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spk08: Ladies and gentlemen, thank you for standing by, and welcome to Instructure's third quarter 2023 earnings conference call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question and answer session, and please be advised that this conference is being recorded. I would now like to turn the conference over to your first speaker, David Banks, Vice President, Investor Relations. Mr. Banks, please go ahead.
spk16: Thank you. Good afternoon and welcome to Instructure's Q3 2023 Earnings Conference Call. With me are Instructure's Chief Executive Officer, Steve Daley, Chief Financial Officer, Dale Bowen, and also Peter Walker, who will assume the role of CFO of Instructure on November 13th. We will discuss our Q3 2023 earnings results, as well as the signing of a definitive agreement to acquire Parchment, the world's leading academic credentialing platform. We will provide an overview of the transaction as well as an initial view into their financials based on due diligence conducted to date. 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 uncertainty, and our 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 make from time to time with the Securities and Exchange Commission. All of our statements are made as of today, October 30th, 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 gap to non-gap measures included in our press release, which is posted on the investor relations section of our website. Note that we have also included supplemental materials under the events and presentations header on the investor relations section of our website in association with the purchase of parchment. We are unable to provide a reconciliation of expected parchment adjusted EBITDA or expected combined net leverage ratio without unreasonable efforts. With that, let me turn the call over to Steve.
spk17: Thanks, David. I'm delighted to welcome everyone to today's call. We're excited to announce and share details of our acquisition of Parchment. In addition to Dale and I will be reviewing our Q3 results and providing guidance for Q4 and the full year 2023. Before I discuss the quarterly results, let me provide some of the details of the very exciting announcement of our pending acquisition of Parchment. I will explain what Parchment does, how this acquisition fits strategically, discuss the business model, and provide details about the transaction. Parchment is the world's leading academic credentialing program with integrated enrollment solutions to support learner mobility. Parchment has more than 15,000 customers, primarily in North America with a presence in several key international markets, and has exchanged north of 165 million credentials over two decades. The company's Parchment Award product is a leading credentialing platform, issuing transcripts, diplomas, certificates, verifications, and badges to more than 15,000 customers. Parchment Pathways, their enrollment solution, helps more than 1,000 institutions efficiently process incoming transcripts, recruit students, support dual enrollment, and enable course sharing across systems. Strategically, this acquisition will accelerate the scale and reach of the Instructure Learning Platform. At Instructure, our goal is to help provide rich learning experiences that elevate student success and amplify the power of teaching. Partsman's goal is to provide evidence of learning through credentials of all types and to connect those credentials to opportunity. As we bring these two companies together on the Instructure Learning Platform, we can engage a learner throughout their lifelong learning journey providing evidence of their learning, and remove the friction for educators and learners at key transition points. Whether those transition points are for the high school senior applying to college or the workforce, the college student transitioning to the workforce, or the lifelong learner wishing to upskill or reskill, the Instructure Learning Platform will be their companion in that journey. In addition to the powerful strategic fit, we expect Parchment to bring Instructure important relationships with new buyers in our traditional customer base, a significant expansion of our total addressable market, and a high-quality revenue stream with meaningful and profitable organic growth opportunities. In higher education, Parchment has relationships with both registrars and admissions offices, which we expect will become much more important as the integration of traditional and non-traditional learners continues. Additionally, these relationships open up an estimated $2 billion TAM opportunity for Instructure as we become integral to the demonstration of learning. Based on our due diligence, Parchment's high quality revenue is approximately 95% recurring with strong gross retentions in the mid to high 90s and multiple avenues for future growth. Importantly, Parchment is a very profitable company today with high cash flow conversion, and we expect to achieve incremental cost synergies as we integrate the businesses into Instructure. As we have consistently communicated, M&A is an important part of our strategy to drive long-term durable growth. We have a strong track record of successfully integrating acquired companies, completing six integrations in the last four years. We have confidence we'll execute similarly with Parchment. The all-cash transaction is valued at $795 million net of a $40 million tax asset, or approximately 16 times Parchment's expected 2024 adjusted EBITDA. inclusive of anticipated run rate cost synergies. We expect to finance to deal with cash and incremental debt under our existing credit facility. Parchment is expected to generate approximately $115 million in revenue in 2024 and is expected to grow in the low double-digit range. We remain committed to managing our strong balance sheet and cash flow through this acquisition. Once completed, the combined company's net leverage is expected to be approximately four times net debt to adjusted EBITDA. We expect to delever rapidly as we continue to grow adjusted EBITDA and generate cash flow. Pending regulatory approval and other customary conditions, we expect the deal to close in the first quarter of 2024. Turning now to our financial results. Q3 results exceeded our previously communicated guidance range for revenue and adjusted EBITDA. fueled by our efficient go-to-market organization and unyielding dedication to customer satisfaction. Q3 revenue was $134.9 million, up 10.2% year-over-year, impacted by a currency headwind of 60 basis points. Subscription and support revenue of $123.1 million grew 12.2%. Q3 adjusted EBITDA grew 22% year-over-year to $58.2 million, driving a strong 43.2% adjusted EBITDA margin. We believe the strength of our Q3 performance demonstrates the effectiveness of our business model. With the onset of the new school year in North America, August and September remain the most active time of year for use of our platform. This year was no exception. As our Canvas usage volumes again spiked to more than 4 million concurrent users per day, in early September, consistent with our utilization during the COVID era. The resiliency of our platform was evident during this period, as we delivered more than three nines of availability. Now I will share highlights from the quarter, including four key drivers, strong new logo sales, continued progress in cross-sell, the power of our platform strategy, and how we are leveraging our business model. First, our new logo win rates remain strong across all of our markets as evidenced by our continued market share gains. In its 11th annual LMS data update issued in early October, Edutechnica illustrated that Instructure is the only LMS market participant in higher education that continues to gain share, with Canvas LMS leading by more than double its nearest competitor by both number of institutions and enrollments. While we continue to win more than our fair share of competitive bake-offs, we have seen a slowdown in the timing of deal close in higher education, both domestically and overseas. Our strong competitive position and industry-leading platform give us confidence in the long-term durable growth of our business. In higher education, we continue to see great success in adding new institutions as state systems look to standardize around the instructor learning platform. The Montana University System was looking to consolidate all of its 16 higher ed and one K-12 school onto one platform to drive ease of use, better content sharing with Canvas Commons, and provide students a consistent experience across its different campuses. Ten schools within the system chose to move off of two competitors' products and onto Canvas. In North American K-12, the Pasadena Independent School District took advantage of Instructure's growing suite of K-12 solutions, choosing Canvas, Studio, Mastery Connect, Mastery Item Bank, and Training Portal. With nearly 50,000 students, Pasadena ISD signed a 10-year contract whereby Instructure will replace its current classroom solutions because district leaders understood that Canvas is the go-to system for large districts like theirs. They saw Instructure as best suited to handle both curriculum and assessment needs for all their stakeholders. When their teachers saw Mastery Connect, they demanded to have it in the words of our customer during the kickoff call. CFRE, a private and independent education company based in Germany, selected Canvas and Credentials to aid in its focus on non-traditional students across vocational, higher education, and further education. With 18 brands and more than 30,000 students in Germany, CFRE selected our platform based on quality of delivery and user experience. Second, we continue to drive growth with existing customers, both through cross-sell and up-sell, where we see a billion-dollar-plus opportunity. We had a very successful set of customer up-sells in Q3. Demonstrating our continued momentum in serving non-traditional education providers, AWS renewed and expanded its partnership with Instructure by extending its user base for AWS Academy. A partner with Instructure since 2019, the AWS Academy is one of the largest Canvas users and is continuing to scale rapidly. Our ability to scale with best in category uptime convinced AWS to expand with Instructure. Our relationship that started as a pilot in 2019 to several hundred users will expand to 1.2 million users in 2024. and 1.4 million users in 2025 under our contract. South College in Knoxville, Tennessee is an example we see often in our existing customers, starting with an initial cohort of users, viral usage of Canvas, and a growing student body resulted in a significant upsell as we doubled the number of licenses across campus. Within North American K-12, in a strong cross-sell, the Nevada Department of Education added Mastery Connect coupled with its multi-year renewal of Canvas. A customer since 2020, Canvas and now Mastery Connect will be available to Nevada's diverse set of school districts with nearly half a million students statewide. They will use Mastery Connect and the Mastery Item Bank to support formative assessment practices in classrooms to provide teachers with real-time, standard-of-line data that teachers can use to personalize the needs of each student individually. The power of our platform strategy, our third key driver, thrives on innovation and partnerships, and those were evident again in Q3. In September, we announced an exclusive partnership with K16 Solutions, an industry leader for content and data migration and integration, extending access to a powerful archiving solution for all Canvas customers. In this revenue sharing agreement, Canvas archiving, powered by K16 Solutions, gives Canvas users a simple way to control access to sensitive data and back up all student and course data with the click of a button. Our expanded arrangement with the Alabama Community College System, ACCS, represented yet another example of a maturity path we've seen with many higher ed institutions. As part of a broader statewide initiative by Alabama's governor, to reskill and transform the quality of the state's workforce, ACCS saw the value of the Instructure Learning Platform. The system not only opted to standardize on Canvas across its 24 community and technical campuses statewide, a competitive displacement of 12 new campuses in favor of Canvas, they also will add studio, impact, and credentials as a seamless way to digitally transform the state's broader workforce enhancement initiative. We continue to enhance our channel offerings as well. Philippines-based CNE Adaptive Learning Solutions, our most successful channel partner in Asia, enabled us to ink a deal with RMMC, a higher ed institution serving the largest region in the Philippines, including the highly populated island of Mindanao. CNE is behind our largest global channel deals to date, having invested in our partner program and is enabled to implement Canvas and support our APAC customers. As we've discussed in prior quarters, artificial intelligence continues to be of significant interest to our existing customers and in our selling conversations. We continue our work to elevate the industry dialogue around best safe and ethical practices for development, deployment, and use of AI to better serve students and teachers. Our partners with existing and new providers are growing as the instructor learning platform serves as our customer central point of access to their tools for teaching and learning. During the quarter we delivered our own AI based capabilities into beta to select customers. These customers are providing early feedback and will continue to shape our efforts around course and content creation, semantic search, and natural language driven learning analytics. And finally, our results this quarter once again highly indicative of our ability to drive operating leverage in the business. Because of our disciplined investments, we've been able to deliver best-in-class margins, which this quarter started with a four handle. This allowed us to invest in our platform, make strategic acquisitions like Parchment, and drive long-term durable growth. Our business model permits us to continue driving strong top-line results without sacrificing margins and profitability. With adjusted gross margins approaching 80% and adjusted EBITDA margins exceeding 40%, we expect to continue to produce free cash flow that will allow us to reinvest both organically and through M&A to drive long-term durable growth. In conclusion, we believe our strong Q3 results and expanding impact on education position us as a clear leader in the education technology space. And we look forward to the opportunity to continue to drive value for our customers and shareholders in the months and years ahead. Now I will turn it over to Dale to provide further details on our Q3 financial performance and guidance for Q4 and the full year 2023. This will be Dale's final earnings call with Instructure as he is retiring from the company effective November 12th. Dale has made great contributions to Instructure during his four years with the company. He helped us successfully navigate important transitions, including our 2020 shift from the public to private markets and our return to the public markets in 2021. During his tenure, he also established a strong culture of transparency and consistency and built a strong foundation for our next leader. He has agreed to provide transition services through March 2nd, 2024.
spk14: Dale, please go ahead. Thank you, Steve. And thanks to everyone for joining us today. Before discussing our detailed financial results, I would like to point out that in addition to our gap results, I'll be discussing certain non-gap 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 Q3, we continue to show a combination of growth and best-in-class adjusted EBITDA margins. As Steve mentioned, we generated total GAAP revenue of $134.9 million, up 10.2%, and impacted by a currency headwind of approximately 60 basis points. Subscription and support accounted for 91% of our Q3 revenue at $123.1 million, up 12.2% year-over-year, impacted by a currency headwind of approximately 60 basis points. Professional services and other revenue accounted for 9% of our Q3 revenue at $11.8 million, compared with $12.7 million in Q3 of last year. This change was not unexpected, as there was a slight pull through in Q2. Deferred revenue at the end of Q3 was $347.1 million, up 8% year over year. We ended Q3 with remaining performance obligations, or RPO, of $862.9 million, up 9% year over year. 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. Our gross margin profile was supported by our optimized cloud architecture and flexible support model that scales to meet seasonal customer demand. In Q3, gross profit was $105.6 million, representing a 78% up from 77.8% in Q3 of 2022. Turning now to operating expenses. Sales and marketing expenses for Q3 were $23.7 million or 17.6% of revenue, down 210 basis points from 19.7% of revenue in Q3 of 2022. Research and development expenses for Q3 were $15.1 million or 11.2% of revenue compared to 12.7% in Q3 of 2022. General and administrative expenses for Q3 were $9.7 million or 7.2% of revenue, down from 7.6% in Q3 last year. Non-GAAP operating income for Q3 was $57 million, representing a 42.3% operating margin up from 37.7% in Q3 of 2022. Q3 adjusted EBITDA was $58.2 million, representing a 43.2% adjusted EBITDA margin, up from 38.9% in Q3 of last year. Non-GAAP net income was $35.8 million in Q3, or 25 cents per share compared with $29.5 million or 21 cents per share a year ago. Turning to the balance sheet and cash flow statement, we ended Q3 with $308.6 million in cash, cash equivalents, and restricted cash, and $487.4 million of long-term debt, net of discount, resulting in a 0.88 times net debt to trailing 12-month adjusted EBITDA ratio. Free cash flow in our historically strong third quarter was $180.8 million compared with $178.3 million in the prior year, up 1%, due primarily to timing. Recall that in our Q2, free cash flow growth was very strong. Adjusted unlevered free cash flow, which adjusts for the impact of transaction costs, sponsor costs, impaired leases, and other non-recurring costs paid in cash, was $200.1 million, up 6.6% year-over-year from $187.6 million in the year-ago quarter. Our collections activity normalized this quarter, so the year-over-year increase reflected that. I will now conclude the call by providing guidance for Q4 and for the full year of 2023 for revenue and adjusted EBITDA. We have provided additional guidance details in our earnings press release. For the fourth quarter of fiscal 2023, we expect revenue in the range of $133.3 million to $135.3 million. For the full year, we expect revenue to be in the range of $528 million to $530 million, up $2.8 million at the midpoint compared with the annual guidance we provided on our Q2 call in July. We expect Q4 adjusted EBITDA in the range of $53 million to $55 million, representing an adjusted EBITDA margin of 40.2% at the midpoint. For the full year, we expect adjusted EBITDA in the range of $211 million to $213 million, representing an adjusted EBITDA margin of 40.1% at the midpoint. For the full year, we expect adjusted unlevered free cash flow to be in the range of $207 million to $211 million for an adjusted unlevered free cash flow margin of 39.5% at the midpoint. In summary, our Q3 and year-to-date results were very strong, as once again we exceeded our guidance. We continue to execute at a high level to deliver growth, best-in-class margins, and strong free cash flow. As I depart Instructure, I want to say thank you to all of my colleagues and to our investors and analysts as well. I'm grateful for the opportunity to have been CFO for the last four years, and I'm delighted to leave the business in such a great financial position. I have utmost confidence in this company and the ability of its people to continue executing. As I step away from Instructure, in the near term, I'm delighted to share that I'll be leveraging the Canvas learning platform as a substitute math teacher in a Salt Lake area middle schools. I wish Peter well as he assumes his role, this role. I'm certain you will all enjoy meeting and working with him if you haven't already. With that, I'll turn it back to Steve.
spk17: Thank you, Dale. And thanks again for your service to Instructure. We all appreciate that you've left the business in such great shape financially. I have every confidence that we will continue to execute and carry on the great track record you've established. It's now my pleasure to introduce our incoming CFO, Peter Walker. Peter has 15 plus years of executive experience, including more than 10 years as a CFO. He is currently the CFO of Sterling Check Corporation and will start at Instructure on November 13th.
spk09: Peter? Thank you, Steve. I'm thrilled to be Instructure's next CFO. You and your team have built a market-leading global technology business from startup to scale in just 15 years. with a mission-driven culture and people I knew immediately were a great fit with my values and aspirations. My significant experience in executive roles as both a CFO and Chief Strategy Officer for global public companies and prior P&L ownership responsibility will add depth to Instructure's leadership team. My success in designing and leading strategies that grow organic and inorganic revenue improve customer experience, and reduce costs will be impactful as we move into the next phase of Instructure's growth, from a half billion in revenue to a billion dollars plus and beyond. I'm excited to create value for Instructure stakeholders as we continue to grow the business and expand profitability. I'm particularly passionate about investor relations. One of my first priorities is our investor engagement roadmap, building on all the great work that has been done. I'm also passionate about leading and developing and structure strong finance team. I will attend the Raymond James Conference in New York in early December with Steve. I look forward to meeting more of the investor community there. That concludes our prepared remarks. At this time, operator, please open up the line for questions.
spk08: Thank you, ladies and gentlemen. Just a reminder, any questions, please press star one. If you find that your question has already been addressed, you can remove yourself from the queue by pressing star one again. We'll go first this afternoon to Stephen Sheldon at William Blair. Hey, thanks. It's been great working with you, Dale, and look forward to working with you, Peter. First here on the parchment deal, it sounds like you're expecting low double-digit growth there, but do you think there's an opportunity to accelerate that growth rate, especially with any benefit from cross-selling between the two businesses and maybe just any detail you've brought on what cross-selling opportunities there could look like?
spk17: yeah um yeah thanks thanks for the question uh stephen if we um you know we we have been um really excited about this acquisition uh i think the way that it connects our you know what we do in the classroom with the evidence of what's you know the learning that's happened and the ability to demonstrate that that the learners can you know demonstrate their skills and their uh accomplishments uh is is is what one, the industry needs, and it also really accelerates our strategy. The reality is we've been appropriately conservative, I think, in the modeling as we've done, as we've set guidance, as we've built the models around this. There are areas where we believe that there are top-line synergies over time. We haven't built those into our models today, but particularly as we think about students as they cross those transition points. So dual enrollment, the ability to share courses across campuses works really well with our catalog product. The badges work that we're both doing, the comprehensive learning record over time, we do believe that those will all be a creative growth drivers for us. We just haven't modeled those yet into the businesses or the guidance.
spk08: Got it. Makes a ton of sense. And maybe with this deal, you're also moving a little beyond the scope of what you've done historically in the higher ed software stack by getting into admissions and enrollment. So curious if you see more opportunities on that front to move into new areas. And just generally, has your thinking changed at all about how broad of a software platform you want to be in higher ed?
spk17: Yeah, it's a question that I think you've asked us before as well. What I would say is, as we look at where the adjacencies are to our current business around teaching and learning, we're looking for those areas where there is an overlap in the Venn diagram, if you will. So where we see that parts of what we're doing in the classroom are very applicable to the things that maybe new parts of the institution may be using. And this was one of those areas where it made a lot of sense for us to kind of combine the two organizations. Learn Platform, the last acquisition we did was very similar on the K-12 side where we addressed some new buyers, but there's still a lot of overlap with our existing users and our buyers. You can expect us to continue to look for opportunities just like this, where they're close adjacencies, open us up to new budgets, open us up to new experiences, new relationships. And yes, I do think it provides nice fertile ground for us to continue both organically and inorganically expanding that platform.
spk13: Great to hear. Thanks. Thank you. We'll go next now to Josh Baer at Morgan Stanley.
spk10: Great. Thank you for the question. Dale, it was great working with you and good luck ahead. One for Steve was hoping you could talk a bit about the process for finding the next CFO. What were some of the things that you were looking for and ultimately what led you to Peter? For Peter, what attracted you most to Instructure and this opportunity?
spk17: Yeah, great. Great. Thank you for asking that question, Josh. So this was a process that we took, you know, it was a very deliberate process. We were looking. I had had some conversations with Dale about what he wanted to do, when, where he wanted to do those things. We approached it as we wanted to look for somebody that had great experience in the public markets. We were looking for somebody that has worked in models of companies that have had PE ownership, that know how to drive growth, that are very good at articulating growth strategies to the streets and being able to help our investors understand the levers within growth. And we took a while to do this. It was a fairly long process. We engaged recruiters. We met with a lot of different people. What really kind of sealed the deal for me with Peter was good cultural fit. We felt like he would work well with the team. He could get very passionate about the mission. a long tenure working with the public markets. I really liked the way that he approached his investors and the way that he helped them understand the key drivers of the model long-term and explaining how those would affect our results going forward and felt like he brought a lot of good experience and detailed understanding of of how you know how a business like ours would work so again, it was a it was a very rigorous and you know pretty long process to find the right person Peter you want to share.
spk09: yeah happy to jump in so i'd say I was first attracted by the mission of in structure always been extremely passionate about education and what that can do for people. on a global basis. And so that's what brought me in. And then once I got interested, I have a pretty diligent process of first starting with how large is the TAM that the company operates in? How fast is that TAM growing? So as I learned that information about Instructure, I was really excited about the large TAM and significant growth rate there. Next, I look for a company who is number one or number two in the market. Clearly, Instructure is number one in the markets they play. Then I look at ownership, you know, who owns the company, found it very interesting that, you know, a great firm like Tama Bravo is still involved with the company, but also the company is public. And then once I get through that, it really goes to the people and the culture. And that's what sealed the deal for me. You know, from the first time I met with Steve and the rest of the management team, it was just a great and very natural fit from day one. So yeah, really excited about this opportunity and excited about all the value we're going to create going forward.
spk13: Great. Thank you very much. Thank you. We'll go next now to George Kurosawa at Citi.
spk04: Thanks for taking the questions. I'm on for Steve, and great working with you over the years, Dale. Maybe to start with on the parchment deal, you know, you disclosed 15,000 customers. maybe if you could give a little color on what does that footprint look like and how much overlap is there with the existing customer base?
spk17: Yeah, you know, we will. So as I look at the overall customer base, obviously with our footprint in higher ed and Parchment's leading market share in higher ed as well, you know, there is some overlap within the customer base. We you know, the the The exciting part is that the relationship we expand our relationships within those even even when we are you know when we have those joint customers and so. We will kind of will disclose that as we as we get further closer to close as we get as we close this deal will be able to. To show you a little bit better where that overlap is but just know that we, you know we feel good about the. You know the relationships that parchment has the the the reputation that they have with those customers is similar to the one that we feel like that we have with our customers and. You know, there is a there's a significant opportunity for us to share share customer lists and and be able to expand our customer base on the instructional learning platform.
spk04: That makes sense and then. You know, Instructure clearly has some credentialing capabilities in the platform today. Maybe you could just help us understand, you know, where kind of the real level ups in terms of features and functionality that Parchment brings. Thanks.
spk17: Yeah, you know, there's a couple areas where I see, you know, some level up, to use your words, right? So, first of all, when it comes to, you know, that transition that students are making, What we're seeing more and more, particularly since the pandemic, is that learners are much more mobile and they're much more willing to kind of mix and match, if you will, their educational experiences. And they're looking to do that in a way that's most convenient for their lifestyle, whether they're working or they're willing to go full-time to school. And so there's a number of technologies that Parchment have around The ability to dual enroll students, whether when they're in high school, you know, be able to get college credit, you know, while they're completing their high school diploma. There's technology around allowing institutions in a system to be able to share courses so that a student can decide, you know, when they're living at home, they can go to local community college, but maybe they're going to the state university during the fall and the winter. And that ability to kind of transfer the credits to share those courses is an area where we think we can get an acceleration in both our roadmap as well as our footprint within a customer and that ability to transfer those credits in that process. The other piece that we're early in our development is around the comprehensive learner record and being able to provide rich data of a record and a portfolio for students where they've got a lot of work done that we feel we can leverage to go much faster on a roadmap in that area. So, you know, a few really exciting areas that we think it's going to drive, you know, long-term for us is going to drive our roadmap and drive ultimately long-term growth. Awesome.
spk04: Thanks for taking the questions.
spk13: Thanks, George. Thank you. We'll go next now to Joe Verlink at Baird.
spk07: Yeah. Hi, everyone. Just, you know, starting out, best wishes to Dale, and it kind of makes me want to be back in whatever grade Dale's going to be teaching just to get that substitute teaching experience. But, you know, maybe just to go to the one comment you made about, you know, slowness in deal closings in higher ed. I guess my question is, what's your take on why this is happening now? And then in the past, you know, you've kind of talked about the RFP activity in higher ed should be elevated in 2023 and 2024. Is it still elevated and this is just a delay in closing or are you starting to maybe recalibrate on the RFP environment into next year as well?
spk17: yeah yeah thank you for for that question joe um it's uh it so so i'll just start as is with the with the you know um with the overall market we you know i've i've never felt better about our competitive position you know the breadth of our portfolio is really and and the momentum in our business we continue to gain share um in the market you know per the edu technica um data shows that canvas lms is the only one gaining share in in in north american higher ed so from that perspective i feel really good what we're seeing is um it's interesting because um we are seeing you know our activity is good uh in fact you know and and again don't over index on rfp because it's about 30 to 40 of our business but in the rfp space i think we had the highest rfp activity in the last six years in North American higher ed. But across the world, we're seeing that the pace of deals have slowed and they're deferring some of these projects. And when we ask our customers about it, what they're really telling us is, look, I mean, it's not a surprise, right? I mean, we've been talking about all of the macro trends in higher education, right? Declining enrollments, budget challenges, the removal in the U.S. of federal stimulus funding where we feel it a little more acutely in north america but we feel across higher ed around the world is still dealing with some of these bigger challenges and so what they're telling us is look we've got to work through and they're being very thoughtful about this we're trying to work through our what is our strategy and what is our digital transformation strategy how do we go gain new revenue streams how do we go address that non-traditional student. And so as that mix starts to shift, they're hitting the pause button on projects until they get their strategies figured out. Now, from our perspective, we're, you know, I feel really good about that because we're very well positioned to address it, whether it's a traditional or a non-traditional student. You know, as our portfolio of products we have today through both organic and M&A has really grown to be able to address those over the last several years. And the fact that we're at the table having these conversations with them You know, we are that trusted advisor. It bodes well for us, you know, long term. And I believe we're going to continue to be able to drive long term growth in this space. It is a temporary slowdown that we're seeing. Again, not in the activity, because again, that's been really active. It's more in the pace that we're seeing of the deals closed.
spk07: That's great. And then just a related follow-up on this, is there any kind of guidance or assistance you can give just in terms of the financial implication of this particular comment? Because I think, Steve, you're alluding to this, if you just look at your RPO development or kind of what the implied bookings are, that seems really good. And so is it the case that in structure, because you're taking share and you're not totally wed to higher ed, like you're ultimately delivering on your growth with maybe a more difficult backdrop. I guess I'm trying to get to maybe an expectation for how this could manifest in 2024 numbers.
spk17: Yeah. And we, you know, Joe, we're not guiding to 2024, but you are really good at, you know, those kind of questions, right? Try to get me to the guide to 2024. What I will tell you, Joe, is, you know, it is, like I said, right, we're seeing a slowdown, a lengthening of those deals. We do feel like we're very well positioned, but we do think this will be, you know, this will be a temporary slowdown in the near term for the business. And again, you know, the long-term growth prospects are really good, particularly as these institutions start to work through their strategic long-range plans.
spk13: Okay, I'll leave it there. Thank you very much. Thanks, Joe. We'll go next now to Fred Havemeyer at Macquarie.
spk15: Hi, thank you. And firstly, Dale, it has been an absolute pleasure working with you. Sorry to see you go, but I honestly am a little envious that you have a substitute teacher gig lined up already. That's fantastic. And Peter, I'm really looking forward to working with you. For this quarter, I'm particularly interested in the competitive win that you called out in your press release, Montana and Pasadena higher education and K-12 respectively. I'm curious to hear, you called out some of the aspects that led to those wins, and I'm quite curious to hear a little more qualitatively and deliberately here, what drove those competitive wins? What were the differentiating factors for Instructure?
spk17: yeah uh it's a great question um um fred um it's it you know the uh we're seeing more and more um this trend towards uh you know um particularly education systems that are looking at how do we better address this this change in kind of the student expectation right the student is much more mobile they want to they want to be able to move through their learning journey, right, by picking and choosing, right? It used to be I applied, I went to a university, I went there for four years, I got my degree. It's much more mobile nowadays. And so what we're seeing is that the systems are starting, like Montana, Alabama Community College System, right, they're starting to look at this and say, what's the best way for us to provide a student experience that is best in class and consistent across that? And so So what we saw, particularly with Montana, was this, you know, they looked at somebody like California Community College System, you know, that is standardized on Canvas. They said they looked at that and said, okay, we want that kind of student experience. We want the ability for students to be able to share courses. Interestingly enough, as part of that deal, they had Quotely, which is part of the Parchment portfolio in there. And so we see them, you know, and we see them looking at how do we make that transition from K-12 systems within Montana, make that easier and simpler. So, you know, I would say, you know, for us the advantage was that we have, you know, the market leading position in both K-12 and higher ed, which was a key, you know, key decision factor. The fact that we, you know, we've demonstrated our ability to scale to large implementations across the system. that we had some of the stuff that we've been working on with catalog, with some of the technologies to address non-traditional really well was good for them. And then the fact that we have strategic relationships, that we have a community of institutions that have done similar things, that they can share and talk with each other, all of those things added in on top of the fact that market-leading LMS, but a much broader platform than we had even three years ago that has all the pieces that help them address that, both the traditional and the non-traditional. What we've referred to in the past as omni-channel was a really big decision factor for them.
spk13: Thank you for that. Thank you. We go next now to Brian Peterson at Raymond James.
spk11: Thanks for taking the question. Dale, I've really enjoyed working with you. You've definitely taught me a lot of math over the years, so maybe I can join Joe out there in Utah for some remedial lessons. And Peter, look forward to meeting you at the conference. So Steve, just on Parchment, you guys mentioned the $2 billion incremental TAM, $115 million in revenue. Is there anything that you can share about some of their products or part of the platform that are maybe ahead in the adoption curve and what products have the most white space?
spk17: Yeah, you know, it's a good question. We will, you know, we will plan a much more fulsome review of this when we do our, you know, when we give you our 2024 guidance after this deal has closed. But let me just give you a high level, Brian. As you look at the overall revenue, that TAM breaks down between the awards product, which is a lot of the credentialing pieces, and the Pathways product. Within the credentials, part of their business is around transcripts and diplomas. It's a good, steady grower. What we're seeing in that space is that the mix in amount of credentials that an individual student is requesting is increasing. And so with this mobility that students are expecting, they need to make more requests of these transcripts. So from that perspective, we see growth through just the number per student that we're seeing. In addition, as those transcripts get more Will Get broader right as you start to think about it in the context of badging as you think about it as a portfolio that will be. That will be an outsized grower in our in our opinion and on the pathway side, you know it's still it's still early days when we talk about kind of dual enrollment and cross course sharing it's becoming a much more. it's much more topic of conversation in the selling process so. So that area will show outside growth versus the rest of the business as well, if that makes sense.
spk11: No, that doesn't make sense.
spk17: Brian, let me just add, they have a very small footprint in international. They bought a company that was based internationally, based out of Australia. We believe that there's an opportunity to grow international above the average growth rate for the company. as we kind of leverage our infrastructure worldwide.
spk11: Understood. And maybe just following up to some prior questions just on the LMS activity this year. Steve, would you say it's more of a budget dynamic or is it more of other priorities dynamic? As you kind of look at the lens of non-traditional learning and those ambitions there, I'd be curious what your existing customers are doing there and how they may be leveraging Canvas versus what some of your non-customers are struggling with. Is there any insight to be going from from there?
spk17: Yeah, no, it's a good question. You know, I think I think budget and priority are, you know, they both come into play. We know the budgets have been tight in in higher education. And part of that is, you know, the enrollment decline. They need to find new revenue streams. Right. And and so so it's it's a little bit of that and a little bit of of the prioritization, right? And we've got to figure out what we're going to do for the future. Our existing customers are grappling with the same challenges, right? A lot of our conversations are about how do we extend the Canvas environment outside of the four walls, outside of the traditional learning experience? How do we create this omni-channel experience for learners that are either all remote or hybrid or all in person, and we're getting a lot of energy, if you will, around then how do we demonstrate skills? How do we demonstrate that for the student as they're looking to go out into the workforce? And so our customers are asking for the same thing. Because our solutions are so sticky, our renewal rates We just went through a massive renewal rate cycle over the last two quarters, right? And we saw improvement year over year on renewal rates. So they're also doubling down on our platform as the platform to really address those opportunities. Thank you.
spk13: Thank you. We'll go next now to Terry Tillman at Truist.
spk02: Yeah, thanks for fitting me in here. Congrats on the Parchment acquisition. Dale, congratulations to you and your retirement. I hope you're an amazing teacher. And congratulations, Peter. I'm looking forward to getting to know you. I was going to actually follow up on a couple of prior questions on Parchment first, and then I had a follow-up. And I'm sorry in advance that the first question might be a multi-parter. On Parchment, you know, if I look at the $115 million and the $2 billion TAM, and I know this is way oversimplifying it, but it is like a 6% market share That seems pretty small at this point. And it sounds like, I think, Steve, you said awards is probably the biggest component and there's some other really fast-growing small pieces. But if we look at like the biggest part of awards, are there legacy share donors in this market or did folks try to build their own kind of credentialing system? Just kind of curious where we are in terms of greenfield, brownfield, et cetera, as you all work to monetize this interesting opportunity.
spk17: Yeah, you know, the primary shareholders in this space are NSC, the National Student Clearinghouse, and Parchment. You know, and in our diligence, you know, the feedback came back very positive on Parchment as far as the view of the technology, the view of the relationship that they have with their customers. And so from that perspective, when you look at kind of the – um you know the uh transcript and diploma side of the business those that's it really is uh um it is those two right and and and that is a pretty stable business that's very you know very high uh gross retention it's in the you know mid to high 90s uh gross retention so um so from that perspective very very predictable very um uh very very strong market share uh the where the where the opportunity is and which is is a bit of greenfield is is um the credentialing right what the badging is is is is new opportunity the uh comprehensive learner record those pieces are where we'll be able to drive uh growth and uh again more of a greenfield type of sale than it is than it is a market share uh takeaway and then when it comes to the pathways product the dual enroll the crochet course sharing pieces of it. That is all, that is all Greenfield. That's a new market that is, um, is really starting to emerge. And, and like I said, we've, we've had a number of conversations about it. Uh, it's one of the reasons that we were interested in parchment is, is, you know, because historically we haven't had solutions to those, to those problems. So, so that, those are kind of the key areas that we see where we can drive growth and share.
spk02: Got it. Thanks for that. Yeah. Thanks for that. I guess the follow-up question is just related to, uh, international. Maybe, Dale, could you actually share what the revenue was and the percentage growth year over year? And does it feel like this business, you know, is it being impacted by the same amount as North America higher ed, or does it seem a bit more resilient? Thank you.
spk14: Yeah. So, Terry, the international growth was 11% on a constant currency basis. It's 14. We'll drop the queue here in the next couple of days. It'll give you a little more detail on that. But International is still our fastest growing segment out of all that we talk about, so we're pretty pleased with it.
spk17: And to answer the second part of your question that you sneaked in there, Terry, we do see the similar headwinds in higher ed, maybe not as acute and not to the same level that we see in North America, but all higher ed institutions are you know, are asking these questions. I just spent a week in Australia, many of the same questions about, you know, where do we find new revenue streams? How do we address this non-traditional student? How do we meet students where they're at? Those are all things that everybody is grappling with from a strategy perspective and long-term digital transformation strategies.
spk13: Thank you all. Thanks, Jerry. We'll go next now to Devin Au at KeyBank.
spk05: Great. Thanks for fitting me in here. Dale, it's been a pleasure working with you. And Peter, congrats and looking forward to working with you more. Maybe just one question from my end. I wanted to ask about K-12. Nice to see the continued large wins in that market. Unlike higher ed, which you called out some weakness in the sales cycle, have you seen any sort of uptick in deal closing within K-12 or perhaps any uptick in RFP in that segment, just given the whole ESSER funding deadline is fast approaching? Yeah, thank you.
spk17: Yeah, you know, Darren, the activity has been, you know, we've talked about it the last couple quarters, right? There's been a lot of activity in K-12. You're right. There's still, you know, depending on the estimate, a third to half of all the ESSER funds that haven't been committed yet. And so we do see, you know, we do see some activity. you know, we do see some good activity where we're seeing probably the greatest activity in K-12 is around assessment. We're seeing good cross-sell into K-12 this last quarter. And we'll, you know, we think that, you know, Nevada was an example of, you know, our cross-sell of Mastery Connect. So we expect that we'll, you know, we expect that we'll continue through this next buying season when the ESSER funds
spk13: are finally expire. Great. Thanks for the color. Thank you. We'll go next now to Ryan McDonald at Needham.
spk12: Hi. Thanks for fitting me in, and congrats on the next quarter. Steve, maybe just starting on K-12, curious what you're seeing with the Learn platform and your ability to start to cross-sell that in a bit more. I know you were, you sort of launched some of that functionality for free at the user conference and that sounded like the interest was pretty high in it, but just sort of interested in what you're seeing there, uh, post the event.
spk17: Yeah, we, you know, we've, um, uh, you know, we've, what we're seeing is a lot of, we've seen a lot of activity. So, um, you know, as, as we made that acquisition and we, and we, we put it into the hands of our sellers to be able to start carrying those conversations forward. We've seen some good pipeline growth. And so as I look at kind of the learn platform interest, it's extremely high. We continue to see a need. Our, you know, our customers are telling us, you know, as we think about, you know, all of this technology that was deployed during the pandemic, we're seeing that it's, you know, They're trying to rationalize what that looks like. And, you know, our pipeline is more than doubled since we did the acquisition. And we see, you know, we see real interest in this. So I expect that, you know, we talked about contribution being de minimis in 2023. But as we go into 2024, I feel pretty confident about, you know, the level of interest and the activity that's going on with learn. And as you talked about, part of that seeding strategy is just starting to take hold in our customer base, and we believe that's going to drive even more pipeline.
spk12: Super helpful, Collar. And maybe just one on Parchment. I noticed from sort of looking at the company website that they've got a connection in into the workforce, industry organizations and enterprise organizations. Just curious if you think that this acquisition can help kind of close the loop on the strategy for know canvas student pathways and sort of bringing those those you know non-traditional learners upskilling them and then sort of validating those credentials as they as they go back into the workforce or try to you know find a new new role is that how we should think about maybe that a portion of this acquisition moving forward that is exactly how you should think about it ryan um it does give us um
spk17: You know, we talked about deeper relationships within the institutions that we play today, but it also creates, um, connections with, uh, inside the workforce. So over time that that will become a much more important part of the strategy that will become the opportunity for us to connect learning through the comprehensive learning record with, you know, outcomes, um, and, um, opportunity for the students long-term. So, yes, we're, we're very excited about, um, the, you know, the, those relationships.
spk13: Great. Thanks for the comment. And we'll go next now to Matt VanVleet at BTIG.
spk01: Hey, good afternoon. Thanks for taking the question. Dale, it's been a pleasure working with you over the last couple years. Maybe the last question, just a little follow-up on there. How much of the conversations with customers, whether it was around catalog or some of the other omni-channel type approaches that you've been having, Steve, catalyzed the need to maybe get the parchment deal done now or highlighting maybe some of the product gaps that you had on the roadmap, but this helped accelerate?
spk17: Yeah, you know, Matt, I'm not sure it changed necessarily the urgency of getting the deal done. You know, this is a, these are, you know, we have a very active M&A roadmap. We have an active engagement with a lot of different companies. We've, you know, we've had conversations with Parchment for over a year and a half as far as just, you know, understanding their business, you know, seeing if there's partnering opportunities. But, you know, in order to get a deal done, both parties have to be ready for it. And so it's more of a function of them being ready, I think, than necessarily us feeling a need to fill a hole. Now, I will say that from my perspective, you know, from the management team's perspective, the conversations that we've had, you know, probably in the last nine months, the conversations we had at InstructureCon really have ramped up. um this concept of i've got to go figure out how to address these these non-traditional students so i think the timing from that perspective is perfect because i you know we're hitting it at a time when the need is front of mind the need is you know the pain is front of mind for for our customer base so i think um you know it's uh you know it is it is a great time uh for us to do this deal from just from a market timing perspective
spk01: Very helpful. And then just quickly, one other follow-up on some of the longer sales cycles. If you were to try to make your best estimate on when some of these deals that you're already working on eventually close, is this starting to feel like it's again sort of the next summer buying cycle is more likely or some of these sort of happen in the interim as you push forward and maybe the catalyst of some of those non-traditional opportunities gets these over the goal line before the next big buying season?
spk17: Yeah, that's a tough one to try to call right now. In international, this is our big quarter. And so we'll see how deals matriculate. We'll have a better view kind of as we meet again in Q1 to talk about 2024. I would say we still feel good about the deals that are getting done. We're winning, right? And we continue to gain share. Um, and then, you know, we'll have to see as we go, as we go forward, whether this, you know, they decide to do these now, you know, there is a lot of impetus for them to kind of time these around their budget cycles around the school, you know, school year in North America, for instance. So, um, we'll, we'll, you know, I don't, um, I don't have a, uh, you know, you know, a crystal ball right now, Matt, uh, as far as when these will close, but, um, But I do again. I do feel good about when they do come. We're you know, we're in a great position to win them Very great.
spk03: Thank you Thank you guys now to Noah Herman at JPMorgan Thanks guys for bringing me in here it's been great working with you Dale really appreciate it and look forward to working with you as well Peter and I just wanted to touch a little bit on the international go-to-market partner program, just how far along are you on that, and how are you thinking about parchment layering into that strategy? Thanks.
spk17: Yeah, so it is. We've had some good wins from a partner program perspective, and we continue to kind of refine that model as we move forward. We do have some targeted countries that we're going after. Philippines is one of those. And we talked about the deal that we just won in the Philippines. We've talked about some in Japan as well. So I expect that to be, again, right now we're really focused on enabling. We're focused on the ability of our partners to support customers in region. And that's where a lot of our focus is. And I suspect that While the growth will be good, the dollars are small still in that space. And we'll, you know, we'll see that grow over time. So I think that's the other thing that, you know, the other thing that I would add is that it does open up new markets for us. It does give us an opportunity to address some areas that, you know, that we've, you know, had some limitations. So for instance, in the Philippines, we go direct and channel. But it gives us access to government contracts and relationships that we don't have. So we'll continue to use that as a key growth driver long term for us and believe that it's an integral part of our international strategy. From the Parchment perspective, we haven't modeled in any acceleration due to the part they're doing to do channel partners. It's an area that as we get into the integration, as we get into really, you know, digging in with them together on the integration plans, we'll evaluate at that time. And so, but again, not built into any of our guidance or our models, frankly.
spk13: Thank you. We'll take our final question from Brent Bill at Jackery.
spk06: Hey, thank you. This is David on for Brent. A lot of talk around the nontraditional learner. I know this is probably a tough question to give a super clear answer on, but maybe if there's a helpful way to frame what percent of the business today comes from this nontraditional learner, assuming it's still fairly small. And where do you expect that that can get to if we look at 10 years over time?
spk17: Yeah, that is a... That is a great question, David. And, you know, we don't break out different, you know, the different segments per se. What I will say is the nontraditional learner, I mean, learning is still happening, right? And what's changed over the last, you know, since really since the pandemic is that learners have become much more engaged in in the pathways that they wanted that they want to follow and pursue in our um in in their learning journey and so we're seeing this as um you know an opportunity to to continue to drive growth across the business it's an opportunity for our existing customers to address more students and historically they have um you know a lot more students than they historically have and and it will be a long-term growth driver for us as they work through their strategy. So, you know, we will, it's a growing mix, still early days, as you mentioned, we'll, you know, but we will, as we kind of turn the corner into 2024, and as we, you know, as we will get back to you with, you know, more details about parchment, more details about our long-term growth and update our growth models in 2024.
spk06: Gotcha. And maybe if I could just sneak in one more just quickly on the AI beta. If you could just bring us, you know, remind us, bring us up to speed on, you know, what you guys are experimenting with as it relates to AI and just, you know, any early feedback would be helpful. Thanks so much, guys.
spk17: Yeah. So this is exciting. You know, we're getting real-time feedback from our customers, those that are involved in those early betas. There's a few areas that we're focused on. So one is data. course content and creation, so we have natural language models that will allow you know, for instance, teachers to be able to create courses inside of canvas that allows us to be able to. You know, use natural language, you know, for instance, I wanted to have two columns on my in my course and I want these headers and that kind of stuff. As well as use it to create content like you know quiz questions and things like that. The second piece is around what we call semantic search. That is the ability to be able to, for students and teachers, to be able to search across all content, all course content, and be able to do it in a way that they don't have to know exactly, you know, what they're looking for. So, for instance, the example we used at InstructureCon was a student says, hey, I remember my teacher talking about a mandolin and, you know, And they didn't really, they talked about the violin, a painting by Picasso. It's able to kind of sort through using artificial intelligence to sort through and deliver a result from that perspective without having to use all the, you know, Boolean logic and all that kind of stuff. And then the third is to be able to use natural language processing for analytics so that administrators and teachers can, you know, naturally go in and say, hey, I want to see which students are struggling with this. it's able to create, organize the data in a way that they can use it for that. Show me all the students that have, you know, that are, you know, have missed four assignments, you know, that kind of engagement. Again, the goal really here is to make lives simpler and easier for teachers is where we start, as well as make it more intuitive for administrators and learners as well. So those are the areas that we're really experimenting in right now, David.
spk08: Thank you. And that is all the time we have for questions this afternoon. Mr. Daly, I'd like to hand things back to you for any closing comments.
spk17: Well, thank you for joining us, everybody. And Peter, once again, welcome to the team as our incoming CFO. You know, we're excited about adding parchment to Instructure. You know, we believe it's going to help drive new growth and opportunity while matching or improving our profitability over time. Combined with another solid quarter of execution, we continue to believe we are unlocking the value of technology and education for teachers and learners alike. So we will continue to drive balanced growth and profitability for you, our investors, and we look forward to connecting with you next quarter. Thanks, everyone.
spk08: Thank you, Mr. David. Ladies and gentlemen, that will conclude Instructure's third quarter 2023 earnings call. Thank you all so much for joining us and wish you all a great remainder of the week.
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