals in that space. And we do it without having to, you know, drop price, we still haven't been the lowest cost in any deal that we've lost. So we feel good about our competitive position as we have in the past few quarters.
spk10: Great. Thank you.
spk08: Your next question comes from the line of Fred Havemeyer with Macquarie. Your line is open.
spk04: Hey, thank you. And I think I'd like to reiterate the sentiment. Congratulations on a strong quarter here. I wanted to ask, considering that Instructure is vertical software as a service addressing the education market, just about the macro backdrop, considering that this is something that has been top of mind with all of the, every other company in software, I really wanted to ask, how do you interpret the macro environment through the lens of your education customers? And is this something that you tend to see the larger recessionary, potentially recessionary or just inflationary impacts pressuring your model or pressuring any of your customers, or is this something you're generally deleveraged from?
spk11: Yeah, it's a good question, Brett, and very apropos, obviously, because of the headlines that are out there. You know, the education market, particularly higher ed, has tended in the past to be kind of counter-cyclical. People get laid off, they go back to education. And then K-12 is funded by property tax receipts, and we see the need to continue that digital transformation in K-12. The number of students isn't going to change because there's a potential for a recession. So we tend to be... insulated from some of these accurate trends that we see in the market today, just from the markets that we plan. And I don't want to overstate it and say we're completely immune to them, but as you can see from the results, it is much more muted. We're much more insulated and delivered, as you said, from those trends. So we feel good about where we're going into our position, and that digital transformation, you know, has to happen as, you know, as the education system, you know, transforms in the next, you know, decade.
spk04: Thank you for that. And then just a follow-up question. We've seen certainly in the headlines all the reports coming out recently about higher education enrollment trends showing that enrollments were declining. I wanted to ask, has Instructure seen this showing up in any of its conversations with higher education institutions, or has this been acting as any sort of a headwind for your model with institutions thinking about potentially resizing deployments, or is this something that is less consequential for Instructure as a whole?
spk11: Yeah, it is. This trend in enrollment declines has been for a couple years. Throughout the pandemic, data would show that enrollments have been down. You know, the institutions that we serve are responding with moves into online nontraditional, right? So while enrollments may be going down, it doesn't – necessarily translate to those students that still want to get a credential or they want to get some sort of training maybe it's not a degree and so you know we're by being in that online non-traditional with our catalog product with our acquisition of concentric sky we're we're a little bit we're hedged against the enrollment declines for traditional four-year degree seeking students In addition, our business is not completely reliant on U.S. higher education, and so less than half of our business is from U.S. higher education, so the diverse nature of our revenue streams means any kind of changes in any one market. And then because we are really a B2B sort of business model, dealing directly with the institutions, we, you know, with multi-year contracts that are non-cancelable, we don't see a huge impact. So, you know, there has been a de minimis impact in our business based on the last two years of enrollment declines for those reasons.
spk10: Thank you.
spk08: Your next question comes from the line of Joe Vrewink with Baird. Your line is open.
spk06: Great. Hi, everyone. I guess I'll stay with the same topic. Steve, you brought up some enrollment data earlier. I think that shows you're still growing your student enrollment in U.S. higher ed by a 10% rate, give or take. When you think about 2022 2023 participating in more bake offs and canvas is maybe one of the only vendors participating, that is still you know growing students. Are you getting some kind of positive feedback positive reinforcement institutions kind of looking to instructor for tips on. maybe how to course correct what could be a more challenging trend just within their institution, and so it breeds success for you in these RFP processes?
spk11: The short answer, thanks, Joe. It's good to talk with you again. Yeah, the short answer is yes. We are, particularly as institutions look for, you know, ways to address those nontraditional students, they're asking us how, you know, what should they do? How have we seen it done? And to your point, it's kind of one of those network effects that helps us in the RFP process. process in addition to you know a traditional strength of ours which has been our customer you know success relationships that we have those combined you know I think in script we talked about that being one of the differentiators in the win so again yes that is a network effect that we're starting you know that we're seeing help us to get those kind of world-class win rates okay great and then
spk06: Just to go back, you know, bringing up that, I think since the IPO in structure has exceeded revenue forecast by 3 or 4%, you know, on average each quarter, where has some of the best upside been seen just over that stretch of time? And as you look forward, like you mentioned, how much of the K-12 stimulus is still left remaining? Would you maybe expect some of the sources of upside to just shift to other areas of the business? So the magnitude of potential upside maybe stays consistent, but you're getting it from different areas than you have over the past 12 months?
spk11: Yeah. Yes, I think you're right. I think as we look at the stimulus funding, not a lot of it has really impacted our business. We're starting to see it. We talked about DeKalb using ESSER funds, but it's It's still a minority of our deals where they point to ESSER funds as the source of that. So, yes, we see strength across the business lines, you know, driven by the trends we've talked about, increased RFP and higher ed, you know, the move away from Moodle and international markets and the K-12 market. digital transformation that's happening. But I do think over the next couple years, you'll see those contributors to that overachievement shift between those three. But again, we saw strong growth in all of them this quarter, and we expect that to continue.
spk10: Okay, great. Thank you very much. Thanks, Joe. Next question.
spk08: Your next question comes from the line of Alex Sklar with Raymond James. Your line is open.
spk02: Thanks. Steve, I want to ask about international demand. Some of the prior questions hit on the macro concerns, but they do seem to be impacting kind of international markets a bit more acutely. Are you seeing any changes in demand broadly internationally?
spk11: We have not. You know, that continues to be our fastest growing market. And so we haven't seen any big changes in demand is the short answer, Alex. And, you know, the need for a, you know, a enterprise class learning management system, you know, the need to, for educational institutions to address, you know, changing needs in their education, you know, the students and the student demands, you know, is one of those drivers that I think transcends some of the macro concerns in those markets.
spk10: Okay.
spk02: Helpful. And then Dale, just following up on Joe's question, maybe ask it slightly differently. But how should we be thinking about the setup into 2023 from a pipeline perspective? I know you talked about a greater number of deals coming in the pipeline that were delayed during the pandemic.
spk10: But in terms of your overall ability to support double-digit growth? It's a good question, Alex.
spk11: We've got a couple of ways that we look at that. First of all, we had mentioned our very high RPO that we have. It's a record RPO number that we have that helps us have visibility into revenue for the next two, three years. So you take that and layer on top of it the visibility that we have into RFPs and that strong pipeline there gives us tremendous visibility into the top line growth and direction that we see with the business moving forward.
spk10: Okay, thanks. Nice win in DeKalb County in my backyard. Good to see a good cross bill there as well. Thanks, Alex. Nice. We could have used you.
spk08: Your next question comes from the line of Terry Tillman with Truist Securities. Your line is open.
spk09: Yeah. Hey, Steve and Dale. Congrats for me as well. And I guess for Alex, I'm a Fulton County neighbor, so I guess congrats for DeKalb County. I just had a couple of questions. The first question is, I mean, it's striking that there is 40% legacy. kind of, I think you said US higher ed LMS out there. I think I had that right. We're in an inflationary environment. There's no question about it. It gets costly to maintain these on-prem solutions or just where you're managing infrastructure. Do you see some sort of kind of looming event or kind of potential more notable uptick in activity as it just gets too costly to maintain these old systems? And what I'm getting at is like, how do you think about Kind of building on prior questions about the RFP activity and the volumes of shots on go in U.S. higher ed over the next couple years, maybe potentially even building more. And then a follow-up.
spk11: Yeah. You know, the activity, as we've talked about, is up, right? This year, next year, you know, that we have visibility into a lot of RFP activity. You know, the major driver for that was the pandemic. I pointed out the difficulty in maintaining your own technology stack and the hardware and everything around that. I think to your point, it's going to become much more costly for institutions to do that on their own. I think the other factor that plays in there, Terry, is the tight labor market and the ability to find, you know, talents. to manage that. So I think those are all, you know, those are all the good, it's a good fact pattern for us, right, to increasingly see that move away from those legacy systems onto the Canvas learning management system. So short answer I think is yes, we do see those as catalysts And I think it's already showing up in our pipeline data that shows that RFP activity is up significantly from 2021. Okay.
spk09: Got it. And, Dale, I mean, you called it out, but it's worth mentioning again. It's impressive year-over-year gross margin expansion. You know, is there – how much more is left in the tank in terms of in the second half, any more incremental opportunities? Or just even how do you think about over the next couple of years? Because it seems like you're really optimizing things right now. Thank you.
spk11: It's a great question, Terry. We're really pleased with our gross margin numbers. And this really is the result of the work the team has done over the past couple of years. It's the engineering team with our hosting environment. It is our customer support team and the variable nature of that to make sure that we are addressing customers and the questions they have and the timing that they have it. As we've said in the past, we expect our gross margins to be in the upper 70s, and we maintain that.
spk10: There's still room for us to expand there, but, yeah, we're really pleased with where we are at this point in the game.
spk08: Your next question comes from the line of Matt VanVleet with BTIG. Your line is open.
spk07: Yeah, good afternoon, guys. Thanks for taking the question and nice job on the quarter. I guess following on Terry's question a little bit maybe from the opposite angle of curious on how you're looking at assessments in K-12 or maybe studio and catalog and higher ed, potentially pulling projects forward, bringing RFPs to market that maybe were scheduled for another one or two years out, but are now sort of bigger catalysts of saying, look, we have this Demand for these additional features additional functionality and now we need to make that lms upgrade because we want to have. Those add on modules or are we still in the factor that you know that the lms is driving the bus, but the decision to choose canvas and the structure overall is that you have these additional add ons.
spk11: Yeah, it's interesting as I've gone out and talked to customers, Matt, because when we're in a new logo opportunity, the entire platform is a definite benefit in the selling process. The fact that the LMS, which tends to be foundational core technology, has these other uh parts that you know differentiate it uh in the market is a contributor to our high our high win rate um But we still are very, you know, we're still very low penetration as far as, you know, about I think just over a third of our customers have more than one product from us. So that opportunity to cross-sell into the existing base is going to be a growth driver for quite some time for us as we kind of optimize ourselves and go to market motions around, you know, into existing accounts. So it really contributes in both areas for us, Matt.
spk07: All right, very helpful. And then I guess digging on the international side a little bit, obviously the partner program seems to be off to a great start, and you announced another great partner in the Indian market. Is it changing what you're thinking about or maybe the roadmap for various markets being direct versus partner? maybe leaning even more into the partner program? Are you still pretty confident in sort of the identified markets as direct being large enough and economically viable enough to do that and just lean on the partners where it's maybe less so?
spk11: Yeah, I think I would characterize it as we've got a tremendous opportunity in the international markets. Some of them we're going to go after direct, and that list hasn't changed. And we still believe, you know, as we look at the market share potential in each of those, you know, many of those markets were still very lowly penetrated. I think the the most penetrated we are is 20 in one in one of our markets that we've been in for a while so still a lot of growth to come out of our direct efforts um this is you know the channel is incremental opportunity for us to grow the business uh and it opens up markets that We would not do business in immediately just because of the investment that's required, but channel partners that have existing relationships, existing contracts, do business with government entities is just for us incremental opportunity on top of what we're doing from a direct perspective. So I don't think it's an either or, and I don't, and channel definitely is not a catch-all for those, you know, opportunities that happen to come by, you know, that aren't in our direct markets.
spk02: All right, great. Thank you.
spk08: As a reminder, if you would like to ask a question at this time, please press star followed by the number one on your telephone keypad. Your next question comes from the line of Stephen Sheldon with William Blair. Your line is open.
spk03: Hi, team. This is Pat McElwee on for Stephen tonight. So I know you had mentioned that the use of stimulus was clear in a minority of your deals, but I just still wanted to ask, as you work through the peak selling season, can you provide an update on how you've seen that support used? If there have been any specific products that seem to have benefited from that, and if you've seen that spend pick up at all as we work through the allocation window for those funds?
spk11: Yeah, there aren't a lot of deals that we can point to yet where the district knows that those funds came from esther funds so uh it's a function of two things one is a lot of them just haven't spent the funds and the other is that a district will get funds from the state and it's not they're not always clear to the district what you know where those funds came from it's just here's a bucket for you to spend so so there's a little um you know it is a little cloudy and figuring you know, an accurate, you know, kind of detailed response to your question, Pat. But what I would say is the funds are available, that they're looking at them, you know, the digital transformation of education in the K-12 space is a very high priority strategically for each of these districts and each of these states. And so we feel confident that this will be a tailwind for us for the next couple of years. In the last budget year that just ended this quarter, Q2, we haven't seen a lot of it yet flow through. So there's still a lot of dry powder, if you will, for the next couple of years, we believe.
spk03: Got it. And then as a follow up, you touched on some of the cross selling success during the quarter, but wanted to ask, as you continue to build out your product set, are you able to provide an update on how reception of some of your more recent product additions like Canvas credentials, for example, has been? And also just how your ability to attach those additional modules at signing has trended?
spk11: Yeah. A couple of the examples that I used in my prepared remarks, each of those we were able to attach additional products, studio, catalog, and impact being the most commonly attached in a new logo. sale it's still early days from a canvas credentials perspective with the concentric sky acquisitions but the pipeline is growing nicely and it's a uh you know it's a and the customers are excited about it um and and you know again our strategy has always been you know we've got We've got really strong customer base that knows how to address a traditional degree-seeking student. Every one of those institutions wants to go address the reskilling market or the credential market, the certificate market, and provide services. students that maybe will never come on campus for a four-year degree, the opportunity to interact with the education institution. So the catalog and credentials investments that we're making, I expect to be big growth drivers in the future for us as the education landscape begins to shift.
spk10: Got it. That's great to hear. Thank you, and congrats again on the strong quarter. Thank you.
spk08: Your next question comes from the line of Brent Phil with Jefferies. Your line is open.
spk12: Thanks. Can you help outline the international drivers? What are the top two or three markets that you're finding great traction now in? And maybe you can just talk to the build-out of how that's going.
spk10: Sure.
spk11: We're seeing strength across the markets. We saw particular strength in APAC in Latin America. Both of those markets performed very well for us this past quarter. We are targeting primarily higher education institutions in those markets. The K-12 market is very fragmented, whereas in higher education it's a lot easier to address in that K-12 market. So we feel good about the progress that we're making in those markets. We had good growth across EMEA, Latin America, and APAC this past quarter, but those two stood out as exceptionally strong growth quarters.
spk12: Just on assessment, is there a baseball reference in terms of the inning you're in or what hole you're on the golf course? I don't know which way you'd kind of describe where assessments is at can you give us a flavor of where where you think you're at and then maybe kind of what what brings this to the next level what is what's the what's the piece that you think would supercharge that that continued cross sell yeah um i would say we're still early innings you know i think we're in the you know maybe the second or third inning uh from an assessment perspective um and there's kind of two things that are driving that one is um
spk11: There is a move basically in the education world to recognize that waiting until the end of the year to do an assessment is fraught with risk as far as if your success is really measured by the number of students that have mastered certain concepts. And so more and more institutions are looking at a way to predict that throughout the year and give teachers the tools to be able to assess whether or not a student is on track to show mastery at the end of the semester. In order to do that, that requires, you know, it's really hard if you're doing it with pencil and paper, right, and bubble sheets and things like that. So having a, you know, having that automated through an online system that's integrated with your learning management system is one of those one of those technologies that you have to have in place to be able to do that well. So we're seeing good, like we mentioned in the remarks, you know, from a product line perspective, we're seeing great growth in our assessment business as part of that digital transformation is not just learning management but also integrating assessment management. And as we see that continue, we think the uptake in these interim informative assessments is going to be significant. So, again, I think we're early innings as we get penetration of technologies like our Mastery Connect assessment management system. That'll be kind of the early indicator that we'll see faster and faster growth in that space.
spk08: Thank you. There are no further questions. I'd like to turn the call back to CEO Steve Daley for closing remarks.
spk11: Well, I just wanted to, again, thank our customers, our partners, employees, and our shareholders for your ongoing support. We're proud of our performance during our first year as a public company. We look forward to continuing to execute on our strategy and building a growing and highly profitable vertical software business that has a significant impact on the digital transformation of education. So thank you for joining us today, and we'll see you next quarter.
spk08: This concludes today's conference call. You may now disconnect.
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