Good afternoon. My name is Chris and I'll be your conference operator today. At this time, I would like to welcome everyone to the Instructure's Q2 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you.

Ms. Natalia Kanevsky, Instructure’s Vice President of Investor Relations. You may begin the conference..

Good afternoon, everyone, and thank you for joining us on today's quarterly earnings conference call. Today's call is being hosted by Dan Goldsmith, CEO; and Steve Kaminsky, CFO. Before we begin, I'd like to remind you that today's conference call will include forward-looking statements based on the company's current expectations.

These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially.

For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release and the other reports and filings we may file from time to time with the Securities and Exchange Commission.

All our statements are made as of today based on information available to us as of today, and except as required by law, we assume no obligation to update any such statements. The content of today's conference call is Instructure's property and cannot be reproduced or transcribed without our prior written consent.

During the call, we will also refer to both GAAP and non-GAAP financial measures. You can find a reconciliation of our GAAP to non-GAAP measures included in our press release, which is posted to the Investor Relations section of our website.

All of the nonrevenue financial measures we will discuss today are non-GAAP unless we state that the measure is a GAAP measure. Now I'd like to turn the call over to Instructure's CEO, Dan Goldsmith..

Mutual of Omaha, Waze, a Google company, and one of the world's largest animation studios all launched Bridge projects within their organizations. We signed American Express who will use Bridge for 10,000 contractor trainees. TELUS International will expand its use of Bridge for employee development and added 40,000 employees across 10 countries.

And, as the academic and professional worlds converge, we continue to see opportunities and adoption of Bridge in education. Tulane University, Colorado State University, and Western Governors University are a few examples of Canvas customers buying or expanding Bridge for the development of their faculty and staff.

As we evaluate the success of the Bridge business, we are monitoring win-rates, attach-rates, and significant deals. Our Q2 results demonstrate progress against all these metrics. During the first six months in my role, I have spent considerable time with customers in schools, in the workplace, and at our events.

I am taking the time to review our business, which will allow us to weigh our investments, evaluate growth opportunities, and ultimately make the right changes moving forward. We are improving the efficiency of our business through a series of ongoing initiatives such as growing engineering talent in Budapest.

We are making solid progress on our strategy, executing to our plan, and strengthening the foundation of our team and our products. With this in mind, we look forward, excited by the prospects for the second half of 2019 and beyond.

I would like to take this opportunity to thank our customers, partners, and employees for their continued support and commitment to Instructure and our mission. I’ll now turn it over to Steve..

Thanks Dan and thanks everyone for joining us today. As Dan mentioned, we delivered a solid Q2 with healthy revenue growth. Let me provide some additional details on our Q2 financials. Total revenue grew 26% year-over-year to $62.9 million, of which subscription revenue was $57.3 million.

This healthy revenue growth is a direct result of customer growth, the contributions from our recent acquisitions and net revenue retention of over 100%. International revenue as a percent of the total was 20%. As a reminder, this quarter our total revenue includes the contribution from our two acquisitions, which is almost entirely domestic revenue.

If you were to exclude that revenue, international revenue as a percent of total for the quarter would have been essentially equivalent to Q1. Twelve month rolling billings at the end of Q2 was $257.3 million, up 20% from the second quarter of 2018, also calculated on a rolling twelve-month basis.

This also includes incremental billings from our two acquisitions, which added to the growth rate. For the remainder of my commentary, unless otherwise noted, I will discuss non-GAAP results and all EPS numbers are on a per common share basis. Gross margin in Q2 was 71.3%.

As we discussed last quarter, gross margin was impacted modestly year-over-year by our recent acquisitions. Q2 total operating expense was $50.8 million. This represents, as a percent of revenue, a decrease of 800 basis points compared to last year.

Of the 800 basis points decrease, the majority was related to the change in compensation policy we discussed last quarter, partially offset by the incremental expense of our two acquisitions. After accounting for those adjustments, we realized a 230 basis point improvement related to operational efficiencies. Our operating loss was $5.9 million.

GAAP net loss for Q2 was $20.7 million, as compared to $12.5 million in the same period a year-ago. Non-GAAP net loss for Q2 was $6 million, which is $0.08 per share lower than Q2 of last year. Turning to the balance sheet, we ended the quarter in-line with our expectations of $47.5 million in cash, cash equivalents and marketable securities.

Free cash flow for the second quarter of 2019 was negative $17.1 million. Additionally, we remain on track to reach approximately breakeven for free cash flow for the full-year.

As we have been talking to investors over the last quarter, we've received requests for additional color surrounding our recent compensation philosophy change, so let me now provide a bit more granularity. In looking at our expectations for full-year 2019, the year-over-year increase in stock-based comp is a direct result of four factors.

The first factor is incremental headcount growth, which is a component of business as usual. The second component is the equity portion of CEO and executive compensation. As a reminder, our prior CEO, Josh Coates, did not receive any equity grants. This was normalized when Dan joined the company.

And, as Dan has mentioned, we have added to the executive ranks which contribute to incremental stock-based compensation. A third component is additional headcount from our recent acquisitions of Portfolium and MasteryConnect.

Combined, these factors account for slightly less than half of the expected year-over-year increase in stock-based compensation. The remainder is related to the overall change in compensation philosophy implemented for 2019. Let me end my remarks with a discussion around our expectations for the third quarter and full-year.

For the third quarter, we expect revenue in the range of $67.7 million to $68.3 million, non-GAAP net loss of $7.4 million to $6.8 million, and non-GAAP net loss per common share of $0.20 to $0.18. For the full-year, we expect revenue in the range of $258 million to $260 million, as compared to our previous guidance of $257 million to $260 million.

We expect non-GAAP net loss of $24 million to $21.5 million, as compared to previously stated guidance of $25 million to $21.5 million, and a non-GAAP net loss per common share of $0.65 to $0.58, as compared to previously stated guidance of $0.68 to $0.58.

Included in our full-year GAAP net loss is $60.3 million for stock-based compensation, a slight increase from last quarter. The slight increase is due to finalizing the accounting for the MasteryConnect acquisition, and the addition of the two executive hires that were made since our last call.

For calculating EPS, we expect our shares to be 37.2 million for the third quarter and 36.8 million for the full-year. In summary, we delivered a solid quarter, and we're well-positioned as we head into our important and busy third quarter. With that, let’s open the lines for questions. Operator, please go ahead..

Thank you. [Operator Instructions] Your first question comes from Brian Schwartz with Oppenheimer. Your line is open..

Yes, hi. Thanks for taking my questions here this afternoon. Hey Dan, just want to ask you about the domestic business in the quarter looks like it had a bounce back here from the first quarter even when I strip out the contribution from the acquisitions.

Just wondering if you can dive a little bit deeper into what you're seeing here on the domestic side. Just wondering if any big deals swung that performance in the quarter and any other commentary that you have on the U.S.

business?.

Hey Brian, how are you doing, it’s good to hear from you. Thanks for the question. So actually the things are going basically as expected this year.

As we mentioned, we are leaning into more proactive demand generation and we're seeing some good signs from that but I don't think there's any outliers in either direction right now sort of business is usual and as expected through the first half of the year..

Fair enough.

And then other questions I want to ask you Dan is we get a lot of questions on just what's happening with the pricing side of the market and I don't know if you want to go back three years or five years or whatever the time horizon is, what are you seeing in terms of pricing on that core Canvas products and then I guess I do realize that's going to vary based on engagement but any commentary just on overall trends would certainly be helpful.

And then also if you could comment on what you're seeing on the renewals in terms of like-for-like renewal on that proceeding pricing? Thanks..

Yes, Brian. I mean just pricing is sort of as usual as well. I wish I had more exciting answers for you here. The one of the things that we focus on is having very consistent and fair pricing in the market.

So from our perspective, there's really nothing strange from a pricing perspective now as we add more products to our educational portfolio, obviously we're seeing some different sales cycles with things like MasteryConnect and Portfolium and there's less of a sort of standard price point in the market for areas like student success.

But in general the pricing and the pricing levels are remaining very consistent and standard for us.

I don’t know Steve, do you want to comment anymore as well?.

Yes, so just to answer the second part of your question Brian, the renewals are coming in as we would have expected. This is always the time of year where if something slips by a week or two that's very typical because there's such an incredibly high volume especially on the education side of our business.

However there's nothing unusual happening, the renewal rates are very consistent with prior years and we're seeing pretty typical activity..

Last question from me and then I'll pass it off. Just want to ask you about the efficiency gains and the margin outperformance I guess in the quarter. I did hear in the commentary, it does seem that that you're happy with what you're seeing so far in the trends on your productivity.

Can you talk Dan maybe about what sort of initiatives that you're starting to put in place here that continue to improve that operational efficiency over time? And is there anything else that's maybe going on there that can maybe remove some of the overheads that can maybe even push forward those margin improvements even better than what we saw in the results here this afternoon.

Thanks..

So Brian, technically that's two questions but that's all right. So on the operational efficiency, on operational efficiency side just a couple quick comments. We're continuing to pursue a number of mechanisms that drives efficiencies within our business and optimize what we're doing, some of those fall the bottom line.

But a lot of those are looking at how we can invest in the business or just driving some optimizations that we can be more impactful. Some of those are optimizing customer service, we've actually implemented in our piloting part time working model, we've shifted or we have some resources in Budapest as well.

We've a variable cost model for CS, we've talked about Budapest a number of times both on the engineering side and the support side. We're looking at some of our vendor contracts as well to look at costs and then to the latter part of your question, yes there is absolutely work that we are actively doing to make sure two things on the headcount side.

One we're rightsizing the teams and the expanded control for managers to make sure that they're right size to power our managing our customer base and sales efforts. The second thing is ensuring that we have the right people in the organization. So we brought in a lot of great talent over the past six months or so.

One of the things that I'm especially proud of is where we are with the senior executive team now with the hiring of Frank Maylett most recently who's coming into the organization as an overall Head of Global Sales. We're bringing some really great talent into the company..

All right, well good job on the results and thanks for taking my questions this afternoon..

Thank you..

Your next question comes from Brad Zelnick with Crédit Suisse. Your line is open..

Hi, thanks for taking my question. This is Bob in on for Brad. Dan we heard a lot of positive buzz surrounding the potential of DIG at InstructureCon. Can you just provide us with an update on how you guys are thinking about monetizing that opportunity.

And any updated thoughts on potential timeline?.

Yes, so from a DIG perspective, DIG first and foremost want to be clear DIG is really the codename for the initiative that we have around data and analytics, data science and machine learning. We will have products that we release over time in these areas but we continue to reiterate, it's relatively early days.

We have some we're in the PVT phase, the product validation tour phase, we're making some great progress working with a number of universities and are getting fantastic feedback. There's not a lot of details to share right now other than we're looking to get this right.

I think data and data and industries like education and vertical markets present a really great opportunity for us to make a big impact on the industry as well as introduce new products.

So when we look towards through the end of this year and continued experimentation and beta efforts, we look towards next year when we might see more considering products and product releases..

That's helpful and just a quick follow-up.

I know it's early but can you just speak about the performance of your recent acquisitions, have they performed relative to your initial expectations?.

Great question. So every day that goes by with an acquisition generally you know more and more around how smooth the acquisition was, you can only see it sort of in interviews and with MasteryConnect and Portfolium both we’re very pleased with where they are, they're delivering on what we expected within the business.

And we're also pleased to see some interesting contracts come forward, some large districts for MasteryConnect, some Portfolium deals not only Portfolium led but Portfolium into Canvas schools as well we highlighted some of those on the calls. So it's still early days for both of those. We're pleased with the field execution.

We're pleased with the results that are right on the mark with our expectations and we're still working on a number of elements around product integration for both solutions. So stay tuned for more product advances over the next six to nine months..

Perfect, thanks for taking my questions..

Your next question is from Scott Berg with Needham & Company. Your line is open..

Hey guys this is Josh on for Scott. So we spoke to some customers at InstructureCon migrating from Moodle to Canvas, accelerating these migrations has taken some time.

Do you think there's any specific driver like total cost of ownership savings or simplifying their IT structure with more Cloud products accelerating this or what are you hearing from these customers?.

Yes, Moodle, Moodle is open source and a lot of organizations by generically and the open source sort of proceed free model which means that their budget allocation and organization around open source solutions is different thing your traditional purchase solution or SaaS solution takes more effort and resource.

You don't get the benefits of ongoing innovation in the same way you've got to manage a lot of the stability and security of the platform and what we found in many cases is that the total cost of ownership like you alluded to is really the key to selling into that that Moodle audience or the open source prospects.

We still have some work to do there but every quarter we see healthy progress around converting customers over to SaaS. It's a TCO sale and we need to keep working along those lines. The other thing is Moodle is much more prevalent in the international space and so the other element with international is that education is market by market.

There's not really many regional or more or global educational organizations. So in addition to us being would articulate strong TCO conversion of Canvas which we're able to, it's also just establishing credibility momentum in markets as we expand into places like France and Spain in the DACH region..

Okay, great. And then just one more for me also at InstructureCon you mentioned that the company is hiring the greatest number of engineers and developers for Canvas in company history.

How should we think about the pace of these hires and implications for OpEx growth throughout the rest of the year?.

Yes, Steve do you want to comment?.

Yes, so we've taken a close look at that and if you look at in the prepared remarks, I mentioned it was 230 basis point operational efficiency improvement.

The total 800 basis point decrease year-over-year, if you look at the details engineering actually is relatively stable, it actually went up by some number of tens of basis points but it was relatively stable versus both G&A and sales and marketing which went down year-over-year again once you remove the effect of the compensation change and the two acquisitions.

So I think that's where it shows up. So it's going to leverage more slowly. This is very consistent with what we've been saying for several years that R&D of the three major categories of OpEx will leverage the most slowly over time as we continue to make investments in our products..

The other thing to mention too is we're already getting strong productivity out of Budapest. So when we look at the global cost profile of our R&D function, we're able to apply a lot more resources at a much better cost profile within the business. So that's a contributing factor to us unlocking that potential..

Okay, great. Thanks guys..

Thank you..

Your next question is from Eric Lemus with SunTrust. Your line is open..

Hey guys. Thanks for taking the questions and nice job in the quarter. You know you talked about in the prepared remarks some of these holdout schools that finally made a switch over to Canvas.

If you look at some of the schools and those opportunities that are up for bid now and under RFP, do you think there's more of willingness for those schools to switch solutions or stay with the current legacy solutions they already have?.

So it varies but in general as time passes, I think there's more and more pressure for organizations to switch solutions, their legacy solutions are not keeping pace with innovation and expectations for teachers and students.

That being said, there's also some resistance just in terms of prioritizations within institutions as well where they might be looking at their current LMS solutions saying hey this is good enough. It's not high or not, it may not be wonderful, it's good enough though and it's stable and so we have other priorities.

With the addition of MasteryConnect and Portfolium as well as the additional advances that we introduced during InstructureCon within core Canvas, we are able to increase the value proposition of Canvas as a learning platform. And we are seeing some good moves forward in our pipeline in opening deals.

The other piece is sales motion is some organizations just don't understand the power of Canvas. And so they've gotten into a pattern of pressing the Renew button over and over again. And so with us leaning more into the market, we're starting to see opportunities created that would have never come to market before.

So I don't think there's generally an inclination of something happening in the market that is driving organizations to consider moving where they haven't been before we're trying, we’re creating more of that demand and understanding different dynamics of change to create the value proposition for these organizations..

Great. Thanks. That is really helpful Dan. Next question on Canvas Conference. There was obviously a lot of themes, a lot of practice to digest at the conference that you presented to the customers whether that be the data analytics, the acquisitions, switch content editor et cetera.

But now when you talk to customers and you look back what do you think actually garnered the most amount of excitement from customers and prospects from the conference?.

Bettina Love was generated a lot of excitement is one of our speakers she was phenomenal. I don't know if you were there for that although Malcolm Gladwell and Dan Heath were hit as well. But I think you're asking more about garnered excitement about the Canvas platform.

So I think there's really two or three things that had gained a lot of excitement out of what we were doing. We had updates on analytics.

We released a lot of capability, we're about to release a lot of capabilities around analytics in the platform that allow institutions to and teachers to look at more student based analytics, course analytics, usage analytics within Canvas, it unlocks a lot more potential for those constituencies to understand, impact and change an opportunity.

So that was a big thing. We made enhancements to some of our communications and group capabilities in Canvas which people are very excited about. And then I think the third thing is some of the integrations, it was a little more subtle but the integrations that we're doing with MasteryConnect and Portfolium also generate a lot of excitement.

Our discussions around data science and ML code-name DIG is something that got a lot of dialog. And what we've talked about they're sort of bringing into the open transparent dialog around the use of data in education. So that got a lot of traction and we'll be continuing conversations well..

Okay, great. Thank you..

[Operator Instructions] Your next question comes from Brian Peterson with Raymond James. Your line is open..

Hi, thank you. So maybe just wanted to hit on the longer term growth opportunity for the Canvas business.

You've had some interesting strategic M&A, I'm just curious how we should be thinking about the right way to look about that growth profile longer-term?.

Hey Brian, how are you? I'm sorry I just want to make sure I understand your question.

You want to understand the longer term growth profile for Canvas?.

Yes, just obviously there have been a significant amount of share gains in the past. You've made some M&A, as we look at the growth profile potentially longer term.

How should we think about the growth, is that 20%, is it high single digits, I’m just looking to get maybe a range on that?.

Yes, I can't talk to a specific range, I know you'd love me to comment on that. What I can say is our prospects for growth and maintaining and accelerating growth moving forward are much greater than they were even six months ago.

We were really focused on core educational LMS and as we look to broaden our impact on education introducing new solutions, we're seeing not only the expansion of the TAM in education and the opportunities that we're already seeing come through the acquisitions and the organic growth of our product offerings and education and there will be more of those to come but we're also seeing those acquisitions and new product capabilities to make core Canvas LMS more competitive.

In fact there were a handful of deals this past quarter that with the addition of MasteryConnect would not have come to the market or maybe not have come our way in the past. So that's probably the best way I could describe it.

Right now we're going to continue with that layer growth strategy that will give us a great opportunity for sustained revenue growth over time. The only other element I'd add to that Brian is the international opportunity as well.

We're as I mentioned in my remarks, we're expanding into additional markets especially in Europe as well as some in Asia-Pac, it takes a little time to get into rhythm and groove of how those markets operates but they represent more and more opportunity for us to drive growth..

Got it. Thanks Dan. And maybe just as a follow-up on the Bridge business, just obviously some high profile logos this quarter. Is there anything that you can share on sales cycles in how those have changed over the last couple of quarters? Thanks guys..

Yes, good question Brian. So a couple of things, we're still in the early phases.

We introduced the Employee Development Platform with the expansion adding engage for employee voice and sentiment and Career for career path thing as well as expanding capabilities of the mobile offering within Bridge as well just about eight weeks ago is at the beginning of June.

So it's still early days for that but we're actually pleased with the number of the employee development wins coming in. The employee development wins coming in even over the last eight weeks and that speaks to the attach rate on deals, we're seeing attach rates as one of our three key metrics come into play.

So we're really pleased with the employee development suite driving that forward. We've always talked about significant deals as well. My excitement is pretty tempered around where we are. So we're really happy to welcome organizations like American Express to the Instructure and Bridge family.

But we want to be very measured in understanding whether these data points are creating a trend or not and give it a couple more quarters. In terms of our progress, we’ve also stood up, our sales team as you know Brian we've gone through a lot of changes within our sales team over the last six months as well.

So hitting late Q2 into Q3, we feel much more sort of stable with our Bridge team filled and up and running and speed with pipeline. So we're going to continue to watch attach rates, watch significant deals which is sort of logos and sizes and then we're also watching win rates.

And as I mentioned in the remarks, we've made progress in all three of those metrics this past quarter..

Great color, thanks Dan..

Yes..

Your next question is from Rishi Jaluria with D.A. Davidson. Your line is open..

Hi guys, this is Hannah on for Rishi. Thanks for taking my questions today. Just starting off, it's nice to see that you've built out the exact team.

I was just wondering if you could talk about maybe the top three priorities you ask for Frank?.

Great, Hannah great questions. So yes, so Frank coming in three priorities. So let me start with a global fabric of our sales methodology. So first and foremost as we've been establishing the team, we want to make sure we have a strong and diligent sales methodology and execution process. Frank has built global teams in the past.

He builds very strong sales cultures and teams, so one of the first things that he's going to be focused on is our sales methodology and our execution. The other thing that that so Frank is going to be focusing on with the team is to ensure that we have good approaches for key deals, key prospects and key markets.

So we're being very strategic and getting ahead of opportunities as early as possible. So that's a big second piece of what Frank will be focusing on as well.

And then the other thing is Frank will be working very closely as part of the overall executive team to ensure that the connectivity across sales and marketing with product and services is very well connected.

Historically, we may have had some disconnects or some working models that have not been as coordinated as we've been going through the pre-sales process. Frank has done a great job in his previous companies, gone on these factors but that would be the third one..

Great. That's super helpful.

And then on the Bridge side, I was wondering if you could speak a little about your M&A philosophy build versus buy and any capabilities you're still looking to build out on that?.

With regards to Bridge specifically or roles in the company?.

I would say Bridge specifically..

So we had a lot of product right now.

We've put a good amount of investment into Bridge as a product that we wanted to reach this milestone of BridgeCon launching our employee development platform and although there's much more to do in terms of flushing out capabilities and working with key customers right now, we have a lot of product to get out to market on.

In organic broadly within the company will be part of our profile moving forward but it really is based upon, so the opportunity for us to accelerate and enhance the business across the business whether it would be in the Edu space or in Bridge. But at this time with Bridge in the corporate space, we have a lot of products.

Now it's about execution and growth..

Great, thank you..

Your next question comes from [Indiscernible] with Berenberg Capital Markets. Your line is open..

Hi guys. Thanks for taking my question. Another Bridge related question maybe you previously provided guidance that over 500 companies are using Bridge and I was just wondering if provide any update to that number.

And if you're seeing any significant change in the size of companies that are adopting Bridge it seems they currently keep disclosing larger and larger new contract wins like with AMX and colors, I was wondering if you could provide any details around that?.

Yes, so I'd say on the first one we have not released, we've grown a good amount since we released that 500 number.

Steve, what is that probably about?.

That was I believe on the Q4 call last year..

Yes, so Q4 last year was probably around 500. So we continue to grow. We're not releasing an updated customer account number right now.

And something we can consider moving forward but we're making steady progress regarding large deals and logos, we're starting with the introduction of the employee development platform, the introduction of our enterprise selling team and us growing and maturing and solidifying some of our sales motions. We're seeing a few things happen.

And I mentioned that three main elements earlier win rates, attach rates and significant deals.

But our ability to learn how to land and expand is something that we're continuing to build muscle memory around and in fact when you look at AMX or some of the other logos we mentioned those are great examples of where we now have MSAs in place and the ability to work within those companies demonstrate success at those company level with a lot more that we can do within those organizations and there's organizations like TELUS and others that have been Bridge customers for some time now that as we introduce new products have continued to adopt and expand.

So my commentary right now is really the fact that we're continuing to embrace and learn some of these new patterns and we're seeing some good in positive results..

Okay, thank you guys..

Sure..

Ladies and gentlemen, this does conclude today’s Q&A period and call. At this time, you may now disconnect. Thank you..