Stride, Inc. Q2 FY2023 Earnings Call

Good afternoon, ladies and gentlemen. Welcome to the Stride Second Quarter Fiscal 2023 Earnings Conference Call. All participants are currently in a listen-only mode, and this call is being recorded. After the prepared remarks from the speakers, there will be a question-and-answer session. Now, I will turn things over to Mr. Tim Casey, Vice President of Investor Relations. Please go ahead.

Thank you. Good afternoon. Welcome to Stride's second quarter earnings call for fiscal year 2023. With me on today's call are James Rhyu, Chief Executive Officer; and Donna Blackman, Chief Financial Officer. As a reminder, today's conference call and webcast are accompanied by a presentation that can be found on the Stride Investor Relations website. Please be advised that today's discussion of our financial results may include certain non-GAAP financial measures. A reconciliation of these measures is provided in the earnings release issued this afternoon and can also be found on our Investors Relations website. In addition to historical information, this call may also involve forward-looking statements. The company's actual results could differ materially from any forward-looking statements due to several important factors as described in the company's latest SEC filings. These statements are made on the basis of our views and assumptions regarding future events and business performance at the time we make them and the company assumes no obligation to update any forward-looking statements made during this call. Following our prepared remarks, we'll answer any questions you may have. I will now turn the call over to James. James?

Thank you. Good afternoon, everyone. I've said this now for the past couple of years that part of our ability to succeed long-term is dependent on the macro environment providing a tailwind for our products and services. A survey that was released just last week found that more than half of all parents have considered a new or different school for their child over the past year. As families continue to see a need for options, more and more are aware that our programs offer that alternative. And certainly, awareness for virtual programs like ours increased dramatically since the pandemic, and we don't see that reversing. In addition, families are increasingly engaged in their child’s education in ways that just a few years ago we didn't see. Parent activism on behalf of their child, whether it be philosophical, safety, religious, medical, or any other host of reasons is on the rise. Now, our total enrollment numbers were disappointing to us. We also said that we saw increasing in-year demand in the early days of October. Well, that continued with us through December, and we ended the quarter with over 180,000 enrollments, up from 174,000 enrollments at the end of September. And in the first few weeks of January, we are continuing to see strong demand as we advance. That Q2 enrollment growth is the largest enrollment gain that this company has ever experienced. We went from being down 8% year-over-year at the end of September and now being down 4%. A number of factors are contributing to the strong results. In-year demand remains strong during the quarter, and we're seeing record levels of retention of existing fees. Once families come to us, they are staying in our program longer. We're seeing many future families continuing to explore their options throughout the year, not just at the beginning of the year. The same survey I mentioned before was conducted at the beginning of January and found that 26% of all parents are currently considering a new school for their children. This benefit is reflected across our metrics. Lead and application volumes remain strong, and referrals and return customers are also trending favorably. We get a number of customer referrals from existing or prior customers, so other customers have always been a pretty significant part of our business and continue to trend very strongly. Many customers who have either been in a program before or looked at a program but did not enroll are reconsidering at very healthy rates. So clearly the market is seeing an alternative they are searching for. This is at a time when our position is as an option for students is solid. The schools we manage and the partners in our network have worked hard to ensure we provide availability and access. Our programs have much flexibility as possible. As a result, we're seeing more students choosing Stride as their educational path. Long term, our core full-time education offering, both general education and career education, are on solid footing and on a growth trajectory for years to come. We're also beginning to make some progress in expanding our product service offerings. This year, we successfully launched a number of new pilot products. We have a number of districts, both large and small, signed up for our updated career platform pilot study and our next version of the platform is ready to use this spring. We also have secured contracts with districts for our upgraded teacher professional development platform and have successfully rolled out our tutoring platforms to a couple of test districts. Our new professional development product offers on-demand training for teachers based on educational test prep. The platform delivers courses in leadership and best practices, counseling, and special programs. It's proven because we have completed training modules for thousands of teachers already this year for our managed progress, and much of it is available now for free. We've received positive feedback on our products so far, and now we're starting to see schools take us up on them. We secured an opportunity to deliver our platforms in one of the largest school districts in the country. I said last quarter that our goal for the year was to expand on our top-line growth and aim to achieve basically flat year-over-year adjusted operating income. Our revised guidance based on these improving enrollment trends continue to show that these are achievable goals. A big driver behind this strength is the sustained success in our career learning programs. I continue to believe that these programs can have an outsized impact on the continuing skills gap and labor challenges in the country today. A recent study demonstrated that 75% of high school graduates do not feel prepared to make college or career decisions after graduation. 72% reported that they are only sometimes or rarely exposed to a variety of career options. Meaning that for many students, it's not just about the ability to do a job, but rather exposure to career assessments, and Stride can be a part of fixing that. Career programs offer students opportunities to explore with over 400 career courses, including career exploration and more in-depth experiences. Students also recognize that schools need to be providing an important aspect of education. More than 60% of students in the same study feel that it is the responsibility of the school to expose them to these opportunities, rather than the responsibility of family and friends, which can disadvantage many students. Our offerings will close these gaps and provide an alternative to schools for shifting their focus towards their students' careers. We also continue to see more companies willing to hire non-traditional candidates. A recent Gartner article on the top workplace predictions showed that the trend towards relaxing formal education and experience required in job postings will continue in 2023. This includes employers reaching out directly to external candidates with non-traditional backgrounds, something our new career platform addresses. I think we have a unique opportunity in front of us to lead innovation around a number of educational products and services. That isn't limited to just K-12 education. I previously mentioned that we rolled out and improved our K-12 offerings and saw significant improvements in customer satisfaction. Recently, that same product was awarded the children's home learning product of the year award. This award recognizes the best digital learning products for children aged four to 18. In addition, Tech Elevator was awarded the adult home large product of the year award, which recognizes the best digital learning products for adults over the age of 18. These awards confirm our best-in-class product suite and encourage us to continue to prudently invest in our future. I'm also proud of the work environment we are creating during these transitional times. We recently ranked number 18 in the top 100 companies for remote jobs by FlexJobs. The quarter was great for Stride. Our business is showing strong demand and improving trends with a favorable macro climate at our back. I believe we are on the cusp of having more meaningful success in some of our newer products and services. Now I'll pass the call over to Donna for a recap of our second quarter results and our updated guidance. Donna?

Thank you, James, and good afternoon, everyone. First, let me quickly recap our reported results. Revenue for the quarter was $458.4 million, an increase of 12% from the same period last year. Adjusted operating income was $76.3 million, up $15.6 million or 26%, and capital expenditures were $16.9 million, an increase of $2.7 million. We are very pleased with the strength in both revenue and adjusted operating income in the quarter. As James discussed, we continue to see strong demand across all of our offerings. This is the first time we have seen enrollment growth from the first quarter to the second quarter. Average enrollments for the second quarter were 177,500, and we finished the quarter in excess of 180,000. This growth supports our belief that students and families are more aware of the school options available to them. It also gives us the confidence to raise our full-year revenue and profitability guidance, which I will discuss later. Now let me provide more detail on our second-quarter results. Career learning revenue was $183.7 million, up 91%. This strong growth was driven by increasing Stride career prep enrollment and continued strength in our adult learning business. Middle and high school career learning revenue was $153.8 million, up over 100%. This was driven by a 58% increase in enrollments and a 29% increase in revenue per enrollment. The quarterly increase was driven by increased funding, some timing impacts, and the better-than-expected retention that James discussed. We continue to see a favorable funding environment and for the full year, we believe revenue per enrollment will increase just over 10% from last year. This increase is a combination of higher funding, better capture, and mixing into higher-funded states. Adult learning revenue in the quarter was $29.9 million, up over 42%. We remain on pace to finish the year with greater than 30% growth in this business. Quarterly revenue for our general education business was $274.8 million. The decrease from last year is due primarily to the decline in enrollments we previously outlined, somewhat offset by an increase in revenue per enrollment. General education enrollments were 111,200, down from 145,600. However, in both career learning and general education, we actually finished the quarter with enrollment that exceeded our first-quarter numbers, a phenomenon that the company has not experienced previously. Revenue per enrollment for general education increased 17% from the second quarter last year. Similar to career learning, we anticipate finishing just over at 10%. Gross margin for the quarter was 37.1%, an increase of more than 100 basis points compared to last year. As we said last quarter, we're seeing a more normal seasonal pattern of our expenses this year in line with pre-COVID years. Additionally, I am pleased to say that we are starting to see some of the efficiencies we discussed last quarter have a positive impact on expenses. However, inflationary pressures still exist. Given these factors, we now believe we will finish the full year with gross margins that are flat to last year, a significant improvement on what we thought last quarter. Selling, general, and administrative expenses were $102 million, up $11.4 million from last year. Most of the increase is due to scaling our adult learning business and our continued investment in new products. Stock-based compensation was $4.9 million for the quarter. Adjusted operating income for the quarter was $76.3 million and adjusted EBITDA was $100.5 million. Interest expense for the quarter came in at $2.1 million and our effective tax rate for the quarter was 27.1%. And finally, diluted earnings per share totaled $1.19. Turning to our balance sheet and cash flow items. Capital expenditures totaled $16.9 million, up $2.7 million from last year. Free cash flow was $147.4 million, up $41.7 million from last year. This increase is tied to revenue growth and the timing of receipts from states that regularly pay us on a lag. We expect to continue to see positive cash flow for the rest of the fiscal year. We finished the quarter with cash and cash equivalents of $318.3 million. Turning to our guidance. For the third quarter of fiscal year 2023, we are forecasting revenue in the range of $445 million to $465 million, adjusted operating income between $70 million and $80 million, and capital expenditures between $16 million and $19 million. For the full year, we are raising our revenue and profitability guidance and narrowing our capital expenditures guidance. We now expect revenue in the range of $1.775 billion to $1.815 billion, up from $1.71 billion to $1.79 billion previously. Adjusted operating income between $180 million and $200 million, up from $160 million to $190 million previously. Capital expenditures between $70 million and $75 million and an effective tax rate between 27% and 29%. Thank you for your time today. Now I'll turn the call back to the operator for Q&A.

Thank you, Ms. Blackman. We'll go first this afternoon to Jeff Silber of BMO Capital Markets.

Congratulations on the strong results. A few items that you had talked about with the improved funding environment. I know it's too early to give guidance for next year, but can we talk about what you think might happen next year? I know a lot of the states and districts are talking about funding right now in terms of what they expect for next year. So any color would be great.

Generally speaking, the funding environment remains strong. I think as you know and as you referenced, a lot of states are sort of in session now and over the next several months to finalize what it will actually look like for next year. So anything right now is still pretty premature. In fact, a lot of the states don't even yet know. And there's a lot of back and forth that will go in the state negotiations around funding. But I think as you also know, some of it will actually depend on how local state economies are projected to be for the next year or so. So they'll take that into consideration as they go through their deliberations. But the early signs are, it continues to look pretty favorable.

Okay. That's great to hear. You also a couple of times mentioned timing. I'm just wondering if we can get a little bit of color on whether there were issues in terms of timing from both an expense and revenue perspective in terms of things being deferred into the third quarter?

There was some timing impact related to our revenue adjustments, resulting in some funding adjustments that we typically expect to see later in the year occurring a little earlier this year. More importantly, regarding our rates, our retention was higher than we had anticipated, as we were somewhat conservative in our earlier forecasts. Therefore, we had to compensate for this later in the year. When comparing year over year, Q1 and Q2 presented an easier comparison to last year because we experienced that catch-up in the late third and fourth quarters of last year.

Donna, I'm sorry. You mentioned the funding adjustment. Can you just explain that again? Is that a benefit in the second quarter? Does that hurt you in the second quarter? Roughly how much was it?

It's a benefit for the full year.

Sorry. So Jeff, I think I want to be sort of clear that these happen sort of every year. We always have some level of fluctuation. I think what we're seeing for the full year net-net, it'll probably be very consistent with last year. And so I think we’re probably in the range last year and this year, timing is a little bit different. But I think as you see, our guidance suggests that we think we're going to end strong even though we did get the benefit in this quarter, in the back half of the year, we do expect to be very strong.

Okay. I appreciate that. I can follow-up with the details offline. If I could sneak in one more question. I'm actually at an EdTech conference and we're hearing a lot about AI, ChatGPT, etc. A lot of the folks think it could be positive in terms of helping them prepare their lesson plans, etc. But there are a lot more people who seem to be worried about students abusing tools like this. I'm just wondering if you've seen anything, are you hearing anything, are you doing anything?

Yes. So I mean, obviously, the sort of the past couple of months, OpenAI has exploded generally, and of course, it has had a lot of press around the education industry and for what it can do sort of impair education. I think it's still too early to really know how it's going to impact the education space. I would say this though. I think early on, people were worried about Google searches as it relates to education and kids being able to ask questions to Google and then along comes things like Alexa and apps that can help solve math problems. This is not a new phenomenon. The application of technology to assist in, I'll say, generically educational problem solving is not new. As an industry, we have to ensure that we're teaching our kids critical thinking skills, which cannot necessarily be replicated yet in any of these technologies. We're going to continue to evolve our programs and curriculum to focus on that. Obviously, to the extent that we're aware of, we do not promote the use of these tools to substitute work. But I think it's very early still on what the impact is going to be. We're certainly not pushing against it, because just like Google, I don't think the technologies are going to go away or there will be some magical way to stop people from using these technologies. We have to lean into it, find ways that we can really adapt to it as opposed to push against it. I'm seeing a lot of people in the education industry, I think as you're referencing, thinking about how to push against it, and that's probably not how I think about it.

Alright. I really appreciate the color. Thanks so much.

Thank you. We'll take our next question now from Stephen Sheldon with William Blair.

Hey, thanks, and really nice work in the quarter. First question here, just wanted to kind of ask how you've been managing teacher capacity through all this? It seems like enrollments are exceeding your expectations. So just how are you feeling about your capacity if you continue to see strong enrollment demand in the second half of this year and into fiscal 2024?

I believe there is both good and bad news in this situation. Initially, we had anticipated higher enrollments at the start of the year, which resulted in some over-hiring in certain areas. However, that has now adjusted to a more normalized state. While there are challenges, our setup allows for greater flexibility compared to a traditional classroom environment, where space is limited. We can accommodate more students in different classrooms without significant issues. Although we typically experience some level of stress in our system each year, particularly due to the teacher shortage, we do not see anything out of the ordinary at this time. With 30 states and 70 programs, the additional 6,000 enrollments from last quarter, spread across various classroom sizes, is manageable for us. While it isn’t a negative situation to be in, we are closely monitoring it and will ensure that we maintain appropriate staffing levels.

I found that very helpful. As a follow-up, I wanted to ask about the trend you mentioned last quarter regarding enrollment shifting from General Ed to career learning. Did that trend persist in the fiscal second quarter? Can you provide any rough estimates of how significant that shift has been as we consider the first half of this year?

Yes. The short answer is, yes, it continues, and I think it's going to continue for some foreseeable future, because I think the career offerings specifically for high school students and for many middle school students, are so much more compelling. You get all of that general education high school with an extra layer of career education on top. It's sort of a no-brainer, and I think it's going to continue for some time to come. If you look at, I’d say, largely the growth in career education, we look at it sort of in the aggregate because we think it's all sort of connected. Right now, we see 90% plus of the funnel for career education is actually generated originally from general education. We do hope in the coming years that we will be able to have more distinct pools as we hone in on our ability to attract incremental customers for our career education programs, but that has not happened yet. So predominantly, it's still one pool.

It's also worth noting that the growth we saw from count date to date. Some of that growth came in from the General Ed side as well.

Thank you. We go next now to Greg Parrish at Morgan Stanley.

Hey, good evening. Congrats on the really strong result. I guess, let’s talk about enrollment so far in January. I know what happened last quarter was unprecedented, but what are you seeing so far in January? I mean, could potentially third quarter be higher as well?

So definitely, I don't want to predict where third quarter is going to end. Historically, the third quarter is a quarter that declines as well. In fact, the third quarter tends to be harder for us because you have withdrawals that happen, and you have fewer schools that have available spaces to actually backfill those withdrawals. So logistically, the third quarter is generally speaking harder for us than the second quarter. However, in the first three weeks of this month so far, we continue to see strength in our funnel, strength in applications and demand, and growth in enrollments through the first few weeks of the new quarter. But it's going to be hard, I think, to continue that trajectory at least the way we saw in Q2 through the end of Q3. I don't think it's impossible to grow from Q2 to Q3, but it will be a challenge to maintain the same trajectory. If you look year-over-year, sort of the implication is that if we can keep going here, we can certainly get close to some good year-over-year comparisons.

Okay, great. That's helpful. And then maybe I want to switch to adult learning. Growth accelerated in the quarter, it's 42%. I think in the calendar fourth quarter, there was a ton of uncertainty going on in the macro environment, typically a slower seasonal month for many, and you accelerated. So can you talk about what drove the strength in the quarter and whether that step-up is sustainable for the rest of the year?

Yes. In the adult space specifically, which has 42% growth year-over-year in the quarter, execution is key. I have to give a lot of credit to the strong leadership within that segment. They are running the business well, and this year we are finally turning around performance from portfolios that were underperforming. We've seen that across the portfolio. Generally speaking, in recessionary type markets, adult education tends to be strong, so we are seeing a favorable environment for it. I hope to see continued growth moving forward.

Great. And just one more from me. I kind of wanted to narrow down here on the revenue per enrollment because you've got a couple of things going on. I understand there was some one-time anomaly catch-up captured in revenue per enrollment for the second quarter that we can't extrapolate going forward. But then we said that second half revenue per enrollment is still expected to be strong, similar to last year. You mentioned that growth for the year was expected to be up 10%, but if second-half revenue per enrollment is strong, doesn't that bring you well above 10% year-over-year? Maybe there's some conservatism involved given that we don't know what the funding environment is like, but I wanted to clarify.

It's worth pointing out when I talked about the year-over-year comparisons. Last year we were more conservative with what we thought would happen with retention. We had a catch-up in Q4 due to better than expected retention. This will mean that the year-over-year for Q4 will be less favorable than in the first half of the year.

Just following up on what Donna said, it's an important point. Historically, over the past several years, we gain strength in revenue per enrollment from Q1 to Q2, and so on. Some of that is due to our conservative estimates. We'll have strength throughout the year which implies continued double-digit growth. However, the Q4 comparison will be tough given last year’s performance, making it challenging to have high percentage growth. This is where the full year percentage gets diluted, as we've indicated.

Okay. That's all very helpful and congrats again on the quarter, and thank you.

We will go next to Tom Singlehurst at Citi.

Yes. Good evening. It's Tom here from Citi. Thanks for taking the question and congratulations on the results. First question I wanted to ask about was market share. I noticed that another company indicated that their revenue was down for them, and I think overall enrollment fell in the same period. I know geographically you don't necessarily align perfectly, but would you say that you have gained market share based on your trends?

You had a totally fair question. The short answer is, yes. I think we gained market share. We're seeing across the landscape that U.S. virtual programs are getting shut down in brick-and-mortar schools, so the whole pie is starting to shrink a little bit. As we sustain or grow, our market share mathematically by default will grow. We are seeing strength in our funnel, in our demand, and we see that continuing through the year. The overall macro trends around these programs continue to be strong and I think that it will work in our favor as brick-and-mortar operations either shrink or shut down their programs. I think we have gained market share attributed to this shift.

That's great. And the second question, I mean, obviously, fantastic news that you're looking for revenue per enrollment up 10%. Previous guidance was 7% to 10%. Could you unpack the drivers of those changes again? Specifically, is some of that growth a function of enrollment performance across the second quarter, effectively having a larger base that can help both of those metrics?

There are a couple of factors at play. We have strong funding increases and we're capturing more of the rate increase in attendance. We're also seeing a mix shift. We've also done some pass-through revenue where we actually have to spend the revenue that we received. There are a number of factors that impact our rate. As James mentioned earlier today, we are in a strong funding environment and are growing in states that pay high rates while shrinking in states that pay lower rates, which certainly affects our overall performance.

I want to give some credit. The team, especially Donna's team, has done a fantastic job. We talked about driving efficiencies in our business that positively impacted both gross margin and operating line. We entered the year in a little bit of a hole and committed to digging ourselves out. While the macro environment helped us, and enrollment as well, we have also driven efficiencies in this business, which contributed to improvements. It’s a combination of factors.

If I could just follow up, when you talk about capture, is that linked to strong enrollment and your ability to extract funding that you're expecting? Is that how I should interpret that?

Yes, part of the capture is that if we have a student enrolled and we meet certain criteria for those students, we actually get the full amount of the PPR. That's what I mean by capture.

Capture is essentially our version of the yield metric. For every $100 that's available to us, on average we capture or yield $75. We're always striving to yield more, moving from 75% to 80%, then 80% to 83%. We’re focusing efforts on enhancing that yield. We're seeing improvements this year.

Perfect. That’s very encouraging. Thank you very much.

Ladies and gentlemen, it appears we have no further questions today. So we'd like to thank you all so much for joining us on the Stride second quarter fiscal 2023 earnings conference call. Again, thank you all so much for joining us, and we wish you all a great evening. Good night.