Instructure Holdings, Inc. (NYSE:INST) Q3 2022 Earnings Conference Call November 1, 2022 5:00 PM ET
Company Participants
April Scee – IR
Stephen Daly – CEO & Director
Dale Bowen – CFO
Conference Call Participants
Joshua Baer – Morgan Stanley
Frederick Havemeyer – Macquarie
Joseph Vruwink – Robert W. Baird & Co.
David Lustberg – Jefferies
Steven Enders – Citigroup
Brian Peterson – Raymond James & Associates
Matthew VanVliet – BTIG
Joseph Meares – Truist Securities
Stephen Sheldon – William Blair & Company
Operator
Ladies and gentlemen, thank you for standing by, and welcome to Instructure’s Third Quarter 2022 Earnings Call. [Operator Instructions]. I would now like to turn the conference over to your first speaker, April Scee, Investor Relations. April, please go ahead.
April Scee
Good afternoon, and welcome to Instructure’s Third Quarter 2022 Earnings Call. We will be discussing the results announced in our press release issued after the market closed today. With me are Instructure’s Chief Executive Officer, Steve Daly; 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. 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 other reports and filings, we file from time to time with the Securities and Exchange Commission.
All of our statements are made as of today 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 the website. All of our non-revenue financial measures, we discuss today, are non-GAAP, unless we state that the measure is a GAAP measure.
With that, let me turn the call over to Steve.
Stephen Daly
Thank you, April, and good afternoon, everyone. Thank you all for joining us for our third quarter 2022 earnings call. During today’s call, Dale and I will provide an overview of company results for the third quarter and provide fourth quarter and updated full year 2022 guidance. Instructure delivered another strong performance in the third quarter, exceeding our guidance across all metrics as we benefit from the digital transformation of education, favorable federal funding dynamics, our strong reputation for innovation and leading market positions. Third quarter GAAP revenue was $122.4 million, up 14.2% year-over-year, while allocated combined receipts or ACR, was $122.5 million, up 12.8% year-over-year. We think ACR, which adds back the impact of fair value adjustments to acquired unearned revenue gives investors better visibility into the underlying growth of our business.
We delivered this growth while continuing to demonstrate the strength of our business model with a non-GAAP gross margin of 77.8% in the third quarter, up roughly 90 basis points year-over-year as we optimize our third-party technology costs and improve the efficiency of our support operations.
Third quarter adjusted EBITDA grew 15.4% year-over-year to $47.6 million, a 38.9% margin of ACR as we further demonstrated operating leverage on both the gross margin and adjusted EBITDA lines. I’m proud of these results and excited about the future and want to thank our employees for their continued dedication.
I’d now like to review 3 things: our results across the K-12, higher education and international markets, continued evidence that our platform strategy is working and our progress penetrating nontraditional education opportunities. First, across our K-12 higher education and international businesses, our focused go-to-market and expanded set of offerings are driving continued strength and bringing new logos onto the platform.
Starting with North America K-12. Market research firm ListEdTech reported last month that 33% of all districts are using Canvas, displacing Google Classroom as the share leader in this segment of the market. We are proud of this achievement and continue to see high win rates. Our pipeline remains very healthy and budgets for digital transformation projects are robust as ever, with 70% of ESSER funds yet to be invested according to the Department of Education.
However, record teacher retirements and strained capacity are slowing decision-making and impacting K-12 sales cycles near term. On the other hand, we continue to hear from K-12 decision-makers that Instructure products are more critical than ever. This validates the long-term demand for our platform, and we expect the funding environment to remain favorable for the foreseeable future. We remain confident we will continue to gain share in K-12 because of the essential role the Instructure learning platform plays in the classroom in the post-pandemic era. For example, we converted a 600 student pilot program with Wichita Public Schools, a large K-12 district to a district-wide implementation of Canvas with a plan already in place to expand the Instructure learning platform further once Canvas is live.
Now turning to North American higher education. Canvas is a leading learning management platform with more than 40% market share. Win rates remain high as higher education institutions continue to select Canvas for ease of use, scalability, flexibility and superior user experience. During the quarter, the University of Texas, San Antonio selected Canvas as its LMS, replacing a long-term relationship with one of our larger competitors. UTSA was already using our Impact product. And after a long evaluation process, decided to migrate to Canvas because of our engaging learning platform and the power of combining Canvas, Studio, Catalog and Impact. Looking ahead, we expect North American higher education growth opportunity to remain strong as nearly 40% of higher education institutions in the U.S. still use legacy LMS systems, providing plenty of opportunity.
Finally, international remains the fastest-growing part of the business during the third quarter, up 21.5% year-over-year. Our international market focuses on a narrow group of markets where we go direct, like Ireland, where there is strong connectivity, a high student to device ratio and a propensity to spend on education. During the quarter, the University of Galway selected Instructure learning platform after a lengthy evaluation process due to its world-class user experience and unrivaled interoperability.
As you know, we also launched a channel program in January of this year, and that enables us to cost-effectively enter new international markets and address the next tier of growth, and we are gaining momentum, adding 13 value-added resellers. Looking ahead, the international higher education LMS market share that we have is in the single digits. We expect this segment to remain our fastest-growing segment in the year ahead. We believe the international business will continue to drive durable growth as institutions continue to upgrade from legacy, open source and sluggish on-premise systems.
Second, I want to talk about the growing success of our platform strategy. During the quarter, our Instructure learning platform strategy gained further traction with strong success with both cross-sell and upsell. Since 90% of instructional workflows are facilitated by an LMS, we are well positioned to cross sell additional modules. During the quarter, we saw several examples, including the Provident School District, which after a competitive RFP process, added Elevate and MasteryConnect onto an existing Canvas base due to our ability to scale assessments and curriculum across the district.
We also saw a meaningful win with the Iowa Department of Education, including implementations for more districts and also adding Studio to their state contract. Looking ahead, we are still in the early innings on cross-sell and see meaningful opportunity. Our current product portfolio alone represents roughly a $750 million cross-sell opportunity in our existing customer base. We expect to continue investing in the platform through organic development and M&A as we increasingly connect every aspect of teaching and learning and expand our addressable market.
Finally, I wanted to update you on successes with nontraditional education opportunities. We believe our investments will contribute to long-term durable growth, and we are excited about the early traction we are seeing. Canvas, when combined with Catalog, Studio and credentials, increasingly allows universities to address not only individuals within the 4 walls, but also those beyond it. We are also seeing strong interest from innovative institutions that are looking to us to harness nontraditional education opportunities that expand their addressable market.
Our focus on innovation and our ability to creatively address opportunities in a changing higher education landscape drove several wins during the quarter, including Arizona State University. ASU has been a long-time strategic customer and has now chosen Canvas to power ASC’s Thunderbird School of Management’s $100 million learners global initiative. This initiative aims to offer online global education in 40 different languages to learners across the globe, 70% of whom will be women. We believe this advances Thunderbird’s mission to empower and influence global leaders and advance equitable and sustainable prosperity worldwide and in Instructure, we share ASU’s mission to improve the world through education, and we are proud to power this initiative, which is one of the many ways we are advancing our strategy to address the estimated $5 billion nontraditional online market opportunity.
We also had a large win with PeopleCert, a leading provider of professional assessments and certifications that does the majority of its business outside the U.S. as part of their digital transformation and business growth strategy, PeopleCert chose Canvas as a learning management system that will deliver training to its 250,000 learners on their journey to certification. PeopleCert chose Canvas due to our ability to scale their worldwide application, and this partnership helps us cost-effectively enter new international markets.
In summary, I am confident and optimistic about our business. Even with the challenges our K-12 customers are facing, we believe the diversification of our business across higher education and K-12 with leading shares in North America and growing market share across the world positions us for long-term durable growth. In addition, we believe our focus on continuous improvement will drive enhanced profitability versus our already industry-leading margins.
I will now turn the call over to Dale to talk about our third quarter financial results.
Dale Bowen
Thank you, Steve, and thanks again to everyone for joining us today. Before discussing detailed financial results, I’d 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.
Instructure continues to display a unique combination of both strong organic growth and best-in-class margins. For the third quarter of 2022, we remained a rule of 50-plus company with 12.8% ACR growth and 38.9% adjusted EBITDA margins, further validating the underlying quality of our business. As Steve mentioned, we generated third quarter 2022 total GAAP revenue of $122.4 million, up 14.2% year-over-year and ACR of $122.5 million, up 12.8% year-over-year. As a reminder, ACR adds back the impact of fair value adjustments to acquired unearned revenue, so it provides investors better visibility into the underlying health of our business.
Subscription and support revenue accounted for 89.6% of our third quarter revenue at $109.7 million, up 14.1% year-over-year, primarily as a result of the continued momentum within our core Canvas LMS product, both domestically and internationally, in addition to strong upsell and cross-sell of our other products.
Professional services and other revenue accounted for 10.4% of our third quarter revenue at $12.7 million, up 14.9% year-over-year, driven by strong implementation and training services delivery in our higher education business. Deferred revenue at the end of the third quarter was $320.9 million, up 11.8% from the third quarter of 2021. Remaining performance obligations or RPO were $792.6 million in the third quarter, up 16% year-over-year and we recognized 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. Please note that when I refer to margins in the upcoming comments, we calculate margins based upon ACR.
Our gross margin profile remains very strong with our optimized cloud architecture and flexible support structure that scales to demand to meet customer demands. In the third quarter, our gross profit was $95.3 million, representing a gross margin of 77.8%. This is compared to a gross margin of 76.9% in the third quarter of 2021.
Turning now to operating expenses. Sales and marketing expenses for the third quarter were $24.1 million or 19.7% of ACR, up from 18.7% in the third quarter of 2021. Research and development expenses for the third quarter were $15.6 million or 12.7% of ACR, up from 12.3% in the third quarter of 2021 as we invested in engineering headcount to pursue our ambitious product road map. General and administrative expenses for the third quarter were $9.3 million or 7.6% of ACR, down from 8.8% in the third quarter of 2021. Non-GAAP operating income for the third quarter was $46.2 million, representing a 37.7% operating margin, up from 37.2% margin in the third quarter of 2021.
In the third quarter, adjusted EBITDA was $47.6 million, representing a 38.9% adjusted EBITDA margin, up from 38.0% in the third quarter of 2021. This result was better than our expectations and reflective of both our strong top line growth and disciplined management of our cost structure. We are pleased with the roughly 90 basis point improvement in operating margins and adjusted EBITDA margins, demonstrating the power and efficiency of our model. Non-GAAP net income for the third quarter was $42.4 million or net income of $0.30 per share compared to $33.7 million or $0.25 per share a year ago.
Turning to the balance sheet and cash flow statement. We ended the third quarter with $263.4 million in cash, cash equivalents and restricted cash and $491.5 million of long-term debt, net of discount, resulting in a 1.3x net debt to trailing 12 months adjusted EBITDA ratio. As a reminder, the timing of cash collections is highly seasonal in our business with the vast majority of annual license fees invoiced in the second and third quarters and collected during the third and fourth quarters. As a result, our cash balances and cash flows are lower during the first half of the year and grew significantly during the second half of the year. Operating cash flow in the third quarter was $179.9 million compared to $161.2 million in the third quarter of 2021. Free cash flow was $178.3 million in the third quarter compared to $160.0 million in the third quarter of 2021. Our adjusted unlevered free cash flow was $187.6 million in the third quarter compared to $174.3 million in the third quarter of 2021.
As a reminder, our strong free cash flow conversion is driven by our favorable billing terms, low capital expenditures and our accumulated tax assets, which we believe will act as a shield for the next several years.
I will now conclude the call by providing guidance for the fourth quarter and updated guidance for the full year of 2022 for ACR unlevered free cash flow and adjusted EBITDA. We have provided additional guidance details in our earnings press release. We expect fourth quarter 2022 ACR in the range of $120.7 million to $121.7 million or a growth rate of 8.8% at the midpoint of the range. We are raising our full year fiscal 2022 ACR guidance to $472.1 million to $473.1 million or a growth rate of 14% at the midpoint of the range and a $4.8 million increase versus our prior guidance. Normalizing for the Bridge divestiture, our full year ACR guidance growth rate is up 15% at the midpoint.
As a reminder, in February of 2021, we sold Bridge, our corporate LMS business. Bridge contributed approximately $4 million of ACR during the first quarter of 2021. We expect fourth quarter adjusted EBITDA in the range of $43.8 million to $44.8 million, representing an adjusted EBITDA margin of 36.6% at the midpoint of the range. For the full fiscal year 2022, we expect adjusted EBITDA in the range of $174.8 million to $175.8 million, representing an adjusted EBITDA margin of 37.1% at the midpoint of the range and a $5.8 million increase versus the prior guidance. Our increased fiscal year 2022 adjusted EBITDA guidance reflects higher growth and stronger gross margins as we continue to optimize our third-party technology costs. We are also adjusting our full year 2022 adjusted unlevered free cash flow guidance down to a range of $181.5 million to $182.5 million.
To summarize, the strength of our international business, our industry-leading efforts in nontraditional education and the exceptional dedication of our team allowed us to deliver balanced growth and profitability again in the third quarter. We are particularly proud of the top line performance in the current teaching and learning backdrop, where higher ed students are returning to class less quickly than anticipated, and decision-making has slowed in K-12. The diversification of our business is helping to offset this. And as highlighted by our increasing market share, we are gaining momentum as a platform of choice. This positions us well to win a disproportionate share of business, both now and when the educational backdrop improves. In addition, we believe our focus on continuous improvement will drive enhanced profitability versus our already industry-leading margins.
With that, Steve and I are happy to take any of your questions.
Question-and-Answer Session
Operator
[Operator Instructions]. Our first question will come from the line of Josh Baer with Morgan Stanley.
Joshua Baer
And the question is on M&A and the platform strategy. Just wondering when you think about all the potential spend per student budget dollars up for grab, which areas are most attractive outside of the current portfolio? And then how — what are you seeing in the current M&A environment? If you could touch on valuation and willingness to sell, that would be great.
Stephen Daly
Yes. Great questions, Josh. And there are a couple of areas that are very interesting to us from an M&A perspective. I’ll start first though with your second question, which was what does the current environment look like? It’s still pretty active. So we’ve got a lot of activity going on. We’re engaged with a lot of different companies. I would say valuations are not necessarily coming down, expectation isn’t coming down as quickly as we’ve seen in the public markets.
So there’s still a little bit of a little bit more frothy expectations, I would say. But there’s still a lot of opportunities. And like I said, we’re very busy, and we’re really excited that we’ve got such a — our balance sheet is in such a good position to be able to react and to those opportunities. Now the areas where we’re interested in is we still think there are some things that we can do within assessment to kind of broaden our reach and assessments in K-12 and higher ed.
We’re still looking in online and nontraditional areas that we can continue to build — we’re building a lot there, but that we can add to that. Student success is a new area that we don’t have a lot of technology in today that we’re — we think there’s an opportunity to buy in. And then we’re always looking for platform tech tuck-ins like a couple of that we’ve done in the last 6 or 9 months to help us kind of build out that platform even more quickly. So a lot of opportunity, and we feel really good about our position to be able to act on those things.
Operator
Your next question will come from the line of Fred Havemeyer with Macquarie.
Frederick Havemeyer
Congratulations on reporting a strong quarter here. I wanted to ask, there’s been some shifts in some of the players in both the K-12 and the higher education market. And I’d love to get some context on what you’re seeing there. Think Edmodo certainly noting some planning for certain levels of shutdown in the K-12 market. And we’re about a year after the Anthology and Blackboard merger. So I’m wondering have these dynamics shifted at all some of the conversations you’re having in the market opened up additional market share or offered any disruption points?
Stephen Daly
Yes. Good to hear from you, Fred. Yes, I would say that — within K-12, we see Edmodo was not a huge factor in the U.S. It had some position outside of the U.S. I wouldn’t say based on their position, it’s really changed a lot the dynamics within that K-12 space. We’re still in there talking about digital transformation. We’re still talking about the bigger picture of how a platform can help that. And so I wouldn’t say there’s been a big change as far as the conversations go. As we mentioned in the remarks, we’re seeing still a focus on digital transformation, a lot of — a lot going on in K-12 right now, and they’re dealing with a lot of things outside of these kind of platform installations, but I wouldn’t say there’s any change there.
Anthology is interesting, Fred, in higher education. It’s been a while since Blackboard was acquired by Anthology. We’ve seen — we saw kind of a pickup in our RFP activity. We still see that in the pipeline for next year as well. And the main competitors that we’re replacing are either Moodle or Blackboard. And so we feel good about our success and the wins that we’ve been having and the activity in the pipeline against that Anthology portfolio.
So feel pretty good about where we sit competitively, I haven’t seen a ton of change in the dynamics over the last 3 to 6 months.
Frederick Havemeyer
And just a follow-up on ESSER funding in general here. I’m curious, could you just contextualize how you’re seeing your K-12 schools and your clients deploying ESSER funding and where that might be focused and how that could continue to play out…
Stephen Daly
Yes. Good question. go ahead.
Frederick Havemeyer
Just if it’s assessment, if it’s LMS, if there’s any particular product focus?
Stephen Daly
Yes. It’s interesting as we dig in, and there’s been a lot of press about this. The K-12 districts are really dealing with a lot right now. They’re dealing with teacher shortages, they’re dealing with — the administrators are having sub in classes. They’re dealing with collective bargaining agreements. There’s just — there’s a lot going on right now. And so the ESSER funds are budgeted there. The plans have been — they’ve been submitted to the federal government. They’ve been approved — they’re not getting spent as fast as we thought they would get spent because of a lot of these other competing priorities.
But the — we still see LMS as the foundation for a digital transformation strategy, and we’re seeing success as demonstrated in our market-leading share now. Assessment is a big opportunity for us. We’re still early innings. But a big part of where money is starting to go, Fred, is in addressing learning loss, right? That’s a huge deal. And it’s going towards things like tutoring. But ultimately, the districts are needing to prove is what I’m doing, working, right? And that’s where the assessment technologies come in and play a critical role. So again, we — this is a long-term trend, and we’ve got another couple of years of ESSER funds before they expire. So we do think that, that’s — it’s going to be a key part of that — those strategies in the future.
Operator
Your next question will come from the line of Joe Vruwink with Baird.
Joseph Vruwink
Great Steve, go back to your comment on sales cycles in K-12 since the second quarter is the biggest selling period and I think the quarter ago sounded fine. Is this all new development post the peak season? And then how does this end up manifesting in your model because guidance looks good, RPO looks good. So is it the case that K-12 is behind plan, but we’re just seeing higher ed in international more than offset it?
Stephen Daly
Yes. I would say, Joe, the sales — I mean we talked in our last earnings call about kind of sales cycle, the fact that ESSER funding wasn’t being spent, right? There was a lot of competing priorities for digital transformation in the current environment. That has continued. We continue to see — they just are struggling with the capacity to make decisions. As you said, we’re pleased with our performance this quarter. We’re confident in our guidance for next quarter.
But we do see this as kind of a transient kind of near-term challenges getting the money kind of freed up in the K-12 system to buy technologies in the classroom. And so we are — we still feel good about the long-term growth of that part of the business. And we also feel good about where we are from a — higher ed continues to be kind of the foundation and consistent performer for us, and our international markets are successful. So I feel good about where we are and the fact that we were able to raise guidance and the confidence we have in that guidance.
Joseph Vruwink
Okay. Great. And then just a quick one for Dale. Why is the free cash flow guidance moving down?
Dale Bowen
Yes. So Joe, as you know, our unlevered free cash flow is a bit of a noisy number. There’s a lot of things that go into this metric and a number of ins and outs. So let me just hit just with a few highlights. First, Steve mentioned this, the K-12 has got some longer sales cycles. Another element is high ed. We’re really performing well there. Some of our wins are competitive takedowns that begin next year. So you’ll see that evidenced in our RPO, but not necessarily the current unlevered free cash flow.
And then last one is just keep in mind that we’ve got some currency changes impacting the international business. But overall, we’re just really pleased with our unlevered free cash flow. That conversion remains 100% as we guide to the end of the year.
Operator
Your next question will come from the line of Brian Peterson with Raymond James.
Brian Peterson
So Steve, I appreciate all the commentary on sales cycles. I could want to focus on maybe a little bit more about pipeline. And where do you feel like that is strongest as we kind of head into 2023. I would love to get any thoughts there.
Stephen Daly
Yes. So yes, thanks for the question, Brian. And we are — we’re right in the middle of our planning for 2023. So we’re not going to give you any guidance, even if you ask it with a sneaky pipeline question. But we are…
Brian Peterson
I’ll do my best.
Stephen Daly
Yes. I know, you always do. That’s why we love you. The pipeline is building nicely. What we’re seeing more in K-12 is that just a deal lengths are lengthening, right? So the time to close is lengthening. So the deals aren’t going away. They’re still there. It’s just a question of the capacity to be able to close those deals. But we feel good about where our pipeline is right now.
Brian Peterson
Got it. And maybe a follow-up. How are you guys thinking about investing in the business and the current macro? And I think we’re all aware that your end market is much less immune to the macro, but we’re also seeing a lot of talent become available in certain areas. And it’s very high margins. I just didn’t know what your philosophy to your thoughts on kind of investing in the business have changed over the last couple of quarters, but any thoughts on that?
Stephen Daly
Yes. No. It is — to your point, I would say the labor market for us, it’s been a little easier to hire in the recent months. We have a very focused kind of investment strategy. We’re looking — we’ve made a number of investments. You look at our R&D spending. We’ve added a lot of engineers over the last 2 years, our quota capacity. We continue to invest in quota capacity. So we’re going to continue to make those investments.
It will be very targeted. We feel based on our disciplined investment approach, right, and what we know in the business, we can continue to make the right investments to continue to that durable top line growth while still being able to expand our margins. So we don’t feel like we’re impinging on our growth while still being able to expand those margins.
Operator
Your next question will come from the line of Terrell Tillman with Truist Securities.
Joseph Meares
This is Joe Meares on for Terry. Just want to hit the higher ed, K-12 international question from a bit of a different angle. The growth in international was great 21.5% this quarter. ACR grew 13%. Could you just give us maybe qualitatively whether or not K-12 or higher ed grew greater or less than that 13%? And then kind of what are your expectations over the medium term for these 3 portions of the business in terms of growth rates?
Stephen Daly
Yes. So we’re pleased with the growth that we’re seeing across the board. We and we continue to see success in each of our markets. Our win rates are still trending above 70%. We’re now #1 market share in higher ed and K-12. Higher ed continues to be kind of our consistent performer. And more importantly, the foundation for future growth reaching into that nontraditional, like the announcement we made with ASU. So we feel good about those overall. Our K-12 sales cycles are lengthening as we talked about. It’s not really related to macro, it’s really a capacity to spend. And we are seeing some currency headwinds in the higher — in the international market.
So we still expect international to be our fastest-growing market, and we still feel in the long term, that’s the right way to be thinking about it. And as we talked about last time, we think kind of the North American market between the 2 is a high single-digit to low double-digit grower. And that mix between which has grown faster or slower is going to change on almost quarterly basis. But that’s the way I would think about it long term for our business, Joe.
Joseph Meares
Super helpful. And then just as a follow-up on the international business. I mean, given the macro, is there any slowdown in RFPs? Or is it just the fact that you guys still have, I think you said low single-digit market share that the growth trajectory there is still so much white space that you’re not having to worry about the macro as much.
Stephen Daly
Yes. I would say, again, our business is less impacted by kind of macroeconomic trends, right? I think the labor shortage has obviously been a challenge in K-12 for us. But traditionally and historically, when we go into an uncertain economic time, higher ed actually enrollments increases during those times. And so we do think we’re going to be kind of insulated against those things. I think the biggest challenge for us just from an international perspective is what everybody else is seeing, which is currency, right? And the strength of the U.S. dollar is putting pressure on those growth rates in the short term.
Joseph Meares
Congrats on this present level.
Operator
Your next question will come from the line of Matt VanVliet with BTIG.
Matthew VanVliet
I guess digging into the K-12 market a little deeper. Curious if you’re seeing much of a difference in a propensity to spend from some of your existing customers looking at either expansion or cross-sell deals relative to net new customers, just sort of how those are progressing. It sounds like the net new were probably slow, but curious if the cross-sell is seeing any better traction?
Stephen Daly
Yes, it’s a good question. The — you’re right with the net new and some of our examples that we used demonstrated kind of cross-sell, right, and selling into the existing base, which is always easier. I think it’s balanced with the fact that when we’re short on teachers, right, there’s a reluctance to kind of introduce new things into the classroom at this point, right? And so they don’t want to kind of disrupt what the teachers are trying to do. So it’s pretty across the board where we’re seeing that kind of lengthening cycles as say, try to deal with some of these teacher shortages and collective bargain agreements, they’re trying to get through now and all that kind of stuff.
Matthew VanVliet
Okay. And then as we look towards the midterm elections here next week, do you feel like any of the issues, whether it’s on a state-by-state basis or some of the more national level issues and potentially switching of party controller, Congress will make any difference in some of these sales cycles, either opening up or projects may be getting pushed forward at the state level. Anything that you’re monitoring closely that we should be aware of?
Stephen Daly
Well, I think the — just having some clarity, right, and just getting through it and having some stability and more — it really comes down to the — what the districts are focused on right now. And so if we can get more stability, we can get more teachers in the classrooms. We can — regardless of what happens with the parties and power that’s going to be the biggest determinant of sales cycle and how quickly these ESSER funds can get spent. And frankly, political party perspective, outcome — student outcome is — everybody can get behind good student outcomes going forward. So we don’t — we do not see anything related specifically to the midterms that will like effect one way or the other.
Operator
Your next question comes from the line of Stephen Sheldon with William Blair.
Stephen Sheldon
First, I wanted to ask about gross retention rates, kind of what they look like heading into the new school year. Any major changes relative to what you’ve seen historically in either higher ed or K-12 as contracts came up for renewal, just given, I think it was a heavier renewal quarter. Just any detail there?
Stephen Daly
Yes. Stephen, we’ve — we’re pretty proud of our reputation and the investment that we make in our customer success teams and really they’re really plugged in and really take good care of our customers. We haven’t seen any substantial changes in kind of gross retention. We’re in higher ed with reduced enrollments, our business model, the way we contract a B2B type of fashion kind of mutes any dramatic changes there. So while we may see some downgrades, it’s not been massive, and we expect that to continue. And in the K-12 space, we are — we’ve been through renewal cycles on some of the state deals they’re renewing. And so we haven’t seen anything changed dramatically on the gross retention side.
Stephen Sheldon
Got it. Good to hear. I want to follow up on the international side, just given that sounds like it continues to outperform your expectations and it sounds like the channel partnerships are working well. So just given that success, is there more you can do to feed that traction in terms of building even more partnerships, expanding direct sales capacity in select regions. Just how are you thinking about that?
Stephen Daly
Yes. We’ve — the plan that we put in place was a plan that we felt that we could execute. There is a limit — you can’t just keep throwing dollars at it, right? You get a marginal return. So we feel like the investments that we’re making in the quota capacity that we’re adding for those direct — those direct countries that we’re going after, we’ve got the right amount of quota capacity. And then from the international perspective, I mean, from the channel perspective, we feel good about the partners that are signing up, the number of partners that we’re signing up. I’ve said this from the first quarter, right, is — this is a 24-month investment before we really start to see those pay off. We’re deep in training and enabling our channel partners to be able to sell. But we feel good, pipelines is building. We’ve already seen some bookings come through our channel partners. So we’re pleased with our progress so far.
Operator
Your next question will come from the line of Brent Thill with Jefferies.
David Lustberg
This is Dave Lustberg on for Brent. I wanted to ask a little bit about the impacts of higher ed enrollment. We saw the recent report of a 1% decline in higher ed enrollment. Obviously, you guys have contracts 1 to 5 years, right, in your annual basis is paid upfront noncancelable. So just talk about how enrollment declines might impact the model into 203? And then obviously, thinking potential recession in 2023, which should potentially be good for higher ed enrollment? Like just talk about how that impacts your ability to grow revenue, that would be helpful.
Stephen Daly
Yes. It’s a good question, David. And good to hear from you. It’s — so the way to think about it is, you’re right, we are insulated to a certain extent, dampened is probably a better word, right? We won’t see the massive swings when enrollments were down 4% last — during the pandemic. The 1% is actually a little bit better than what was — everybody was thinking the decline in enrollments was going to be this year. So it does roll into our guidance that we’ve given you. Going into Q4, we’ve taken all that — those downgrades into account. I think the important thing though is that the number of people that are seeking education isn’t going down, right? What we’re seeing is a reduction in kind of traditional degree-seeking enrollments. And our investments in the nontraditional going to market with somebody like an ASU or like PeopleCert, right, is addressing a whole new set of students that isn’t included in that enrollment data.
So in the long term for us, it’s a net — it doesn’t matter which — where learners are, we will meet the learners wherever they’re at. And so we do feel good about our growth prospects in higher ed longer term just because of that.
David Lustberg
That’s helpful. And maybe just one more for me, if I may. On cross-sell, I think in the past, you guys have said the average customer — or excuse me, about 30, maybe high 30s customers are using more than 1 product today. I know you guys called it a $750 million cross-sell opportunity. Just talk a little bit about the different products you have in cross-sell, what’s doing best? I think you pointed that assessment. But ultimately, as we look forward, how many products do you think you can realistically sell into some of these different districts and schools, that would be helpful.
Stephen Daly
Yes. We’re going to sell hundreds in David, but we — there’s a lot of opportunity. We have 4 or 5 products today that we could cross-sell, whether it’s higher ed or K-12. As we’ve talked about in the past, our assessment solutions carry big average selling prices. So has kind of an outsized impact on revenue as we get success there. We’re still early days in that cross-sell. And you’re right, it’s in the 30-some percent across the board that have more than 1 product. And we’re seeing an increase. So the number of customers grew this quarter. So we’re seeing success there. But again, there’s still a lot of opportunity to sell more of those products.
Operator
Your next question will come from the line of Steve Enders with Citigroup.
Steven Enders
Great. I just want to ask about the investments that you are making in R&D and in higher ed and there. I guess what’s kind of the biggest area that you’re focused on in terms of the product road map and where that could potentially go and how it fits into the current portfolio?
Stephen Daly
Yes. So one area that we’ve been investing in over the past couple of years will continue to is that nontraditional space. So investment in products like Studio and Catalog impacts our newly acquired Concentric Sky or Badgr and our certifications. Those are areas where we’re continuing to make organic investments for growth and feel really good about the progress. Again, the deal we just signed with ASCO, with our PeopleCert deal, right, a lot of that is because we are we’re investing to address that nontraditional.
We continue to make investments in integration and the platform and how we bring the solutions together with the idea that as you marry the learning management system with the assessments, you now have a rich set of data to help teachers be able to teach to student by student. And so we — that’s in the big area for us is integration and the platform. And then we’re making — we’re continuing to make investments in our Core Canvas and within higher ed and K-12, but to, again, continues to advance those, make it easier to use, make it more intuitive, allow us to differentiate against our competition, but really to address the evolving needs of both our higher ed and K-12 customers.
Steven Enders
Okay. Great. That’s helpful. And maybe just on the margin profile. I mean, good leverage that showed here in the quarter and the guide. But how much more room is there to continue kind of driving that up and other kind of — what are kind of the key areas that maybe we should be thinking about where we could see some incremental opportunity there.
Stephen Daly
You cut out on just — you said maybe thinking about a…
Steven Enders
Yes, just in terms of the margin profile and the leverage that you’re showing, what are some of the areas that maybe we could see some incremental opportunity to drive a little bit more there?
Stephen Daly
Yes. So I think there’s still room in our gross margins. with the operations and engineering teams are very focused on continuing to kind of optimize our infrastructure to reduce our hosting costs and our third-party providers. We continue to make program and systems investments in customer support to help drive down our cost to support our customers as well. We have room. We continue to get leverage in our sales and marketing spend. Again, as we gain market share as we’re the leader, this is such a referential sale that there’s kind of this virtuous cycle that happens and we get much more efficient and effective in how we go to market and we get looks at all the deals that come along. And then our channel investment, we believe, is a good way to scale the business without adding a bunch of direct costs into the model.
So there’s a number of areas in the P&L where we believe we can get more leverage from a profitability perspective.
Operator
There are no further questions at this time. I’ll turn the call back over to Steve Daly, CEO, for closing remarks.
Stephen Daly
All right. Well, thank you, everybody, for joining us today. So we are super excited about the future of Instructure. We’re happy with our performance. And I just wanted to thank our employees, our partners and our customers for the important work that you all do in helping bring education to the world. We’re confident in our ability to grow both our revenue and our margins in the future, and we look forward to continuing to share our success with you all. So thank you.
Operator
Ladies and gentlemen, that does conclude today’s meeting. Thank you all for joining. You may now disconnect.
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