These days, every industry has its software-as-a-service (SaaS) play. Instructure (NYSE:INST) started out as purely an education play; its Canvas and Arc tools allowed for learning and collaboration via the cloud. Its Bridge tool, however, is focused on helping companies quickly train and evaluate employees.

As you'll see in the details below, that second focus -- on companies -- is getting more and more important. While the earnings the company released this week were relatively ho-hum, the exciting tidbits were buried in the details.

Group of employees being trained via computers

Image source: Getty Images.

Instructure earnings: The raw numbers

Before we get into the nitty-gritty, let's look at how Instructure performed on the headline numbers.

Metric Q1 2019 Q1 2018 Growth
Revenue $58 million $48 million 21%
EPS* ($0.11) ($0.21) Loss narrowed 48%
Free cash flow ($39 million) ($17 million) Loss expanded 124%

EPS = earnings per share. *EPS presented on non-GAAP basis. Data source: Instructure IR.

This is a mixed bag if ever there were one.

Let's start by highlighting the growth in subscription revenue, the real driver of long-term value. This detail is often skewed by professional service revenue. This second line of sales is basically customers paying Instructure for help in installing software and training people on the interface. Instructure gives it away for very low margins.

  • Subscription revenue grew 23%.
  • Gross margins for subscription revenue contracted 212 basis points to 73.8% -- after factoring out stock-based compensation and other nonrecurring factors.

While the slight margin compression might raise a few eyebrows, Instructure showed very strong leverage during the quarter. While subscription revenue jumped 23%, non-GAAP operating expenses were up just 9.6%. It cost the company less and less to serve its customers, which should be great news for long-term investors. 

And as far as free cash flow is concerned, that was primarily impacted by the acquisition of MasteryConnect, which came on the heels of the Portfolium acquisition earlier in the year

Digging deeper

The company announced several different wins in its different business lines. One huge difference this time around is that management highlighted the company Instructure was replacing at many of its institutions -- a direct shot across the bow for these competitors.

Its Canvas education platform signed:

  • Rutgers and its 70,000 students (won over from Blackboard)
  • Florida State College at Jacksonville and its 19,000 students (Blackboard)
  • Orange County Public Schools -- the country's ninth-largest K-12 district
  • Several different UK schools totaling 40,000 students (Moodle)
  • UniFil and its 11,000 students (Blackboard)
  • The Learning Lab in Singapore and its 10,000 students

Bridge, on the other hand, had wide-ranging contracts signed, including:

  • SAFESpaces365 and its 240,000 "learners"
  • Finance company SoFi and its 1,500 employees
  • EDUCASE and its 10,000 members

Outlook

Dealing only on headline numbers, Instructure made very slight revisions to its revenue guidance (upward) and non-GAAP earnings (downward). 

  • For Q2, the company expects to to lose $0.24 per share on $62.1 million in revenue.
  • For the full year, Instructure believes it will lose $0.63 per share on $258.5 million in sales.
  • Free cash flow, while being decidedly negative in the first quarter, is expected to be break even for the full year.

But there are two important details from the prepared remarks which are worth noting.

First, the company said its DIG artificial intelligence and machine learning tool is progressing, but is not expected to be available in the immediate future. More importantly, new CEO Daniel Goldsmith highlighted growing connections between the company's higher education clients and its enterprise clients, saying, "Corporations have long hired university-trained talent, bringing new professionals to fuel growth. Most recently, corporations have been turning to university partners... These forces are creating an unprecedented ecosystem of change that is right in Instructure's sweet spot."

Instructure's primary moat has always come in the form of high switching costs. Once schools and companies adopt a platform -- especially when that platform can be updated via the cloud in real time -- that revenue is very sticky.

But if companies and schools start using Instructure -- particularly its measurement tools -- in tandem, that would also help the company benefit from network effects. Companies that want access to evaluative data would need to use the same platform as schools, and vice versa. 

If Instructure could engage that flywheel, it would be a huge deal for investors. And it's an important detail long-term shareholders should pay close attention to in the quarters ahead.