Stride, Inc. Q3 FY2024 Earnings Call

Good day, everyone, and welcome to the Stride Third Quarter Fiscal 2024 Earnings Call. Today's call is being recorded. I would now like to turn the conference over to Timothy Casey, Vice President of Investor Relations. Please go ahead.

Thank you, and good afternoon. Welcome to Stride's third quarter earnings call for fiscal year 2024. With me on today's call are James Rhyu, Chief Executive Officer; and Don 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 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 will answer any questions you may have. I will now turn the call over to James. James?

Thanks, Tim, and good afternoon. The state of education in the United States continues to evolve, but more importantly, the way parents and students view that education is evolving. Every survey and research I have seen this year confirms that customers want choice. A recent survey by the National School Choice Awareness Foundation strongly supports this. Of those surveyed, almost three-quarters indicated that they’d at least considered a new school for their child over the past year, an increase from just over half last year. Almost two-thirds looked for a new school for their child, and over half said they were likely to consider a different school over the coming year. The paradigm on college as a default option for students is beginning to show real cracks. In a recent survey of high school students, more students found that on-the-job training courses leading to licensure and courses leading to professional certifications were a better value than two- or four-year college degrees. That value equation between college and skills training is swinging in favor of skills training. The Wall Street Journal also recently published a number of articles on this trend. They reported that 52% of college graduates are in jobs that do not make use of their skills or credentials. They also reported on the growing trend of Gen Z students entering skilled trades, leaving the traditional college path behind to pursue high-paying skilled jobs. One of the most compelling findings was that the most critical factors for college graduates defining success are the things that Stride can offer at the high school level: a choice of major, internships, and getting the right first job. We, at Stride, are delivering tomorrow's education today. Artificial intelligence also continues to dominate the news cycle in education as well as other industries. We are building a foundation to support our AI efforts and are developing and testing ways to improve the customer experience for the teachers and students we serve. Initial feedback is very encouraging. We remain committed to incorporating AI and other technologies into our programs, but we will do so by putting the right tools into the hands of teachers and students to supplement their work and empower all parties. Now we just finished another incredible quarter. We reported record quarterly revenue and our enrollment hit a new all-time high of 198,400 students, sequentially higher than last quarter and higher than the pandemic levels of fiscal year '21. Our in-year enrollment growth now for two years running indicates that the landscape of education choice is expanding and is more fluid, and that the fall is just one indicator of customer sentiment. Many of you are already wondering about the upcoming fall season. While we are focused on delivering for our customers this year and ending the year strong, if the trends we are seeing in enrollment continue, we've set ourselves up for a strong fall season. Application volumes as a proxy for demand continue to trend strongly, and conversion rate indicators are positive. As of today, we have the largest cohort of re-registering students in Stride's history. There's still a lot of work to be done before next school year, but we feel we are well positioned to continue to grow enrollment. Given the landscape of education today, I believe Stride represents one of the many emerging trends on the future of education by delivering on tomorrow's education today that is accessible, technology-driven, flexible, career-focused, and proven. With that, I'll pass the call to Donna. Donna?

Thanks, James, and good evening, everyone. As James talked about, we continue to see strong in-year enrollment trends in the third quarter. Coupled with our strong retention numbers, we feel comfortable increasing both our revenue and profitability guidance for the full year. We now anticipate revenue growth between 10% and 11% and adjusted operating income growth between 39% and 44%. These growth rates align with the annual growth rates we outlined in our 2028 target in November. Turning to our quarterly results, we reported revenue of $520.8 million, an increase of 11% from the third quarter of fiscal year 2023. Adjusted operating income of $96.4 million was up 20% from the same period last year. Earnings per share rose to $1.60, an increase of $0.30 from last year, with capital expenditures of $16.3 million, up $1.1 million from last year. Career Learning, middle and high school revenue grew 11% to $167.9 million. This performance was driven by enrollment growth of 10% year-over-year and revenue per enrollment growth of 2%. We continue to see enrollment growth in the quarter, up over 1,000 from the second quarter. This is a continuation of in-year enrollment trends we've seen in the second and third quarters over the last two years. In our General Education business, revenue was $328.9 million, up 14% from last year. This strength was also driven by continued enrollment growth in the quarter, with average enrollment finishing the quarter up almost 4,000 from last quarter. Revenue per enrollment in the quarter was up 7.5% from last year. As we think about the fourth quarter, it's important to remember that we anticipate enrollment declines from the third quarter high, as most of our programs no longer accept new enrollments during the quarter. There is always the opportunity for us to convert these leads into enrollments for the upcoming school year, but we still expect a sequential decline in Q4. Per pupil revenue continued to be impacted by timing, and particularly for Career Learning, we are comparing against a strong comp from last year when we finished the year up 16%. We continue to see good funding increases across General and Career. However, in any given quarter, these can be impacted by a number of things, including mix, yield, and timing impacts from prior year catch-up that we've previously discussed. While it's still early in the process for next year's funding, as of right now, we see an overall positive funding environment at the state level for fiscal year 2025, although not as strong as we’ve seen over the past two years. States are grappling with the loss of extra funding in the coming school year, which could impact how they decide to allocate funds across schools. Our adult learning business continues to be impacted by the slowdown in our quoting programs. Revenue for the quarter declined $5.9 million to $24 million. Next, our Allied Health programming continues to see strong growth, but not enough to offset declines in our boot camps. MedCerts should finish the year with revenue growth of more than 20%. Gross margin for the quarter was 38.7%, up 140 basis points from last year. We're still benefiting from the efficiency efforts we've implemented last year, though not as strongly year-over-year as some of these efficiencies took hold in the back half of last year. Importantly, we're not content with those efforts, and we continue to drive improvement in gross margin while supporting strong academic outcomes. For the full year, we still expect to see gross margins improve by 200 to 250 basis points. Selling, general and administrative expenses for the quarter were $113 million, up 10% from last year. Stock-based compensation for the quarter was $5.3 million. We now expect to finish the year with stock-based compensation in the range of $28 million to $31 million. Adjusted operating income for the quarter was $96.4 million, up 20% from last year, marking our strongest quarter ever. Adjusted EBITDA was $120.5 million. As with every year, we expect fourth quarter profitability to be less than the third quarter as we begin to ramp up marketing and other spend for the upcoming school year. Interest expense for the quarter was $2.4 million. Our effective tax rate for the quarter was 26.1%. Diluted earnings per share was $1.60. Capital expenditures in the quarter were $16.3 million, $1.1 million above our spend last year. Free cash flow, defined as cash from operations less CapEx, was $52.2 million, down from the prior year period, mostly due to timing of cash receipts. We expect fourth quarter free cash flow to significantly exceed last year as a result. We finished the third quarter with cash and cash equivalents of $376.6 million and marketable securities of $194.1 million. Based on continued in-year enrollment and retention trends, we are raising the low end of our full-year revenue guidance and updating our profit guidance. We now expect revenue in the range of $2.025 billion to $2.04 billion, adjusted operating income between $280 million and $290 million, capital expenditures between $60 million and $65 million, and an effective tax rate between 24% and 26%. Thank you for your time. Now I'll turn it over to our operator for Q&A.

We take our first question from Alex Paris with Barrington Research.

Hi, thanks for taking my questions. And congrats on the beat and raise. I just have a couple of questions here. First off, while Career Learning is still growing enrollment faster than General Education, General Education has accelerated. And now the growth rates are kind of comparable. Is that how we should think about the growth rates regarding the respective segments going forward, comparable growth rates now that you've rolled out Career Learning so significantly?

Yes. I think directionally, that's probably right, Alex. I think the only distinction really is going to be on two levels. One is, obviously, mix, meaning predominantly our career programs are high school-oriented, right? So there's great mix in the shifts. We've seen strength in some of our lower-grade programs recently, but that can shift. And then schools opening. To the extent that we have new programs opening, we really do try to ensure they open with career programs, but several dynamics could make that uneven. But yes, I think both of those will continue to grow, and they're going to continue to have strong market dynamics for us.

Speaking of opening schools, what's the plan for fiscal 2025? If you could talk about it, either in terms of new states or new programs and a number of new core learning programs versus a number of new General Ed programs?

One of the things we laid out as part of our Investor Day back in November is a number of states that we are focused on looking at, continuing to try to expand in the states where we're not currently operating to grow programs in states we already do. I don't have anything to announce today. As you might recall, when we talked about our 2028 guidance, that guidance was not predicated on the fact that we would add new states, but we are having great conversations with states to add new programs. We will have more to discuss in Q4 and Q1, but we don't want to get ahead of ourselves before we have any deal signed.

One thing I'd add is that the new states versus new programs equation for us sometimes is not obvious where the better benefit is. For example, some states have restrictions on our programs, limiting us to grow in size and scope. In those states with high demand characteristics, it can be more beneficial to open a new program rather than a new state. This is not necessarily a trade-off; it’s about seizing opportunities that present themselves where we believe growth will thrive.

If there are states where we are nearing caps, we have opportunities for growth by either having those caps eliminated or expanded.

Thank you for that information. I have one last question before I return to the queue. I've noticed that the other income line item is growing quite rapidly, both for the quarter and year-to-date. Can you explain what is included in that line of other income, following operating income?

As you know, we generate a lot of cash in the business, and we're taking that cash and investing it in marketable securities. That’s what’s driving the increase in that line item. If you look at our cash number, it may be lower than you would expect because we're actually investing that cash. You'll see some of that in our marketable securities and short-term assets as well as our longer-term assets.

Great, super helpful. Thank you. I’ll get back in the queue.

We'll take our next question from Jeff Silber with BMO Capital Markets.

Hey, thanks so much. This is Ryan on for Jeff. Just had a question on the funding environment. We saw some data that districts are beginning to cut back on tech spend just to get ahead of the cliff in September. I was wondering if you could give any more color on your confidence on the funding environment for next year. Thanks.

Yes. I think there are two separate issues at play here: the ESSER cliff you mentioned and the overall funding environment. The ESSER cliff is a federally funded program, while baseline funding is largely state-based. Districts are indeed feeling pressure because that federal funding is set to disappear. Historically, the intent of that funding was temporary and was not meant for ongoing structural costs. Many districts have made their own decisions regarding how best to manage their costs moving forward. We, however, have not had the same pressure because we haven’t relied heavily on that funding. We have seen some benefits indirectly, but our cost structure doesn’t need adjustment due to ESSER funding ending. That said, we've kept the pursuit of cost efficiency at the forefront. Overall, the funding environment at the state level remains positive and stable as we move into next year, with expectations of continued funding increases. While we anticipate some one-time impacts based on mix and flow-through factors, we do not foresee any severe issues.

Got it. That makes a lot of sense. And then just for the follow-up, I think you mentioned your application volumes and conversion rates were looking good for the fall cohort. I know it's still kind of early. Can you give any more color on what's driving that success?

Yes. My comment was really focused on the trends this year as we are just beginning the fall cohort season. There isn’t a lot of data yet, but the in-year season we’ve seen has been strong. Application volumes and conversion rates are both positive, and if this year’s trends continue, we expect a good fall season. We’ve worked hard over the past couple of years to improve our operational efficiency, which has positively influenced both application volume and conversion rates. Market dynamics also play a crucial role, contributing to this optimism.

Got it. Great quarter. Thank you very much.

We take our next question from Greg Parrish with Morgan Stanley.

Good evening. Thanks. I’d like to add my congrats on the quarter and strong results. So I guess I'll just ask about fall enrollments a slightly different way. Maybe just kind of zooming out higher level, you have sort of long-term financial targets out there that imply mid-single digits to high single-digit enrollment growth, high single-digit at the upper bound of your 2028 targets. So that's kind of the framework you have out there. If you think about next year, are there any sort of headwinds to that framework? Or do you expect the kind of growth in the long-term framework knowing what you now?

Yes. Based on what we see, we don't foresee any headwinds against that framework. I think your question is a good way to think about it. We are trying to build a long-term growth business. I understand people's concerns about the fall, but we are committed to long-term growth. The market dynamics and our own operational cadence suggest we are right within our growth framework and expect to continue executing well against that.

Great. And then maybe talk about the M&A pipeline. I mean, is that full at the moment? Could you see things ramping up? Are you seeing M&A activity kind of ramp up broadly? And then, sort of secondly and related, maybe you can update us on the Board's willingness to potentially leverage up if the right acquisition target presents itself? Or do you sort of prefer the very low leverage position you're in?

We've always been active in our M&A pipeline. I must admit I’m a bit bearish on valuations at this point. I don’t see anything on the near horizon for us. I want to ensure that we deploy capital for good returns with high probability. My Board would support the right strategic deal if it comes along, including if that means leveraging up, but they'd be focused on making responsible long-term decisions for shareholders. Personally, I prefer the lower leverage position we're currently in. Ending the year with a few hundred million dollars in net cash puts us in a comfortable position, especially with several hundred million dollars of maturity due in a few years. We must be cautious of the credit markets, which can tighten suddenly.

Awesome. Yes. That's great color. And then maybe for my last question, sort of an odd one. But I want to talk about your marketing strategy. You're ramping up your campaign for this year. I don't know if you're doing anything differently. You talked about this on the prior question; you saw a lot of improvement last year versus the year prior. So I guess this season, is it running the same game plan that gave you success last year, or are there any material changes?

Yes. It's a little bit of both. The program we ran last year was an improvement over the prior year, and we will continue with those strategies. However, we also have a multiyear roadmap of improvements that require time, investment, and execution. We can't implement everything at once. I believe there are still many opportunities for us to improve our execution, streamline the funnel, and convert more leads. The team has laid out a strong plan to continue improving our metrics.

We'll take our next question from Tom Singlehurst with Citi.

Thank you for taking my question. This is Tom from Citi. I have a couple of inquiries. First, I have noticed that Pearson, as a competitor, has reported several contract wins, indicating they have taken over existing virtual school operations. I'm curious if there are similar opportunities for Stride to acquire additional operational schools and if this could lead to enrollment growth in the future.

I want Pearson to succeed, as a healthy competitive market benefits everyone. Education in this country needs that balance. While I respect their pursuit of growth through acquisitions, I believe we can grow the pie instead of dividing it further. Our approach focuses on expanding our own customer base without needing to take over others' clients. Our growth plans are not dependent on new states or winning contracts from competitors. We will continue pursuing our long-term targets independently of that segment of competition.

The second one is on the technology boot camps piece. I mean, obviously, the trends that you're seeing there are representative of what's being seen sort of across the industry. I'm just interested in what, if anything, you're going to do about it? I mean, is it just one of those things where you just need to stick with it and wait for it to work through? Or is there some remedial action to try and stimulate demand? Any thoughts on when that turns around would be very much appreciated. Thank you.

Yes. What we're experiencing is indicative of the broader market. Trends are changing quickly as people realize the implications of AI and how expensive it can be for developing a large language model. We’re taking a foundational approach to investing appropriately for outcomes that benefit our customers. Instead of making sensational announcements around AI, our strategy remains focused on long-term significance in skills training, especially in tech. Corporate B2B opportunities seem to be emerging, reinforcing the value of tech education. While I can't predict a turnaround timeframe, I believe in our long-term growth strategy and its capacity to adapt to evolving market conditions.

That’s very clear. Thank you.

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

Hey, James and Donna, you have Matt Filek for Stephen Sheldon. Congrats on the nice quarter. And thank you for taking my questions. To start, can you provide an update on tutoring and share some thoughts on when tutoring might become more material to the story?

Our approach to tutoring is twofold. Firstly, we focus on our traditional online tutoring solution featuring state-certified teachers, which is distinguished in the market. Several states are allocating funds for these programs, and we're gaining traction with new clients. While I don't expect it to become material to our $2 billion-plus revenue line within the next year, it does have long-term potential. We're seeing promising growth and contracts for next year, along with favorable customer feedback. The competitive landscape is changing, with new players introducing AI products, but we also foresee opportunities in that area. We're also exploring how to augment our tutoring offerings with AI-driven solutions using proprietary small language models. The quality of vendor products is fluctuating, which may compel districts to seek bids, presenting us opportunities.

Got it. That's helpful. Great to hear the initial traction has been strong. Just as a quick follow-up to that, though. Can you remind us your plans on delivering the tutoring services to non-Stride students? Is that something that students would come directly to Stride for? Or could those tutoring services possibly be delivered through integrating with a learning management system or something similar?

Our service is delivered directly to consumers and through districts at present. Integration with a learning management system or similar back-office solution is definitely something we would like to explore. We don't have announcements right now, but the proposition is compelling. However, there are important issues to consider, such as student privacy and concerns related to AI-generated outputs. We must be deliberate about how these tools are rolled out and ensure they function appropriately.

Got it. That’s helpful. Thank you, James.

And with that, that concludes today's presentation. Thank you for your participation today, and everyone may now disconnect.