Instructure Holdings, Inc.

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.

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.

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.