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 a 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 Daly; 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 financial, 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 uncertainties, and our results may differ materially.

For 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, 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 GAAP to non-GAAP 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..

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 Instructure 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. 10 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 tenure contract whereby Instructure will place its current classroom solutions because district's 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 $1 billion 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 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 0.5 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 backup 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 see to enhance our channel offerings as well. Philippines-based C&E 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.

C&E 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 Instructure Learning Platform serves as our customer's 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. Dale, please go ahead..

Thank you, Steve, and thanks to everyone for joining us today. Before discussing our detailed financial results, I would like to point out that in addition to our GAAP results, I'll be discussing certain non-GAAP results.

Our GAAP financial results, along with the reconciliation between GAAP and non-GAAP results can be found in our earnings release, which is posted in the Investor Relations section of our website. In Q3, we continued to show a combination of growth and best-in-class adjusted EBITDA margins.

As Steve mentioned, we generated total GAAP revenue of $134.9 million, up 10.2% and impacted by a currency headwind of approximately 60 basis points. Subscription and support accounted for 91% of our Q3 revenue at $123.1 million, up 12.2% year-over-year, impacted by a currency headwind of approximately 60 basis points.

Professional services and other revenue accounted for 9% of our Q3 revenue at $11.8 million compared with $12.7 million in Q3 of last year. This change was not unexpected as there was a slight pull through in Q2. Deferred revenue at the end of Q3 was $347.1 million, up 8% year-over-year.

We ended Q3 with remaining performance obligations, or RPO, of $862.9 million, up 9% year-over-year. We expect to recognize revenue on approximately 75% of our RPO over the next 24 months.

In discussing the remainder of the income statement, please note that unless otherwise stated, all references to our expenses, operating results and share count, are on a non-GAAP basis. Our gross margin profile was supported by our optimized cloud architecture and flexible support model that scales to meet seasonal customer demand.

In Q3, gross profit was $105.6 million, representing a 78.3% gross margin, up from 77.8% in Q3 of 2022. Turning now to operating expenses. Sales and marketing expenses for Q3 were $23.7 million or 17.6% of revenue, down 210 basis points from 19.7% of revenue in Q3 of 2022.

Research and development expenses for Q3 were $15.1 million or 11.2% of revenue compared to 12.7% in Q3 of 2022. General and administrative expenses for Q3 were $9.7 million or 7.2% of revenue, down from 7.6% in Q3 last year. Non-GAAP operating income for Q3 was $57 million, representing a 42.3% operating margin, up from 37.7% in Q3 of 2022.

Q3 adjusted EBITDA was $58.2 million, representing a 43.2% adjusted EBITDA margin, up from 38.9% in Q3 of last year. Non-GAAP net income was $35.8 million in Q3 or $0.25 per share compared with $29.5 million or $0.21 per share a year ago. Turning to the balance sheet and cash flow statement.

We ended Q3 with $308.6 million in cash, cash equivalents and restricted cash and $487.4 million of long-term debt, net of discount, resulting in a 0.88 times net debt to trailing 12-month adjusted EBITDA ratio.

Free cash flow in our historically strong third quarter was $180.8 million compared with $178.3 million in the prior year, up 1% due primarily to timing. Recall that in our Q2 free cash flow growth was very strong.

Adjusted unlevered free cash flow, which adjusts for the impact of transaction costs, sponsor costs, impaired leases and other nonrecurring cost paid in cash was $200.1 million, up 6.6% year-over-year from $187.6 million in the year ago quarter. Our collections activity normalized this quarter, so the year-over-year increase reflected that.

I will now conclude the call by providing guidance for Q4 and for the full year of 2023 for revenue and adjusted EBITDA. We have provided additional guidance details in our earnings press release. For the fourth quarter of fiscal 2023, we expect revenue in the range of $133.3 million to $135.3 million.

For the full year, we expect revenue to be in the range of $528 million to $530 million, up $2.8 million at the midpoint compared with the annual guidance we provided on our Q2 call in July. We expect Q4 adjusted EBITDA in the range of $53 million to $55 million, representing an adjusted EBITDA margin of 40.2% at the midpoint.

For the full year, we expect adjusted EBITDA in the range of $211 million to $213 million, representing an adjusted EBITDA margin of 40.1% at the midpoint. For the full year, we expect adjusted unlevered free cash flow to be in the range of $207 million to $211 million for an adjusted unlevered free cash flow margin of 39.5% at the midpoint.

In summary, our Q3 and year-to-date results were very strong, as once again, we exceeded our guidance. We continue to execute at a high level to deliver growth, best-in-class margins and strong free cash flow. As I depart Instructure, I want to say thank you to all of my colleagues and to our investors and analysts as well.

I'm grateful for the opportunity to have been CFO for the last four years, and I'm delighted to leave the business in such a great financial position. I have utmost confidence in this company and the ability of its people to continue executing.

As I step away from Instructure, in the near term, I'm delighted to share that I'll be leveraging the Canvas Learning Platform as a substitute math teacher in the Salt Lake Area Middle Schools. I wish Peter well as he assumes his role -- this role. I'm certain you will all enjoy meeting him, working with him if you haven't already.

With that, I'll turn it back to Steve..

Thank you, Dale, and thanks again for your service to Instructure. We all appreciate that you've left the business in such great shape financially. I have every confidence that we will continue to execute and carry on the great track record you've established. It's now my pleasure to introduce our incoming CFO, Peter Walker.

Peter has 15-plus years of executive experience, including more than 10 years as a CFO. He is currently the CFO of Sterling Check Corporation and will start at Instructure on November 13.

Peter?.

Thank you, Steve. I'm thrilled to be Instructure's next CFO. You and your team have built a market-leading global technology business from start-up to scale in just 15 years with a mission-driven culture and people I knew immediately were a great fit with my values and aspirations.

My significant experience in executive roles as both a CFO and Chief Strategy Officer for global public companies and prior P&L ownership responsibility will add depth to Instructure's leadership team.

My success in designing and leading strategies that grow organic and inorganic revenue, improve customer experience and reduce costs will be impactful as we move into the next phase of Instructure's growth, from $0.5 billion in revenue to $1 billion plus and beyond.

I'm excited to create value for Instructure's stakeholders as we continue to grow the business and expand profitability. I'm particularly passionate about Investor Relations. One of my first priorities is our investor engagement roadmap, building on all the great work that has been done.

I'm also passionate about leading and developing Instructure's strong finance team. I will attend the Raymond James Conference in New York in early December with Steve. I look forward to meeting more of the investor community there. That concludes our prepared remarks. At this time, operator, please open up the line for questions..

Thank you. [Operator Instructions] We'll go first this afternoon to Stephen Sheldon at William Blair..

Great. Thanks. It's been great working with you, Dale, and look forward to working with you, Peter. First here on the Parchment deal, it sounds like you're expecting a low double-digit growth there.

But do you think there's an opportunity to accelerate that growth rate, especially with any benefit from cross-selling between the two businesses? And maybe just any detail on what cross-selling opportunities there could look like..

Yes. Yes. Thanks for the question, Stephen. We have been really excited about this acquisition.

I think the way that it connects our -- what we do in the classroom with the evidence of what's the learning that's happened and the ability to demonstrate that, that the learners can demonstrate their skills and their accomplishments is what, one, the industry needs, and it also really accelerates our strategy.

The reality is, we've been appropriately conservative, I think, in the modeling, as we've done -- as we've set guidance as we've built the models around this. There are areas where we believe that there are top line synergies over time.

We haven't built those into our models today, but particularly as we think about students as they cross those transition points, so dual enrollment, the ability to share courses across campuses works really well with our catalog product, the badges work that we're both doing, the comprehensive learning record over time, we do believe that those will all be accretive growth drivers for us.

We just haven't modeled those yet into the businesses or the guidance..

Got it. Makes a ton of sense. And maybe with this deal, you're also moving a little beyond the scope of what you've done historically in the higher end software stack by getting into admissions, enrollment.

So curious if you see more opportunities on that front to move into new areas? And just generally, has your thinking changed at all about how broad of a software platform you want to be in higher ed?.

Yes. It's a question that I think you've asked this before as well. What I would say is, as we look at where the adjacencies are to our current business around teaching and learning, we're looking for those areas where there is an overlap in the Venn diagram, if you will.

So where we see that parts of what we're doing in the classroom are very applicable to the things that maybe in new parts of the institution may be using. And this was one of those areas where it made a lot of sense for us to kind of combine the two organizations.

Learn Platform, the last acquisition we did was very similar on the K-12 side, where we address some new buyers, but there's still a lot of overlap with our existing users and our buyers.

So you can expect us to continue to look for opportunities just like this, where their close adjacencies open us up to new budgets, open us up to new experiences, new relationships. And yes, I do think it provides nice fertile ground for us to continue both organically and inorganically, expanding that platform..

Great to hear. Thanks..

Thank you. We'll go next now to Josh Baer at Morgan Stanley..

Great. Thank you for the question. Dale, it was great working with you and good luck ahead. One for Steve, I was hoping you could talk a bit about the process for finding the next CFO.

What were some of the things that you were looking for? And ultimately, what led you to Peter? And then one for Peter, what attracted you most to Instructure and to this opportunity?.

Yes. Great. Thank you for asking that question, Josh. So this was a process that we took -- it was a very deliberate process. We were looking -- I had some conversations with Dale about what he wanted to do, when, where he wanted to do those things.

And so, we approached it as we wanted to look for somebody that had great experience in the public markets.

We were looking for somebody that has worked in models of companies that have had PE ownership, that know how to drive growth, that are very good at articulating growth strategies to the Street and being able to help our investors understand the levers within growth. And we took a while to do this. It was a fairly long process.

We've engaged recruiters. We met with a lot of different people. What really kind of sealed the deal for me with Peter was a good cultural fit. We felt like he would work well with the team. He could get very passionate about the mission. A long tenure working with the public markets.

I really like the way that he approached his investors and the way that he helped them understand the key drivers of the model long term and explaining how those would affect our results going forward and felt like he brought a lot of good experience and detailed understanding of how a business like ours would work.

So again, it was a very rigorous and pretty long process to find the right person.

Peter, you want to share?.

Yes. Happy to jump in. So I'd say I was first attracted by the mission of Instructure. Always been extremely passionate about education and what that can do for people on a global basis. And so, that's what brought me in.

And then once I got interested, I have a pretty diligent process of first starting with how large is the TAM that the company operates in. How fast is that TAM growing. So as I learned that information about Instructure, I was really excited about the large TAM and significant growth rate there.

Next, I look for a company who is number one or number two in the market. Clearly, Instructure is number one in the markets they play. Then I look at ownership, who owns the company. Found it very interesting that a great firm like [indiscernible] with the company, but also the company is public.

And then once I get through that, it really goes to the people and the culture. And that's what sealed the deal for me from the first time I met with Steve and the rest of the management team, it was just a great and very natural fit from day one.

So really excited about this opportunity and excited about all the value we're going to create going forward..

Great. Thank you very much.

Thank you. We go next now to George Kurosawa at Citi..

Thanks for taking the question and for Steve, and great working to you over the years, Dale. Maybe to start with on the Parchment deal. You disclosed 15,000 customers. Maybe if you could give a little color on what does that footprint look like.

And how much overlap is there with the existing customer base?.

Yes. We will -- so as I look at the overall customer base, obviously, with our footprint in higher ed and Parchment's leading market share in higher ed as well, there is some overlap within the customer base.

We -- the exciting part is that the relationship -- we expand our relationships within those even when we are -- when we have those joint customers. And so, we will kind of -- we'll disclose that as we get further closer to close. As we close this deal, we'll be able to show you a little bit better where that overlap is.

But just know that we feel good about the relationships that Parchment has, the reputation that they have with those customers is similar to the one that we feel that we have with our customers. And there's a significant opportunity for us to share customer list and be able to expand our customer base on the Instructure Learning Platform..

That makes sense. And then Instructure clearly has some credentialing capabilities in the platform today. Maybe you could just help us understand where kind of the real level ups in terms of features and functionality that Parchment brings. Thanks.

Yes.

There's a couple of areas where I see some level up to use your words, right? So first of all, when it comes to the -- that transition that students are making, what we're seeing more and more particularly since the pandemic is that learners are much more mobile and they're much more willing to kind of mix and match, if you will, their educational experiences.

And they're looking for to do that in a way that's most convenient for their lifestyle, whether they're working or they're willing to go full time to school.

And so, there's a number of technologies that Parchment have around the ability to dual enroll students, whether when they're in high school, be able to get college credit while they're completing their high school diploma.

There's technology around allowing institutions in a system to be able to share courses so that a student can decide when they're living at home, they can go to local community college, but maybe they're going to the state university during the fall and the winter.

And that ability to kind of transfer those -- the credits to share those courses is an area where we think we can get an acceleration in both our road map as well as our footprint within a customer and that ability to transfer those credits in that process.

The other piece that we're early in our development is around the comprehensive learner record and being able to provide rich data of a record and portfolio for students, where they've got a lot of work done that we feel we can leverage to go much faster on a road map in that area.

So a few really exciting areas that we think is going to drive long-term for us is going to drive our road map and drive ultimately long-term growth..

Awesome. Thank for taking the questions..

Thanks, George..

Thank you. We go next now to Joe Vruwink at Baird..

Hi, everyone. Just starting out best wishes to Dale and it kind of makes me want to be back in whatever grade that was going to be teaching just to get that substitute teaching experience. But maybe just to go to the one comment you made about slowness and deal closings and higher ed.

I guess my question is, what's your take on why this is happening now? And then in the past, you've kind of talked about the RFP activity in higher ed should be elevated in 2023 and 2024.

Is it still elevated and this is just a delay in closing? Or are you starting to maybe recalibrate on the RFP environment into next year as well?.

Yes. Thank you for that question, Joe. It's -- so I'll just start with the overall market. We -- I've never felt better about our competitive position.

The breadth of our portfolio is really and the momentum in our business, we continue to gain share in the market per the Edutechnica data shows that Canvas LMS is the only one gaining share in North American higher ed. So from that perspective, I feel really good. What we're seeing is, it's interesting because we are seeing -- our activity is good.

In fact -- and again, don't over-index on RFP because it's about 30% to 40% of our business. But in the RFP space, I think we had the highest RFP activity in the last six years in North American higher ed. But across the world, we're seeing that the pace of deals have slowed and they're deferring some of these projects.

And when we ask our customers about it, what they're really telling us is, look, I mean it's not a surprise, right? I mean we've been talking about all of the macro trends in higher education, right, declining enrollments, budget challenges, the removal in the U.S. of federal stimulus funding where we feel it a little more acutely in North America.

But we feel across higher ed around the world is still dealing with some of these bigger challenges. And so, what they're telling us is, look, we've got to work through, and they're being very thoughtful about this. We're trying to work through our -- what is our strategy and what is our digital transformation strategy.

How do we go gain new revenue streams? How do we go address that nontraditional student? And so, as that mix starts to shift, they're hitting the pause button on projects until they get their strategies figured out.

Now from our perspective, we're -- I feel really good about that, because we're very well positioned to address it, whether it's a traditional or nontraditional student. As our portfolio of products we have today through both organic and M&A has really grown to be able to address those over the last several years.

And the fact that we're at the table having these conversations with them, we are that trusted adviser. It bodes well for us long term. And I believe we're going to continue to be able to drive long-term growth in this space. It is a temporary slowdown that we're seeing, again, not in the activity because again, that's been really active.

It's more in the pace that we're seeing of the deals closed..

That's great. And then just a related follow-up on this. Is there any kind of guidance or assistance you can give just in terms of the financial implication of this particular comment? Because I think see if you're alluding to this, if you just look at your RPO development or kind of what the implied bookings are, that seems really good.

And so, is it the case that Instructure because you're taking share and you're not totally led to higher ed like you're ultimately delivering on your growth with maybe a more difficult backdrop? I guess I'm trying to get to maybe an expectation for how this could manifest in 2024 numbers..

Yes. And we -- Joe, we're not guiding to 2024, but you are really good at those kind of questions, right, try to get me to guide 2024. What I will tell you Joe is, it is, like I said, right, we're seeing a slowdown, a lengthening of those deals.

We do feel like we're very well positioned, but we do think this will be a temporary slowdown in the near term for the business. And again, the long-term growth prospects are really good, particularly as these institutions start to work through their strategic long-range plans..

Okay. I’ll leave it there. Thank you very much..

Thanks, Joe..

We'll go next now to Fred Havemeyer at Macquarie..

Hi. Thank you. And firstly, Dale, it has been an absolute pleasure working with you. Sorry to see you go, but I honestly, I'm a little envious that you have a substitute teacher gig lined up already. That's fantastic. And Peter, I'm really looking forward to working with you.

Just for this quarter, I'm particularly interested in the competitive win that you called out in your press release, Montana and Pasadena, higher education and K-12, respectively. Curious to hear you called out some of the aspects that led to those wins.

I'm quite curious to hear a little more qualitatively and deliberately here, what drove those competitive wins? What are the differentiating factors for Instructure?.

Yes. It's a great question, Fred. It's the -- we're seeing more and more this trend towards particularly education systems that are looking at how do we better address this change in kind of the student expectation, right? The student is much more mobile.

They want to be able to move through their learning journey, right, by picking and choosing, right? It used to be I applied, I went to a university. I went there for four years, I got my degree. It's much more mobile nowadays.

And so what we're seeing is that the systems are starting, like Montana, Alabama Community College System, right, they're starting to look at this and say, what's the best way for us to provide a student experience that is best-in-class and consistent across that? And so what we saw, particularly with Montana was this -- they looked at somebody like California Community College System that is standardized on Canvas.

They said, they looked at that and said, okay, we want that kind of student experience. We want the ability for students to be able to share courses. Interestingly enough, as part of that deal, they had which is part of the Parchment portfolio in there.

And so we see them and we see them looking at how do we make that transition from K-12 systems within Montana, make that easier and simpler. So I would say, for us, the advantage was that we have the market-leading position in both K-12 and higher ed, which was a key decision factor.

The fact that we've demonstrated our ability to scale to large implementations across the system that we had some of the stuff that we've been working on with catalog, with some of the technologies to address nontraditional really well was good for them.

And then the fact that we have strategic relationships that we have a community of institutions that have done similar things that they can share and talk with each other.

All of those things added in on top of the fact that market-leading LMS, but a much broader platform than we had even three years ago that has all the pieces that have them address that both the traditional and the nontraditional. What we've referred to in the past is omnichannel was a really big decision factor for them..

Thank you for that..

Thank you. We go next now to Brian Peterson at Raymond James..

Thank you taking the question. Dale, I've really enjoyed working with you. You've done and taught me a lot of math over the years, so maybe I can join Joe up there in Utah for some remedial lessons. Peter, look forward to meeting you at the conference. So Steve, just on Parchment, you guys mentioned a $2 billion incremental TAM, $115 million in revenue.

Is there anything that you can share about some of their products or part of the platform that are maybe ahead in the adoption curve and what products have the most white space?.

Yes. It's a good question. We will plan a much more fulsome review of this when we do our -- when we give you our 2024 guidance after this deal has closed. But let me just give you a high level, Brian. As you look at the overall revenue, that TAM breaks down between the awards product, which is a lot of the credentialing pieces and the pathways product.

Within the credentials, part of their business is around transcripts and diplomas, a good, steady grower. What we're seeing in that space is that the mix and amount of credentials that an individual student is requesting is increasing. And so with this mobility that students are expecting, right, they need to make more requests of these transcripts.

So from that perspective, we see growth through just the number per student that we're seeing. In addition, as those transcripts get more -- get broader, right, as you start to think about it in the context of badging, as you think about it as a portfolio, that will be an outsized grower in our opinion.

And on the pathway side, it's still early days when we talk about kind of dual enrollment and course sharing, it's becoming a much more -- it's much more a topic of conversation in the selling process. So that area will show outsized growth versus the rest of the business as well. That makes sense..

Brian, let me just add. They have a very small footprint in international. They bought a company that was based internationally based out of Australia. We believe that there's an opportunity to grow international above the average growth rate for the company as we kind of leverage our infrastructure worldwide..

Understood. And maybe just following up to some prior questions just on the LMS activity this year.

Steve, would you say it's more of a budget dynamic? Or is it more of other priority dynamic? And as you kind of look at the lens of nontraditional learning and those ambitions there, I'd be curious what your existing customers are doing there and how they may be leveraging Canvas versus what some of your noncustomers are struggling with? Is there an insight to be going from there?.

Yes. No, it's a good question. I think budget and priority are -- they both come into play. We know the budgets have been tight in higher education, and part of that is the enrollment decline.

They need to find new revenue streams, right? And so it's a little bit of that and a little bit of the prioritization, right? And we got to figure out what we're going to do for the future.

Our existing customers are grappling with the same challenges, right? A lot of our conversations are about how do we extend to the Canvas environment outside of the four walls, outside of the traditional learning experience? How do we create this omnichannel experience for learners that are either all remote or hybrid or all in person? And we're getting a lot of energy, if you will, around then how do we demonstrate skills, how do we demonstrate that to -- for the student as they're looking to go out into the workforce? And so our customers are asking for the same thing.

The -- they're also, because our solutions are so sticky, our renewal rates, we just went through a massive renewal rate cycle over the last two quarters, right? And we saw improvement year-over-year on renewal rates. So they're also doubling down on our platform as the platform to really address those opportunities..

Thank you. We'll go next now to Terry Tillman with Truist..

Yes. Thanks for filling me in here. Congrats on the Parchment acquisition. Dale, congratulations to you in your retirement. I hope you're an amazing teacher. And congratulations, Peter. I'm looking forward to know you. I was going to actually follow up on a couple of prior questions on Parchment first, and then I had a follow-up.

And I'm sorry in advance that the first question might be a multiparter. On Parchment, it's -- if I look at the $115 million and the $2 billion TAM, and I know this is way oversimplifying it, but it is like a 6% market share. That seems pretty small at this point.

And it sounds like, I think, Steve, you said awards is probably the biggest component, and there's some other really fast-growing small pieces.

But if we look at like the biggest part of awards, are there legacy share donors in this market? Or did folks try to build their own kind of credentialing system? Just kind of curious where we are in terms of greenfield, brownfield, et cetera, as you all work to monetize this interesting opportunity..

Yes. The primary shareholders in this space are NSC, the National Student Clearinghouse and Parchment. And in our diligence, the feedback came back very positive from -- on Parchment as far as the view of the technology, the view of the relationship that they have with their customers.

And so from that perspective, when you look at kind of the transcript and diploma side of the business, so that's -- it really is -- it is those two, right? And that is a pretty stable business. That's very high gross retention. It's in the mid- to high 90s gross retention. So from that perspective, very predictable, very strong market share.

The -- where the opportunity is and which is a bit of greenfield is the credentialing, right? The badging is new opportunity, the comprehensive learner record, those pieces are where we'll be able to drive growth. And again, more of a greenfield type of sale than it is a market share takeaway.

And then when it comes to the Pathways product, the dual enroll core sharing pieces of it, that is all greenfield. That's a new market that is really starting to emerge. And like I said, we've had a number of conversations about it.

It's one of the reasons that we were interested in Parchment is because historically, we haven't had solutions to those problems. So those are kind of the key areas that we see where we can drive growth..

Thanks for that. I guess the follow-up question is just related to international. Maybe Dale, could you actually share what the revenue was in the percentage growth year-over-year? And does it feel like this business -- is it being impacted by the same amount of North America higher ed? Or does it seem a bit more resilient? Thank you..

Yes. So Terry, the international growth was 11%, on a constant currency basis it's 14%. We'll drop the Q here in the next couple of days, we'll give you a little more detail on that. But International is still our fastest-growing segment out of all that we talked about. And so we're pretty pleased with it..

And to answer the second part of your question that you sneaked in there, Terry, we do see the similar headwinds in higher ed, maybe not as acute and not to the same level that we see in North America, but all higher ed institutions are asking these questions.

I just spent a week in Australia, many of the same questions about where do we find new revenue streams, how do we address this nontraditional student, how do we meet students where they're at? Those are all things that everybody is trying -- is grappling with from a strategy perspective and a long-term digital transformation strategies..

Thank you all..

Thanks, Terry.

We'll go next now to Devin Au at KeyBanc..

Great. Thanks for putting me in here. Dale, it's been nice to work with you, and Peter, congrats and looking forward to working with you more. Maybe just one question from my end. When asked about K-12, nice to see the continued large wins in that market.

Unlike higher ed, which you called out some weakness in the sales cycle, have you seen any sort of uptick in deal closing within K-12? Or perhaps any uptick in RFP in that segment, just given the whole ESSER funding deadline approaching? Thank you..

Yes. Devin, the activity has been -- we've talked about in the last couple of quarters, right? There's been a lot of activity in K-12. You're right, there's still -- depending on the estimate, a third to half of all the ESSER funds that haven't been committed yet.

And so we do see some good activity where we're seeing probably the greatest activity in K-12 is around assessment. We're seeing good cross-sell in the K-12 this last quarter. And we'll -- we think that Nevada was an example of our cross-sell of MasteryConnect.

So we expect that will continue through this next buying season when the ESSER funds finally expire..

Great. Thanks for the color..

Thank you. We'll go next now to Ryan MacDonald at Needham..

Hi. Thanks for fitting me in and congrats on nice quarter. Steve, maybe just starting on K-12. Curious what you're seeing with the Learn platform and your ability to start to cross-sell that in a bit more. I know you sort of launched some of that functionality for free at the user conference. And it sounded like the interest was pretty high in it.

But just sort of interested in what you're seeing there post the event..

Yes. We've -- what we're seeing is a lot of -- we've seen a lot of activity. So as we made that acquisition and we put it into the hands of our sellers to be able to start carrying those conversations forward, we've seen some good pipeline growth. And so as I look at kind of the Learn platform interest, it's extremely high. We continue to see a need.

Our customers are telling us as we think about all of this technology that was deployed during the pandemic, we're seeing that it's -- they're trying to rationalize what that looks like. And our pipeline has more than doubled since we did the acquisition, and we see real interest in this.

So I expect that we talked about contribution being de minimis in 2023. But as we go into 2024, I feel pretty confident about the level of interest and the activity that's going on with Learn.

And as you talked about, part of that seating strategy is just starting to take hold in our customer base, and we believe that's going to drive even more pipeline..

Super helpful color. And then maybe just one on Parchment. I noticed from sort of looking at the company website that they've got a connection in into the workforce, industry organizations and enterprise organizations.

Just curious if you think that this acquisition can help kind of close the loop on the strategy for Canvas student pathways and sort of bringing those nontraditional learners, upskilling them and then sort of validating those credentials as they go back into the workforce or try to find a new role.

Is that how we should think about maybe that a portion of this acquisition moving forward?.

That is exactly how you should think about it, Ryan. It does give us -- we talked about deeper relationships within the institutions that we play today, but it also creates connections with -- inside the workforce.

So over time, that will become a much more important part of the strategy, that will become the opportunity for us to connect learning through the comprehensive learning record with outcomes and opportunity for the students long term. So yes, we're very excited about those relationships..

Great. Thanks for the color..

And we'll go next now to Matt VanVliet at BTIG..

Good afternoon. Thanks for taking the question. And Dale, it's been a pleasure working with you over the last couple of years. Maybe the last question, just a little follow-up on there.

How much of the conversations with customers, whether it's around catalog or some of the other omnichannel-type approaches that you've been having, Steve, catalyze the need to maybe get the Parchment deal done now or highlighting maybe some of the product gaps that you had on the road map that this helped accelerate?.

Yes. Matt, I don't -- I'm not sure it changed necessarily the urgency of getting the deal done. This is -- these are -- we have a very active M&A road map. We have an active engagement with a lot of different companies.

We've had conversations with Parchment for over 1.5 years as far as just understanding their business, seeing if there's partnering opportunities. But in order to get deals done, both parties have to be ready for it. And so it's more of a function of them being ready, I think, than necessarily us feeling a need to fill a hole.

Now I will say that from my perspective, from the management team's perspective, the conversations that we've had probably in the last nine months, the conversations we had at InstructureCon really have ramped up this concept of I've got to go figure out how to address these nontraditional students.

So I think the timing from that perspective is perfect because we're hitting it at a time when the need is front of mind. The need is -- the pain is front of mind for our customer base. So I think it is a great time for us to do this deal from -- just from a market timing perspective..

Very helpful. And then just quickly one other follow-up on some of the longer sales cycles.

If you were to try to make your best estimate on when some of these deals that you're already working on eventually closed, does this -- is this starting to feel like it's, again, sort of the next summer buying cycle is more likely? Or could some of these sort of happen in the interim as you push forward and maybe the catalyst of some of those nontraditional opportunities get these over the goal line before the next big buying season?.

Yes. That's a tough one to try to call right now. In international, this is our big quarter. And so we'll see how deals matriculate. We'll have a better view kind of as we meet again in Q1 to talk about 2024.

I would say we still feel good about the deals that are getting done, we're winning, right? And we continue to gain share, and then we'll have to see as we go forward, whether this -- they decide to do these now. There is a lot of impetus for them to kind of time these around their budget cycles around the school year in North America, for instance.

So we'll -- I don't have a crystal ball right now, Matt, as far as when these will close. But I do -- again, I do feel good about when they do come. We're in a great position to win them..

Great. Thank you..

Thank you. We'll go next now to Noah Herman at JPMorgan..

Hi. Thank guys for letting me in here. It's been great working with you, Dale. I really appreciate it. And look forward to working with you as well, Peter. Just wanted to touch a little bit on the international go-to-market partner program. Just how far along are you on that? And how are you thinking about Parchment layering into that strategy? Thanks..

Yes. So it is. We've had some good wins from a partner program perspective, and we continue to kind of refine that model as we move forward. We do have some targeted countries that we're going after. Philippines is one of those, and we talked about the deal that we just won in the Philippines. We've talked about some in Japan as well.

So I expect that to be -- again, it's -- we're -- right now, we're really focused on enabling. We're focused on the ability of our partners to support customers in region, and that's where a lot of our focus is. And I suspect that while the growth will be good, the dollars are small still in that space, and we'll see that grow over time.

So I think that's -- the other thing that I would add is that it does open up new markets for us. It does give us an opportunity to address some areas that we've had some limitations. So for instance, in the Philippines, we go direct and channel, but it gives us access to government contracts and relationships that we don't have.

So we'll continue to use that as a key growth driver long term for us and believe that it's an integral part of our international strategy. From a Parchment perspective, we haven't modeled in any acceleration due to the part they're doing to channel partners.

It's an area that as we get into the integration, as we get into really digging in with them together on the integration plans, we'll evaluate that at that time. And so -- but again, not built into any of our guidance or our models, frankly..

Thank you. We'll take our final question from Brent Thill at Jefferies..

Hi. Thank you. This is David on for Brent. A lot of talk around the nontraditional learner. I know this is probably a tough question to give a super clear answer on.

But maybe if there's a helpful way to frame what percent of the business today comes from this nontraditional learner, assuming it's fairly small? And where do you expect that, that can get to if we look at 10 years over time?.

Yes. That is a great question, David. And we don't break out the different segments per se.

What I will say is the nontraditional learner -- I mean learning is still happening, right? And what's changed over the last -- since -- really since the pandemic is that learners have become much more engaged in the pathways that they want to follow and pursue in their learning journey.

And so we're seeing this as an opportunity to continue to drive growth across the business. It's an opportunity for our existing customers to address more students than historically they have a lot more students than they historically have, and it will be a long-term growth driver for us as they work through their strategy.

So we will -- it's a growing mix. Still early days, as you mentioned. We'll -- but we will, as we kind of turn the corner into 2024, as we -- we'll get back to you with more details about Parchment, more details about our long-term growth and update our growth models in 2024..

Got you. And maybe if I could just sneak in one more just quickly on the AI beta. If you can just bring us -- remind us bring us to speed on what you guys are experimenting with as it relates to AI and just any early feedback would be helpful. Thanks so much, guys..

Yes. So this is exciting. We're getting real-time feedback from our customers, those that are involved in those early betas. There's a few areas that we're focused on. So one is course content and creation.

So we have natural language models that will allow, for instance, teachers to be able to create courses inside of Canvas that allows us to be able to use natural language.

For instance, I wanted to have two columns in my course and I want these headers and that kind of stuff as well as use it to create content like quiz questions and things like that. The second piece is around what we call semantic search.

That is the ability to be able to for students and teachers to be able to search across all content, all course content and be able to do it in a way that they don't have to know exactly what they're looking for.

So for instance, the example we used it InstructureCon was a student says, "Hey, I remember my teacher talking about mandolin and they didn't really -- they talked about the violin, a painting by Picasso.

It's able to kind of sort through using artificial intelligence to sort through and deliver results from that perspective without having to use all the Boolean and logic and all that kind of stuff.

And then the third is to be able to use natural language processing for analytics so that administrators and teachers can naturally go in and say, "Hey, I want to see which students are struggling with this." It's able to create -- organize the data in a way that they can use it for that.

Show me all the students that have -- that are -- have missed 4 assignments. That kind of engagement. Again, the goal really here is to make lives simpler and easier for teachers is where we start as well as make it more intuitive for administrators and learners as well. So those are the areas that we're really experimenting in right now, David..

And that is all the time we have for questions this afternoon. Mr. Daly, I'd like to hand things back to you for any closing comments..

Well, thank you for joining us, everybody. And Peter, once again, welcome to the team as our incoming CFO. We're excited about adding Parchment to Instructure. We believe it's going to help drive new growth and opportunity while matching or improving our profitability over time.

Combined with another solid quarter of execution, we continue to believe we are unlocking the value of technology and education for teachers and learners alike. So we will continue to drive balanced growth and profitability for you, our investors, and we look forward to connecting with you next quarter. Thanks, everyone..

Thank you, Mr. Daly. Ladies and gentlemen, that will conclude Instructure's Third Quarter 2023 Earnings Call. I'd like to thank you all so much for joining us and wish you all a great remainder of your day. Goodbye..