Instructure Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 31, 2023

There are 14 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Instructure's Second Quarter 2023 Earnings Call. At this time, all participants are in a listen only mode. After the speakers' 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, David Banks, Vice President, Investor Relations.

Operator

David, please go ahead.

Speaker 1

Thank you, Josh. Good afternoon, and welcome to Instructure's Q2 2023 Earnings Conference Call. We will discuss results announced in our press release issued after market close today. With me are Instructure's Chief Executive Officer, Steve Daley 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.

Speaker 1

These forward looking statements are subject to a number of significant risks and uncertainties, and our results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release and other reports and filings We make from time to time with the Securities and Exchange Commission. All of our statements are made as of today, July 31, 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 in the Investor Relations section of our website.

Speaker 1

With that, let me turn the call over to Steve. Thanks, David. I'm delighted to welcome everyone to Instructure's Q2 2023 earnings call. During today's call, Dale and I will share the details of our Q2 results And provide guidance for Q3 and the full year 2023. Q2 results exceeded our previously committed guidance range For our revenue and adjusted EBITDA fueled by our fishing go to market organization and unduly dedication to customer satisfaction, Q2 revenue was $131,100,000 up 14.4% year over year impacted by a constant currency Headwind of 160 basis points.

Speaker 1

Q2 adjusted EBITDA grew 29% year over year to $51,300,000 Driving a 39.1 percent margin, we believe the strength of our Q2 performance demonstrates the effectiveness of our business model. Before we delve into highlights from the Q2, I want to provide some takeaways from our InstructureCon conference that took place in Denver a few days ago. The first such event we've held in person since 2019. We had nearly 2,000 customers, over 100 partners And more than 2,310 executives sold out events. It was gratifying to find the Instructure community is as vibrant as ever.

Speaker 1

We unveiled enhanced and expanded Instructure learning platform innovations centered around core teaching and learning, advanced analytics, lifelong learning and platform integration. We believe these new solutions will save educators time, personalized learning experiences for students and simplify complex tasks for administrators. We also previewed some of our AI strategies and are excited by the feedback from our customers as we move forward with that. Now I will share highlights from the quarter, including 4 key drivers strong new logo sales, cross sell uplift, 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.

Speaker 1

Success there is driven by our ability to solve real world challenges across the teaching and learning landscape. Our focus on lifelong learning and vocational training resulted in a win with Duke University. Duke made a significant investment in the entire Instructure learning platform with the implementations of Canvas LMS, Impact, Canvas Studio and Canvas credentials. Duke's Office of Teaching and Learning spearheaded this transition to bolster their ambition of being a frontrunner In lifelong non traditional education, we now serve all of the top 10 universities in the United States on campus. Also in North American Higher Ed, we had a significant win with Ohio University.

Speaker 1

After 20 plus years on a legacy provider, OU chose Canvas 10 year contract. We won because of the strength of the campus community, our presence in other flagship institutions in Ohio, Our overall market leadership and our ability to deliver a value based comprehensive solution. In North American K-twelve, our platform continues to The green shoots we mentioned during our last quarterly call resulted in strong bookings in Q2 As K-twelve decision makers continue to recognize our products as mission critical, Cincinnati Public Schools joined the Kansas University in the quarter. A long time user of a competitive solution, Cincinnati ran a lengthy process seeking feedback from parents, teachers and students. Their strategy was to implement a new LMS that would deliver best in breed results.

Speaker 1

Canvas was far and away the winner as our LMS clearly matched the district's innovative approach Our reputation for consistent uptime, big feature releases, unmatched service and support and unrivaled student experience Crim serves a changing demographic with an increasing average retirement age and a skilled gap between workforce and graduates. Based on Canvas as a way to address the needs of their student population, allowing them to serve both traditional and non traditional students. Similar to other institutions in Europe, Kremz has strict privacy standards that must be met by their partners. Our global privacy strategy with centers on safeguarding student data Reducing our customers' regulatory burden allows Kearns to comply with rigorous privacy standards in the region, It's gratifying to see our customers responding positively to our unwavering dedication to privacy. 2nd, we continue to drive growth with existing customers, both through cross sell and up sell, where we see a $1,000,000,000 plus opportunity.

Speaker 1

Internationally, we secured a meaningful upsell of Global Pro, one of the largest registered training organizations or RTOs in Europe, Making them our largest customer by user number in Europe. This also demonstrates our ability to serve the needs of non traditional learning institutions. Cross sell was fueled by deals such as Charlotte Mecklenburg Schools, a long time Canvas and MasteryConnect customer. After a multi vendor evaluation, the district chose our assessment Because of the rigor and accuracy of the solution, it gives better insight and student growth. This further validates our platform This platform strategy, our 3rd key driver, drives on innovation and partnerships.

Speaker 1

During Instructure Con, Sharad Bijasimham, our Chief Product Officer, provided a glimpse into many new product initiatives designed to shift the educational paradigm, Enhance teacher efficiency and foster student success. Among the most important partner driven deals in the quarter, we won a contract with 1 of the We Created a proposal that examined the impact of math intervention on both student outcomes and teacher outcomes. In addition to expanding a great partnership with the large Technology business win also has garnered the attention of large districts that are looking to participate in research. And we are thinking big about partnerships. Also at InstructureCon, we announced that we are teaming with Khan Academy, bringing together our Instructure learning platform with Khan's AI powered student tutor and teaching assistant, Khanwego.

Speaker 1

Through this partnership, we are offering world class content from Khan Academy With the industry's most widely used commercial LMS, leveraging generative AI to empower educators to meet students where they are in their educational journey. We are committed to bringing AI to the teaching and learning process with intent, safety and equity. To that end, we also announced the emerging AI marketplace last week, which gives educators visibility and access to the AI solutions that are integrated into the Instructure learning platform. We have worked with our customers to define privacy and security standards to ensure AI solutions are safe and each partner in the marketplace is committed to the In just the last 2 years, we have nearly doubled our partner base. Truly, our investment in the Instructure learning platform gives our customers access to innovation And finally, our results are indicative of our ability to drive leverage in the business.

Speaker 1

Because of our disciplined investments, we've been able to deliver best in class margins that in turn allow us to invest in our platform and drive long term durable growth. Our business model permits us to continue driving strong top line results without sacrificing margins and profitability. As evidenced in this, we saw record renewals in Q2 as customers that came on during the COVID-nineteen pandemic continue to see value in a more normalized environment. With adjusted gross margins approaching 80% and adjusted EBITDA margin nearly 40%, we expect to continue In conclusions, we believe our impressive Q2 results and expanding impact on education position us as a clear leader in the education technology space. We look forward to the opportunity to continue to drive value for our customers and shareholders in the months and years ahead.

Speaker 1

Now I will turn it over to Dale to provide further details on our Q2 financial performance and guidance for Q3 and the full year 2023. Dale, please go ahead. Thank you, Steve, and thanks again to everyone for joining us today. Before discussing our detailed financial results, I'd like to point out that in addition to our GAAP results, I will be discussing certain non GAAP results. Our GAAP financial results, along with the reconciliation GAAP and non GAAP results can be found in our earnings release, which is posted in the Investor Relations section of our website.

Speaker 1

In Q2, we continue to show a combination of strong top line growth and best in class adjusted EBITDA margin. As Steve mentioned, we generated total GAAP revenue of $131,400,000 Subscription and support accounted for 90% Our Q2 revenue at $118,600,000 up 15% year over year, driven by healthy growth across all of our key markets, With particular emphasis in K-twelve and with cross sell. Professional services and other revenue accounted for 10% of our Q2 revenue at $12,500,000 up 7% year over year. Deferred revenue at the end of Q2 It was $330,700,000 up 17% year over year. We ended Q2 with remaining performance obligations or RPO $853,600,000 up 9% year over year.

Speaker 1

We expect to recognize revenue on approximately 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 strong gross profit margin profile was supported by our optimized cloud architecture and flexible support model It scales to meet seasonal customer demand. In Q2, gross profit was $104,100,000 Representing a 79.5 percent gross margin, up from 77.6% in Q2 of last year. Turning now to operating expense. Sales and marketing expenses for Q2 were $27,600,000 or 21% of revenue, Down slightly from 21.5 percent of revenue in Q2 of 2022.

Speaker 1

Research and development expenses for Q2 We're $16,600,000 or 13% of revenue compared to 14% in Q2 of 2022. General and administrative expenses for Q2 were $9,800,000 or 8% of revenue, down from 9% in Q2 of last year. Non GAAP operating income for Q2 was $50,200,000 representing a 38.3% operating margin, Up from 33.7 percent in Q2 of 2022. Q2 adjusted EBITDA margin $51,300,000 representing a 39.1% adjusted EBITDA margin, up from 34.6% in Q2 of last year. Non GAAP net income was $28,000,000 in Q2 or $0.19 per share compared with $23,800,000 or $0.17 per share a year ago.

Speaker 1

Turning to the balance sheet and cash flow statement. We ended Q2 with $129,800,000 of cash, cash equivalents and restricted cash and $488,400,000 Of long term debt, net of discount, resulting in a 1.83x net debt to trailing 12 month adjusted EBITDA ratio. Free cash flow for the quarter was $23,500,000 compared to $6,600,000 in the prior year, up more than 2 50%. 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 It was $37,100,000 a 129% year over year increase from $16,200,000 in the year ago quarter. Note that our free cash flow was quite strong this quarter due chiefly to accelerated collections.

Speaker 1

We expect that these will normalize as we move through the balance of the year. I will now conclude the call by providing guidance for Q3 and the full year of 2023 for revenue and adjusted EBITDA. We have provided additional guidance details to our earnings press release. For the Q3 of fiscal 2023, We expect revenue in the range of $132,000,000 to $133,000,000 For the full year, we expect revenue to be in the range of $524,000,000 to $528,000,000 up $2,900,000 at the midpoint Compared with the annual guidance that we provided in May. We expect Q3 adjusted EBITDA in the range of $52,500,000 $53,500,000 representing an adjusted EBITDA margin of 38.8% at the midpoint.

Speaker 1

For the full year, we expect adjusted EBITDA in the range of $203,500,000 to $207,500,000 representing an adjusted EBITDA margin of 39% at the midpoint. For the full year, we expect Adjusted unlevered free cash flow to be in the range of $207,000,000 to $211,000,000 for an adjusted unlevered free cash flow margin of 39.7% at the midpoint. In summary, We believe that our first half results put us in great position to drive an even better 2023 than originally expected. We executed at a very high level, exceeding our guidance and continuing to deliver a rare combination of double digit growth and best in class 1. We couldn't be more pleased about our momentum in the marketplace and look forward to updating you on our progress throughout 2023.

Speaker 1

With that, Steve and I are happy to take any of your questions.

Operator

Your first question comes from the line of Josh Bair with Morgan Stanley. Your line is open.

Speaker 2

Great. Thanks for the question and congrats on a strong quarter. I was hoping to get An updated view on growth expectations across K-twelve, Higher Ed and International. Sometimes you have Kind of ranges there. And wanted to ask, just to get also a sense for the gross margins or EBITDA margins or contribution margins across Those segments thinking about how to assess, the impacts from mix shift, Presumably to faster growing international, maybe to K-twelve, how that could impact margins too?

Speaker 2

Thanks.

Speaker 1

Yes. Thanks, Josh, and appreciate the question. We provided some growth expectations in general terms For North America, K-twelve and North America Hyatt Group be in the high single digits and international to be in the low double digits. And that's how we look at the business moving forward. Now in terms of margins, we've not broken our margins by any of those Segments that we've talked about.

Speaker 1

However, I will say that we're very confident in our operating model that we can get very good And positive contribution margins in each of the areas where we participate. Josh, as we've made investments, for instance, in our channel program that were negative margins, frankly, as we began Those investments that we've still been able to improve our margins in the process. So that's the model that we're taking is that we'll continue to see those Improvements even as we see the mix shift between those.

Speaker 2

Okay. That's helpful. Thanks. And then any change In the competitive landscape across those end markets or is it the same story? Thank you.

Speaker 1

Yes, we're seeing similar competitive dynamics across K-twelve, Higher Ed and International. So no change there, Josh.

Operator

Your next question comes from the line of Steve Enders with Citi. Your line is open.

Speaker 3

Okay, great. Thanks for taking the question here. I guess I did want to start Asking about takeaways from the conference and I know there are a lot of product announcements, but I guess what's kind of an early feedback on some of the AI initiatives From the customers that you've talked to and

Speaker 1

I guess how should we

Speaker 3

be thinking about the potential for that to layer into the model here over the next few years.

Speaker 1

Yes. It was good to see you there, Steve. We the feedback was generally very positive. So we had taken time before For basically the last 18 months, we've worked with some customer user groups. We were very pragmatic And really spent time with them understanding where were areas that they'd like us to make investments.

Speaker 1

And so investments like our Using artificial intelligence to help create pages within Canvas that create that creator experience using AI Use regular language to do that was very well received. Some of the stuff that we showed in the labs In the educational moments of the future room, they were very excited about Global search being one of those, some of the things we did recognizing sentiment within a remote environment As well as some of the other pieces that we highlighted, we had a lot of sign ups, If you will, for customers that want to be part of the early adopter program as we work through some of the details on these. So In general, very positive. I'd say it's still early days as far as what impact this is going to have on the business model long term and we're working through those With our customers, as we work to understand which of this functionality, the value that it's bringing Results in changes in pricing or what the cost structure looks like. So it's a little early to be building anything into the models, Stephen.

Speaker 3

Okay. No, perfect. No, that's helpful there. I guess to follow-up, it's good renewal activity and good bookings here In the quarter, how are you feeling about the kind of current budget environment and kind of what's the view into Pipeline opportunity going into 3Q?

Speaker 1

Yes. We feel good about where our Going into the second half, I would say you've read all the headlines about Some of the challenges that higher ed is facing, what we're finding is, in general, those are good that we help them deal with A lot of those challenges, so we feel it's a good long term backdrop for us. And so things like vendor consolidation that we're Sorry to see happen. Customers have told us that they want to standardize around a few strategic platforms, Ours being one of those, the work that we've been investing in over the last 2 years to really ensure that we give Solutions to address non traditional students, the work that we've done to really go after those non traditional education Institutions, all are good backdrops for us for long term durable growth. So we feel good about where we're sitting Going into the second half as well as really long term from a growth perspective.

Speaker 3

Okay, perfect. Thanks for taking the questions.

Speaker 1

Thanks, David.

Operator

Your next question comes from the line of Fred Habermeier with Macquarie. Your line is open.

Speaker 4

Thank you very much and congratulations on the quarter. I think I would like to just begin by asking a little bit about international as well too. Just Generally, certainly we saw and you highlighted the Austria win. Just how do you think about that opportunity going into And throughout the balance of this year, of course, into next year, just how far along do you feel you are with your international partner go to market program? And Just how confident are you in the international opportunities?

Speaker 1

Yes, it's a good question, Fred. We feel really good about our positioning for international. So as we highlighted in the script, The wins with Krems was in Austria, part of the value proposition that we bring to particularly European customers, But even across the board is the work that we've done really to put in a very robust privacy and security framework. And so we feel good that demonstrates the value of those, particularly when you're dealing with some of the regulatory environments Thank each of the regions it's dealing with. So, feel good about there.

Speaker 1

Moodle is still 70% of the market there. We believe in the opportunity to continue to grow. It's still our fastest grower and that we We can drive a big business over time. So, still feel similar to this we've talked about in the past, Fred, about the opportunity there And particularly about our position to be able to win. Channel investment is still continuing and we're starting to see some progress In the channel, but again, that's probably something that occurs a little bit later in time as far as having meaningful impact on the top line.

Speaker 4

Thank you there. And I think there's another one just

Speaker 5

we've seen

Speaker 4

Canvys is performing well. Your product is Solid, but of course, you've been building a broader portfolio of solutions too. So I'm curious if you can add a little more context also and just where you're seeing adoption of Outside of core Canvas solutions and how that's trending throughout this year.

Speaker 1

Yes. So we saw Particular success in K-twelve with assessments, so Mastery's branded products, whether it's the MasteryConnect, the Assessment management system or the content that rides along with that. So good quarter from that perspective. We're seeing A lot of pickup with our catalog and credentials as we help either Higher institutions address the non traditional or as we go to, we go after some of those non traditional, those RTO organizations Like we talked about in script. So those 2 have been particularly successful from a cross selling perspective, those two areas.

Speaker 1

And then we're seeing good success with our learning platform acquisition. So From a the ability to sell to both sides of the network, either the educational institution as well as selling services to the Partners and providers has been it's met our expectations and the pipeline has grown and nearly doubled since we did the acquisition. So we're feeling good.

Speaker 4

Thank you very much.

Speaker 1

Thanks, Fred.

Operator

Your next question comes from the line of Stephen Sheldon with William Blair. Your line is open.

Speaker 6

Hey, guys. Thanks for taking my questions. First one here, just great to see renewal trends supporting the step up in RPO. So if you went through this heavy renewal period, did anything surprise you either positively or negatively in terms of things like Renewal rates, deal lengths, pricing, upselling, etcetera, are there any trends that you saw consistently such as maybe longer term Longer duration contract renewals, just any detail on renewal activity?

Speaker 1

Yes. Thanks for pointing out the RPO, Steven. Really pleased with it. What we did call out is this is a historic number for us on RPO. I'm really pleased with the renewal team.

Speaker 1

So I would say that the one constant thing that we're seeing out of this group is that we had a lot of customers come on board 3 years ago In the beginning stages of the pandemic and they're finding value still today with learning platform and they're building around learning platform. And so very, very high retention rate. We are seeing some deal length, The contract length extending mainly in the high end space. And the other thing that I would say those renewals Are now coming with additional products that we have out of our portfolio. So really good things coming out of the strong repo Quarter is just close.

Speaker 6

Good to hear. I appreciate that. As a follow-up, it seemed like there's a lot of focus at the user Conference last week on credentialing in higher ed, looks like that was included in the Duke win. So how frequently are you seeing that being included in conversations with New and existing higher ed customers, is this going to be something that practically every university will need to be thinking about to be relevant over the medium term in your view? And what could that mean for your financial opportunity with these types of solutions?

Speaker 1

Yes. This is a conversation that we're having with They're looking at how do they meet the needs of the workforce in the future, how do they demonstrate Skills along the way rather than just pointing to a diploma at the end of their Educational journey. So it is absolutely a point of conversation. It's in almost every conversation that we're having from a selling It is my belief that over time, every institution will have to figure out how to deal with this And the customer panels, not just the one that we had together, but also others Or kind of confirming that this is this really is an opportunity for higher education to really ensure that Enrollments go up and they're addressing the skills based economy going forward.

Speaker 6

Great. Thank you. Nice quarter.

Speaker 1

Thanks.

Operator

Your next question comes from the line of Joe Bruegwink with Baird. Your line is

Speaker 7

open. Great. Hi, everyone. Maybe I'll go back quickly to the last discussion on RPO. Is it possible to translate what you just saw in terms of financial metric like net retention rates and Maybe how the recent renewal cohorts are evolving relative to I think you've talked about 105% to 110% In the past, is that changing for better or worse just in terms of your recent activity?

Speaker 1

I would say, Joe, that RPO number is really noisy. And the main driver for that is the multiyear engagement with our customers. And so I don't know that I would over index on that particular number as it translates to any other metrics. I would say this though, we have This quarter, we saw really good growth in deferred revenue. We saw good growth in our RPO and we had On NRR, there's a couple of things that we would also point to, which would be some of the growth that we saw with the renewals adding I think Joe, I would I think it would be tough to read through on the RPO number to extrapolate what NRR is going to be.

Speaker 1

We're still holding to Our guidance on NRR, where we think that's the end of the year.

Speaker 7

Okay. That's helpful. And then I wanted to ask about guidance. So it looks like the forecast for the second half

Speaker 3

of the year

Speaker 7

entails revenue growth dipping into the high single digit range. How much of that is just reflecting some of the bookings trends you were In the latter part of last year and then on the flip side, as I just look at this quarter's RPO number and think about Maybe RPO billings, it does seem like there's been an improvement in growth rates kind of back to the low double digit range. Is this all maybe just a matter of the timing of when RPO gets deployed and low double digits is Feasibly a better expectation, but maybe the earlier part of next year?

Speaker 1

Joe, so the second half growth really follows the guidance that we provide. So that really follows the normal seasonal pattern that we see in line to North America's fall start in school systems where we have most of the revenue already built into our plan. But we always provide guidance We're confident in delivering and the stable customer base gives us that confidence that we can get those numbers set up. And we'll guide to 2024 numbers in our Q4 call, Joe.

Speaker 7

Okay, fair enough. Thank you.

Operator

Your next question comes from the line of Brian Peterson with Raymond James. Your line is open.

Speaker 8

Hey, gentlemen. Congrats on the quarter. It was great to see you last week. So 2 on the cross sell that you guys referenced this quarter. So Just on the cadence, I'd love to understand if that's more of a renewal dynamic and you're seeing that as part of contracts coming up?

Speaker 8

Or is that actually happening kind of outside of that traditional negotiation cycle maybe with that outside of the RFPs? I'd love to maybe unpack that a little bit.

Speaker 1

Yes. Brian, it's a little bit tough to kind of break it out because we This is our the kind of June, July, August timeframes are our biggest renewal months. And we did see good Cross sell motion in this quarter. So yes, that helps. It's always good to intercept a renewal when it comes to cross sell.

Speaker 1

We don't but we still do cross sell outside of renewal cycle. So it isn't tied necessarily to the renewal, But absolutely the renewal helps when it comes to being able to intersect budgets and things like that. Understood. And maybe just

Speaker 8

a follow-up. No, it does. But I guess maybe for Dale, as we're thinking about cross sell in some of the newer products, How do we think about like $1 booked to $1 going live for revenue? Is that much shorter than the LMS? Or Does it matter by product?

Speaker 8

I'd love to just understand as we think about that diversification of the booking stream, how does that flow into revenue? Thanks, guys.

Speaker 1

Yes, it's a good question. What we're finding is that if we're able to capture what A solution for a customer that has an issue and show them value in our product, they will buy it prior to a contract renewal. And we see that with some of the products we have like, the LP products are a good example of that impact even though we're going to take that. And then what happens, Brian, usually we see like an upsell at the time

Speaker 8

of renewal when they expand that to

Speaker 1

a larger part of their student base. And so It happens all the time, and so it's hard for me to tell you after a booking when that's going to start, because Understood. Thanks guys.

Operator

Your next question comes from the line of Terry Tillman with Truist Securities. Your line is open.

Speaker 7

Hey, Steve, Dale and David.

Speaker 9

Not to worry, I still have some questions left, so you're not getting out of this, that simple. I know credentials and catalogs been asked like 4 times, but I thought I'd ask a 5th time. I was when I was talking to customers just on an ad hoc basis at the conference, It actually was coming out regularly and I've attended your host conferences for many years, whether virtually or in person. And I'm curious though, credentials and catalog, How do they stock up now in terms of kind of the mix of new bookings coming from those add on products versus maybe some of the other products? And it's basically just kind of related to that, where are we in the adoption cycle for those two modules, because it was coming up on a pervasive way?

Speaker 9

Thank you. And then a follow-up.

Speaker 1

Yes. Terry, we don't break out between the different products as far as percentage of bookings, that kind of thing. But To your point, it is top of mind for most institutions. We are still early days. So a lot of conversations, a lot of strategies and pilot Pilots are customers rolling out pilots, some like Duke that are committing to it right upfront.

Speaker 1

But from a revenue contribution perspective, it's It's still a pretty small contribution. We're still kind of early innings.

Speaker 9

Okay. Got it. Understood. And I guess just the follow-up question is, It was striking in terms of the commentary and the narrative around lifelong learning. You all talked about now over a couple of quarters some of these non traditional kind of educational And where it's kind of like rescaling opportunities.

Speaker 9

What I'm curious about is, where are we in terms of how much that's Starting to kind of shake out in the pipeline of some of this kind of more emerging kind of business, because I'm not suggesting we're going to have a new segmentation, another segment. Dale doesn't I want to have to deal with that, but how much is this starting to proliferate the new deal activity, these deals that are outside of the traditional 4 year Academic Institutions.

Speaker 1

We don't break that out Again, Terry, as far as that level of detail, but I would we've been intentional as we've included these deals In our transcripts for the last several quarters because we are seeing a lot more activity in this RTO, further education, those Non traditional education institutions. So we do believe that's a it will be a long term driver for growth for us, Right. It will be an important offset for existing customers as far as enrollments go and It will be a driver for our upsell and our cross sell over the long term. But again, on both sides of those, Whether it's existing institutions, traditional institutions or non traditional, we're still early innings as far as its contribution to our overall results.

Speaker 9

Got it. And I guess though on that kind of emerging part of the business, does Chris Ball need to do anything different with go to market or Do existing sales reps kind of get opportunistically on those deals? Anything you can share about like the go to market if it needs to be any different?

Speaker 1

Yes, that's a great question. We do believe that we have we can go faster if we put Dedicated reps on that non traditional learner group. It does require a little bit different Messaging, positioning, packaging, those types of things. So historically, we have addressed those with our Just saying higher ed sales team, over time, we think that will segment out from a selling perspective.

Speaker 9

Thanks for taking my questions.

Speaker 1

Thanks, Derek. That was only 3 questions this time.

Operator

Your next question comes from the line of Matt VanVliet with BTIG. Your line is open. All

Speaker 10

Thanks for taking the question guys. Nice job on the quarter. I guess when you look at some of the conversations with prospective customers, How much, especially in higher ed, is starting maybe to be driven by some of these credentialing or Non traditional components as they're looking at using technology to really kind of jump into that environment and then you're going to follow-up on more maybe the more traditional Canvas LMS deals or is it still almost all driven by at least LMS being a major part of it?

Speaker 1

Yes, it's interesting that because there's a The non traditional is definitely interest point within the selling process in most institutions that we're talking to. The other big trend that's kind of related to this is that institutions are recognizing that historically the way they've tried to go after these is With a maybe it's continuing education team, which is separate from the team that's worried about how does the on campus And what they're recognizing is they want one platform to drive across all modalities, right? And all we call that omni channel, right? They want one Experience whether you come on campus full time, whether you're fully remote, whether you're doing this to reskill or you're coming for a degree or you just for a credential. So That's the bigger driver of the discussions.

Speaker 1

And then the use of catalog, Which is organically built into the Canvas platform, the addition of credentialing, those things Are the natural progression of the sales call is okay, ADPs in order to address that part of the of your overall platform strategy. That makes sense.

Speaker 10

Okay, very helpful. Yes, no, that's great. And then maybe one more on this topic. Obviously, it was Very, very front and center at the conference and has been for a little while in your commentary. But have you done much work Internally or that you'd be willing to share in terms of how much sort of addressable market expansion all this provides?

Speaker 10

Or Is some of this maybe offsetting potential other declining factors in particularly higher ed and It's a good backfill, but maybe not as additive as it seems at the moment.

Speaker 1

Yes. We think this is a big opportunity for us as far as the number of dressable students And the revenue driver. So we've sized the non traditional space is about $5,000,000,000 market opportunity. Some of that is included in our calculation of the existing $1,000,000,000 cross sell that We've shared with you in the past, but a lot of that is incremental and much bigger than the Traditional LMS market. So we believe it will be a grower our long term durable growth versus A replacement for declining revenues in other places.

Speaker 10

All right, great. Thank you for taking the questions.

Speaker 1

Thanks, Matt.

Operator

Your next question comes from the line of Devin Au with KeyBanc Capital Markets. Your line is open.

Speaker 5

Great. Thanks for taking my question. First one I have is congrats on the new lands at Duke and Ohio. I'm definitely encouraged to see you're landing larger than multiple products attached. Also, I don't think you've highlighted multiple new wins in U.

Speaker 5

S. Higher Ed So just want to maybe double click on the strength in that market specifically. Do you attribute Kind of the strength there just from overall increasing priority from these institutions looking to add more solutions or would you attribute Just trying to just overall better execution from your side.

Speaker 1

Yes. I think We tend to do very well in North American Higher Ed, particularly in the enterprise segment of that Market, and so we have had some good big wins over the last several quarters. This is just continuing on that momentum. And it's been a it's a part of the market that we started in. It's part of market where we have 44% market share now in terms of enrollments, and so what we're seeing is in those discussions is our position in the market, Our Lighthouse accounts and references that we can bring to the table, The fact that we have a scalable platform that has scaled up rapidly during the pandemic and that they can rely on it To scale to their needs, those are all coming into decision factors in addition to just around A typical feature and function sort of discussion.

Speaker 1

The other thing that we are seeing is that many of these institutions Are either, as I talked about earlier, trying to want a single platform across all of the different opportunities that they have to reach students, But also that they're trying really trying to now that they've gone through that explosion that happened during the pandemic trying to consolidate around a few And that's trending in our favor, particularly as we are able to not only offer The LMS, but also as was noted in the difficult the Duke win credentialing and catalog and those other consist So it really is a continuation of the strength that we've seen with our position within North American Higher Ed.

Speaker 5

No, that's great to hear and thanks for the details. One quick follow-up I have is just on the gross margin in the quarter, really impressive, 79.5%. Any additional color you can offer on what drove the higher margin there and should we expect Gross margin declined higher end of the year.

Speaker 1

So, Devin, we're really pleased with the gross margin Figures that we had in Q2. And this is part of just our regular model of expanding margins over time. However, I would say that Q2, we did see some higher margins driven largely by timing of some revenue. However, we expect that that future Quarter normalized back to that steady consistent expansion that you've seen over the last 8 quarters. So And to be clear, we have set long term targets to have gross margins in the upper 70s and we're making progress.

Operator

Your next question comes from the line of Ryan MacDonald with Needham and Company. Your line is open.

Speaker 11

Hi. Thanks for taking my questions. I wanted to start on the K-twelve space. Last week at the conference, there was Quite a bit of interest in demand for the learn platform functionality now that you're rolling that in and integrating that in for customers. Just curious as you think about how you think about the cross sell opportunity there?

Speaker 11

And then given the demand in the K-twelve Your funding for more analytical solutions, is there an opportunity to lead with those types of assets and then sort of Put your get your foot in the door and then sort of cross sell in LMS over time? Thanks.

Speaker 1

Yes. Let me start with the first question about cross selling of Learnt platform. So Learnt platform, As we did the acquisition earlier this year, right, what we recognized was that K-twelve is dealing with a massive ecosystem of EdTech Providers. And so they're looking for help In rationalizing what's working, what's not working in those environments. So we really have two sides of the network with LEARN platform.

Speaker 1

1 are The schools, the districts, the state education authorities, they're looking at it as a tool to really drive Questions of what's being used, how often is it being used as well as what's being used in the environment doing what they claim it can do. Likewise, on the other side of the network is the providers. And they're also wanting to understand it and demonstrate that what they're providing It is working, right, and getting the outcomes that they're trying for. And so we do think that this is going to be a great Also opportunities on both sides of those networks, right, which on the district and state level, We're seeing good pipeline build. We're seeing good integration points with Canvas.

Speaker 1

We announced that The overall usage reports will be integrated in campus for free, so that you can start to see some of that data. And we expect that to drive a lot of interest and continue to generate lead gen for us to go sell cross sell the full blown product. We're seeing a really rapid pipeline build and great success selling to the providers as well. That Evidence as a Service It's growing, the pipeline has grown pretty dramatically. So to your first question, yes, It absolutely is a key driver for us and we believe it's going to we're reaching a point where it's going to be really important Four districts and we think it will be a big growth driver for us in the future.

Speaker 1

On the analytics side, we drive with a Platform strategy when we drop when we have these conversations with our customers and our prospects. And so, Yes, this is a key part of that landing strategy for us. We think that it's a key differentiator Against our competitors in this space and we'll continue to use it as that. But again, with the idea that we're this is about A platform and a platform for teaching and learning that they're working to. So I think the answer to your second question, yes, it can be a good part of our land strategy In addition to the expand part of our cross sell.

Speaker 8

Excellent. And maybe

Speaker 11

just one follow-up, just on the international partner channel. Obviously, you started to Some success with that, with some deals in Asia Pac last quarter. Just curious as how that is progressing as sort of the pipeline builds For the International Solutions there. Thanks.

Speaker 1

Yes. We are seeing We're seeing good pipeline, Bill. We're focused on the channel partners that we believe are going to We are best bet in those space. We're training them up. We are helping them with lead generation.

Speaker 1

We're helping them with deployments. So We're very optimistic about the progress we're making there. Again, we'll probably see that the benefits start to really accrue next year As those investments pay off and as we ramp those channel partners, but good progress, particularly in some of the Asian geographies of

Operator

Your next question comes from the line of Noah Herman with JPMorgan. Your line is open.

Speaker 12

Hey, guys. Thanks for taking our questions. For the first one, have you seen any change in the pace of consolidation compared to what maybe you've seen Before in the last year or so at the higher ed or K-twelve level. Thanks.

Speaker 1

Yes, I would say in the last year or year or so, More of the conversations have been about how do I get a common platform across each of the modalities, whether it's a continuing education department Versus the in person traditional campus experience. So yes, those conversations have been more common. I would say the bigger conversations around vendor consolidation What can how do we reduce the number of suppliers? Those are fairly new for us. Those are in the last Quarter or 2 is where those have started to happen more and more.

Speaker 12

Got it. And then just a quick follow-up. Some of these new features are being layered more into the platform. Do you see any reason to change the sales Instructure going forward as part of the go to market strategy?

Speaker 1

No, we We've changed the comp model each year things get tweaked on it. I don't know that we'll see any major Changes that happen in the coming years as far as how we compensate for, for instance, new features. You're really talking about cross sell and some of the products that layer on top of Canvas, I think, in that question. So We do have in the existing structure, we do have tiered comp models depending on which products you sell. We We move those around occasionally based on what we wanted to set, but the fundamental structure Well, there will be massive change in our cost strategy in the future.

Speaker 5

Got it. Thank you.

Operator

Our final question comes from the line of Brent Thill with Jefferies. Your line is open.

Speaker 13

Hey, thanks for Good evening, guys. It's David Westbrook on for Brent. I wanted to ask, would rather drill in on assessments. I appreciate some of the commentary earlier, but I think last quarter you guys said it was the fastest growing product within K-twelve. I was just curious if you could provide an update on maybe if that held true in Q2.

Speaker 13

And more broadly, how should we be thinking about the durability of growth in this offering? Is it more so with Everyone catching up and assessing where learning loss from the pandemic is, is that why maybe it's harder now and maybe it's not as durable? And on top of that, can you just remind us of the ARPU there? I think in the past, you said it's maybe 2 to 3 times larger Then, Alan, I would appreciate any color you could add there. Sorry, I know that's a lot.

Speaker 1

Yes. No, it's Great to hear from you, David. This weather was continued to be our fastest growing segment in K-twelve. From a durability of growth perspective, this is a kind of digital transformation That will happen and it's not it's some of the catalyst is learning loss, but the idea of being able to provide a teacher with Real time feedback in the classroom of how student is doing against those, the standards that they'll be tested against at the end of the year. That's something that's going to endure and having a solution in place to be able to address that It's going to be just as important as it is to have a learning management system in place for a digital transformation strategy.

Speaker 1

So Absolutely believe it's going to be it is going to drive durable growth for us. It's not going to be a flash in the pan And it's going to be a core part of anybody's digital transformation strategy and the platform that supports it. You're right. If they buy the whole stack from us through the assessment space, including the content as well as the assessment management system, then It can be 2 to 3 times the average selling price of the candidates in implementation. So it does create for us A long term growth opportunity, we're still got low penetration, low double digit penetration into the existing base With our assessment solution, so there's still a lot of room to grow from a growth perspective there.

Speaker 13

Super helpful. And then maybe one brief follow-up before we let you guys wrap it up. On the LMS in K-twelve, obviously, Half of the market is still on vended, right, using free lightweight solutions. We wanted to get your view on what's the catalyst that gets that These districts do really start paying for a premium LMS. Is it maybe that some of these just continue to can always use these free lightweight Or maybe is it some of these ESSER dollars start to get towards back half of 'twenty four use it or lose it, is that maybe a good Driver there, and maybe again, is there any percentage that you think just will forever remain, unpaid?

Speaker 1

Yes. It is there's an interesting dynamic and a little bit of You talked about, right? I do think the ESSER funding is a is creates a good backdrop As far as making decisions about when to start through a true digital transformation, that's really the driver for A district that wants to make an investment in a commercial elements like ours or and it really It takes time for and it takes maturity within the district to be ready for something like that. And so they tend to be very plantful, take time. What we're driving is they want more enterprise features, right?

Speaker 1

They want more integrations with the ecosystem. They want better visibility across The entire districts, not just in a classroom or in a school, they'll want better analytics, For instance, integrated into those solutions, all of those will be kind of the drivers where they really want to take that step So I do think again, as I said earlier, Esser is a good backdrop for this. And we feel good about that pace of Conversion from free to paid. Whether or not there's a portion That does never lose to an enterprise. Eventually, everybody is going to need to at some level.

Speaker 1

Maybe if it was a school with 30 or 40 kids and I think that might not be, but everybody at some point is going to need to digitally transform that experience In the classroom.

Operator

There are no further questions. I'd like to turn the call back to CEO, Steve Daley for closing remarks.

Speaker 1

Great. Thank you. Thank you again and for the insightful questions as always. As you've heard today, we believe our commitment to innovation, customer success and disciplined investments in our platform will continue to unlock new opportunities As we drive value for our customers and shareholders in the dynamic education technology landscape, we're excited about the future. We look forward to continuing to drive The combination of top line growth as well as profitability in the months and years ahead.

Speaker 1

So thank you for your time and participation and look forward to speaking with you again.

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Earnings Conference Call
Instructure Q2 2023
00:00 / 00:00