Stride, Inc. Q2 FY2024 Earnings Call

Ladies and gentlemen, thank you for standing by. I would like to welcome everyone to the Stride, Inc. Conference Call. At this time, all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. I will now hand the call over to Mr. Tim Casey, Vice President of Corporate Development and Investor Relations. You may begin your conference.

Thank you, and good afternoon. Welcome to Stride's Second Quarter Earnings Call for Fiscal Year 2024. 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 Investor 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 based on 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 will answer any questions you may have. I'll now turn the call over to James. James?

Thanks, Tim. Good afternoon. In November, during our Investor Day, we discussed the opportunities for our business and laid out our strategy to deliver what we believe will be market-leading returns. I discussed how increasing uncertainty and volatility in our country has and will continue to increase demand for our offerings. Our second quarter results speak for themselves and demonstrate the macro trends are behind us. Our strategy is getting to play out, and we are executing better. The year began with some uncertainty regarding the trends we might see in-year given the volatility over the past few years. We have been convinced that the market has moved in our direction and that we were not going to fall back to pre-pandemic levels, but there remains a question of whether we could surpass those pandemic highs. Well, we ended the second quarter with 196.5 thousand enrollments, which was an all-time record, surpassing our pandemic-level highs. We saw enrollment growth in both our Career Learning and General Education programs and strength in both new enrollment and retention. We have the largest cohort of new in-year enrollments that we've ever seen, and Americans continue to believe that school choice is good for the education system. A recent poll by YouGov released this fall showed 84% support, giving every child in the U.S. the ability to attend a public school in their state that best meets their needs, regardless of where they live. The results are clear, and it's what we've been hearing for years: parents want choice. They want to be able to choose a school that will meet the unique needs of their child. They want to be able to change their child's future. I also continue to see reports supporting our move into the Career Learning space. This fall, freshman enrollment in four-year institutions for 18 to 20-year-olds declined by 5.2%, and the reason for this decline was that this age group is increasingly choosing to enroll in community college or certificate programs. Students are explicitly looking for short-term programs that have a direct connection to the workforce. While we're still working on driving incremental demand for our career programs, data like this supports our decision to focus on certificate and career pathways in fast-growing, in-demand careers. Students in our programs can graduate high school knowing they've got skills to go directly into the workforce or to choose to attend a post-secondary institution. There is also continuing support for our new products. In November, I outlined our K-12 tutoring product along with some of the demand drivers that support our entrance into the market. A study out of Texas showed a case of two students who received individual virtual tutoring during last school year demonstrated higher reading test scores by year-end, and Virginia launched a statewide high dosage tutoring effort as part of the $400 million investment in education to recover from some academic decline. We know that our tutoring offerings using state-certified teachers can be part of the solution to the nation's learning loss and help drive student success. Taken together, I remain as excited about Stride's ability to change the future for students as I ever have been. The market conditions are right for an innovator like Stride to continue to drive student success across multiple markets. This call marks the end of my third year as CEO, and as we continue to achieve new enrollment and financial records, I still see a long runway in front of us. A couple of highlights I'd like to point out since I was appointed CEO: gross margins are on pace to expand 300 basis points plus or minus. Trailing 12-month reported EPS and reported operating incomes are both up 3 times the level prior to my appointment as CEO. We've got the right team in place and are executing against the strategy that we previously outlined. Thank you. And I will now turn the call over to Donna. Donna?

Thanks, James, and good evening. I know James already discussed our enrollment numbers, but I think it's important to put it into perspective. It was just two quarters ago that we were fielding questions about whether we could return to year-over-year enrollment growth following the pandemic, and now we're talking about exceeding the pandemic high. This speaks to the resiliency of our offerings and the sustained demand for alternative educational options. We are proud to give families a choice, and we believe that the trends point toward long-term growth in our business. All of that has resulted in the first quarter in our history that we achieved over $0.5 billion in revenue. As we updated our revenue guidance for the full year, it now exceeds $2 billion at the midpoint. Turning to our quarterly results, we reported revenue of $504.9 million, an increase of 10% from the second quarter of fiscal year '23. Adjusted operating income of $94.9 million, up from $76.3 million or 24% from the same period last year. Earnings per share of $1.54, up $0.35 from last year, and capital expenditures of $12.7 million, down slightly year-over-year. Career Learning middle and high school revenue grew 7% to $165.1 million. This performance was driven by enrollment growth of 9% year-over-year, somewhat offset by a slight decline in revenue per enrollment. During the quarter, enrollments grew over 3,000, continuing the in-year enrollment growth trends we saw last year. In our General Education programs, revenue was $313.9 million, up 14% from last year. This strength was also driven by continued enrollment growth in the quarter, with enrollments finishing the quarter up 5.4 thousand from the end of September, and average enrollment growth of 9% from last year. Revenue per enrollment for Gen Ed increased 8%. We continue to see strength in funding for education, and while we saw some timing impacts in our Career Learning revenue per enrollment, we still expect to finish the year with revenue per enrollment growth of between 4% and 6% for both clients of the business. Our Adult Learning business revenue declined $4 million to $25.9 million due to weakness in our Tech business we discussed previously. MedCerts continued to perform well. The growth in that business did not fully offset the declines in our boot camp. Gross margins for the quarter were 39.8%, up 270 basis points from last year. We're still seeing the effects of the efficiency efforts we put into place last year and continue to implement. Given the timing of the impact last year, we don't expect gross margin increases to be as strong year-over-year in the second half. We still expect to see gross margins improve by 200 basis points to 250 basis points for the full year. Selling, general, and administrative expenses increased 15% to $116.9 million. Stock-based compensation for the quarter was $7.6 million. We now expect to finish the year with stock-based compensation in the range of $29 million to $33 million. Adjusted operating income for the quarter was $94.9 million, up 24% from last year. Adjusted EBITDA was $118.3 million. Interest expense for the quarter was $2 million. Our effective tax rate for the quarter was 24.9%, and diluted earnings per share for the quarter was $1.54. Turning to our balance sheet and cash flow, capital expenditures for the quarter were $12.7 million, down slightly from last year. Free cash flow defined as cash from operations less CapEx was $160.6 million, up $13.2 million from the prior year period. We finished the quarter with cash and cash equivalents of $364.4 million. Based on the strength of our enrollments, we are raising our full year revenue and profit guidance. We now expect revenue in the range of $1.99 billion to $2.04 billion, adjusted operating income between $265 million and $285 million, capital expenditures between $60 million and $65 million, and an effective tax rate between 25% and 27%. For the third quarter, we are forecasting revenue in the range of $500 million to $520 million, adjusted operating income between $85 million and $95 million, and capital expenditures between $14 million and $17 million. Thank you for your time. Now I will turn it over to the operator for Q&A.

Thank you. Our first question for today comes from the line of Greg Parrish from Morgan Stanley. Please go ahead with your question.

All right. Thank you. Congrats on the strong quarter. I guess we will start with margin, really good expense management again. You unpacked the margin beat, is there anything to call out on the expense management side where you able to outperform your expectation going into the quarter? And then related, if you continue on that trajectory there is upside to the full year, at least the way I look at it, so is there anything timing related or any reason why the back half margin won't be quite as strong as in the second quarter?

On our gross margin, some of the things that we talked about last year we are continuing to do this year. One of the things you've heard me talk about last quarter, just the timing of the teacher hiring had an impact on our margins, but we did a much better job with that hiring process. The materials that we send out are now using more digital, utilizing innovation and technology, using our size and scale, all the things that we talked about, we've continued to do that. And as you might recall, I spent a lot of time talking about gross margins last year, and I said the changes we were making were structural changes, and that still holds true. In terms of the rest of the year, the year-over-year comparison won't be as favorable because some of those efforts were put into place later in the year. So from a comparison perspective, you won't see that. Also, in Q4, we typically have more school-level costs like testing and some restricted funding that we have to spend in Q4, and that's why you might see Q4 gross margin typically not as high as you might see in Q2 and Q3.

Thank you. That's helpful. It seems like you finished at 196, and everything was trending positively throughout the quarter. We're asking this quarterly now, and so far, 23 days into January, we're observing similar trends. It appears that the third quarter is more challenging for adding students compared to the second quarter, but so far in January, it seems to be trending upwards.

Yeah. I think we're not going to talk about the specifics of January today, but yeah, January so far looks pretty good. I think what you said is right, meaning it's harder due to fewer spots even open in Q3, a lot of the enrollment window shuts down in the quarter, so the ability to even add kids closes during the quarter, but I think just from a funnel perspective, we continue to like what we see.

Okay. Fair enough. And then I'm going to ask you about Adult Learning. I know it's small. It's 5%, 6% of revenue. Last quarter, you talked a little bit about macro headwinds, but it seems like, I don't know if there's something shifted in the quarter or was there sort of a big client loss or anything to call out there? And then, I guess, how long does this kind of last for? Maybe it's macro-dependent, but when do you expect this to get back to how it was growing in the past?

I believe the macro challenges are ongoing, and this trend is evident throughout the industry. Our Adult Learning division is not exempt from these industry-wide issues. I anticipate these challenges will persist for the remainder of the year. Looking ahead to next year, we're optimistic. What sets our Adult Learning business apart from the rest of the industry is our technology-driven offerings and boot camps, which also face macro challenges. It's something that everyone in the industry is experiencing. However, our healthcare sector is performing strongly, and as it continues to grow, it may ultimately compensate for any downturns in other areas. Whether that happens next year is uncertain, but I don't foresee it having a significant impact, either positively or negatively, for the coming year.

All right. Fair enough. Thank you very much, and congrats again.

Thank you. Our next question comes from the line of Jeff Silber from BMO Capital Markets. Please go ahead with your question.

Thank you so much. Wanted to focus on the different segments. I'm going to start with General Education. I know you have not broken out. This is a separate segment for too many years, but kind of looking back historically, I think this is the first year we've seen sequential enrollment growth in Gen Ed between the first quarter and the second quarter. I know you cited some improvements in retention, but if we can get a little bit more color, it was actually a nice surprise there.

We did observe an improvement from the first quarter to the second quarter, which is typically when we see a decline. This is primarily due to increased enrollments at the end of the first quarter when families make adjustments in September, many of which come to us. Then we often see a decline in October, November, and into December. However, this year we managed to change that trend, and strong execution played a role in that. It's uncertain whether this represents a broader trend for the future, but we have seen better execution, which contributed to a more robust second quarter. Metrics like conversion rates are also on the rise, indicating that our execution is indeed improving. There is still room for further enhancement, but we don't yet have sufficient data to confirm that the improvement from Q1 to Q2 is a consistent macro trend.

Okay. That's helpful. I appreciate it. If I can move on to Career Learning and let me focus on middle high school, although we did see growth on a year-over-year basis, the growth did slow. Again, we don't have a lot of historical data, but I think it's the first time that we've seen single-digit year-over-year growth in that segment, and so it looks like it did slow. Can we talk about what was going on there?

I believe we're in the single-digit range, and our business is beginning to scale. In some ways, it's like our same-store comparable sales because we're not introducing many new programs. For the year, we can expect to average double-digit growth. If we maintain this low double-digit growth, we'll be satisfied. However, there is a small distinction we're discussing, and the difference between 9% and 10% growth can come down to a few hundred students. So, we're really talking about the finer details here.

Yeah. I was actually referring to revenues, so I know your revenue per student as indicated there, so that's okay, no worries. But I guess your answer to that is valid as well. Okay. I'll jump back in the queue. Thanks so much.

Thanks.

Our next question comes from Stephen Sheldon from William Blair. Please go ahead with your question.

Thank you for taking my questions, and congratulations on the impressive results once again. I wanted to begin by addressing something that many investors have been asking about recently. What does the opportunity look like to expand your Career Learning Solutions into local school districts? You've mentioned some programs previously where students take their core classes in person locally and then participate in your online Career Learning programs for electives. Do you see this as a significant opportunity to pursue in the coming years, and what implications could that have for your team?

Yeah. So I think the short answer is, is it a larger opportunity? Yes. Part of the issue is going to be just with the way that districts across the country will embrace change. Our strategy I think does present an opportunity to get into those districts with our Career Learning program. We will do it in a multi-pronged way, meaning, one is, we will offer them literally the same program that we give our virtual students, which I think can be compelling for some districts. We will also take a little bit of a platform strategy and offer a sort of a light solution, if you will, through our Tallo platform that will allow for districts to do a little bit more self-serve. It will be a little bit more teacher light. It will be less sort of instructor-led, etc., but it will still offer them what we think will be a best-in-class platform solution for Career Learning at the high school level. So that is in a beta phase of that upgrade to our platform, and I don't think just given the selling cycle you'll see much traction for this coming fall just because the selling season for districts is sort of going to get behind us pretty quickly, but I would expect us to be able to offer it a little bit more robustly in the following fall from a platform perspective. But I think the short answer to your original question, yes, it does offer a good longer-term opportunity. I just don't think we're going to see it in the next 12 months.

Got it. Makes a lot of sense. And then just quickly on the Career Learning, the revenue per enrollment, would that mainly be lower due to the mix of students by state? Anything else to call out there in terms of that contracting a bit year-over-year? I know that the comps there was also pretty difficult. And then Donna, I think you reaffirmed expectations for revenue per student or enrollment to be 4% to 6% of what you talked about last quarter. Are trends kind of coming in as you would have expected so far this year?

And so I'll answer part of the second one first. Yes. We expect our revenue per enrollment for Gen Ed and Career to be up 4% to 6%. Will you see a decline in the Career for this quarter? Yes, partly due to mix, as you know, overall our revenue per enrollment with Gen Ed and Career combined was up over 5%. You may recall, that last year in this quarter, we talked about some of the upside we saw in the revenue per enrollment for Career was due to timing, so this is just the offset of that that makes for a tougher comparison.

Got it. Yeah, it makes sense. When do you think you'll start developing a separate marketing funnel for the Career Learning programs? I know this isn't something you've historically done, but you've mentioned it more as an opportunity. Has that begun yet, and if not, when could it become a larger initiative?

Yeah. I'll say in some respects, we've had fits and starts with it already. I think that this is an area where, unfortunately, we have not executed well. I'd say actually we’ve executed poorly. I do think it's an opportunity and I think we will make some investments for this coming fall season in incremental enrollments around Career, remains to be seen if we can be successful, but we definitely think it's a significant opportunity. We believe that part of our issue has been around execution, and we will definitely make some investments in that direction for this fall.

Got it. Well, thanks again for the time and congrats on the results.

Thank you.

Thank you, ladies and gentlemen. As we have no further questions at this time, we will conclude today's conference call. We thank you for participating and you may now disconnect.