Earnings Call Transcript - LRN Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the Stride, Inc. Second Quarter Fiscal 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Instructions have been provided. Thank you. Tim Casey, Vice President of Investor Relations, you may begin your conference.

Tim Casey, Vice President of Investor Relations

Thank you and good afternoon. Welcome to Stride’s second quarter earnings call for fiscal year 2022. With me on today’s call are James Rhyu, Chief Executive Officer and Tim Medina, 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 the Investors section of our 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?

James Rhyu, CEO

Thank you. Good afternoon everyone. As I enter my second year as CEO, I wanted to reflect on this past year and provide some insight into what I see for our future. Environmentally, here are some observations. Unfortunately, the COVID pandemic continues to wreak havoc, even as vaccines have become widely available. There continue to be significant disruptions and uncertainty to K-12 learning. American workers are quitting their jobs at record high levels, with more than 4.3 million public sector workers quitting in November 2021 alone. The national teacher shortage continues to be acute and issues with in-school districts across the country made getting back to normal that much more difficult. As a nation, we continue to politicize issues that should not be political, and education unfortunately continues to be one of those areas. Employers and employees are settling into the work-from-home trend, with estimates showing that almost one-third of all workers were remote at the end of 2021. This environment will continue to cause uncertainty across many sectors of our economy. We already see rising inflation and interest rates and continued disruption in the supply chain. I believe Stride is well-positioned in this environment to continue to thrive by providing solutions that meet the very demands of our times. People of all ages are searching for more educational choice and flexibility, and they're seeking training options to prepare them for economically sustainable careers. Meanwhile, employers are looking for well-trained workers to fill the nearly 11 million job openings in the U.S. Last April, I said that I believe Stride would grow through the pandemic and that I believe the pandemic has created a longer-term structural opportunity for us. My belief is stronger now than it has ever been. One aspect of our culture that helps us is our continuous focus on outcomes. Regardless of what area or discipline, we need to ensure that our students and company are achieving the outcomes we expect. We recently sent out a survey to our alumni to hear what they think. The results demonstrated that what we are doing can have an incredibly positive impact on their lives. 94% of those surveyed believe their online school experience was a success, 92% believe that they benefited academically from their online school experience, and 82% feel that they are on the path toward their desired career. I believe we are just getting started. Another area I've been focused on is innovation. More than 20 years ago, Stride was one of the first education technology companies to enable students to learn online. Now, millions of students later, we must continue to innovate to drive outcomes and reach more learners. To that end, we're continuing to develop new products that will expand our market opportunity and ensure we remain at the forefront of education technology. We are investing behind our digital-first curriculum, our career platform, enrichment programs like eSports, and our professional development platform among other initiatives. This fall, we should have some additional exciting news on how we are progressing. We have an amazing team with an incredible amount of experience in education and technology and I want to ensure we are leveraging that for bigger, more mainstream opportunities. We published our first ESG report in June, outlining the four cornerstones of our approach: expanding lifelong learning options, supporting racial and socio-economic equity and inclusion, fostering transparent leadership, governance and professional development, and contributing to a more sustainable world. We've done some great work already in these areas and are going to continue our focus. I encourage all our investors to read the report and the supplemental update we published in November. Looking forward, we anticipate publishing yearly updates on the great progress we will be making. It's also been just over a year since we acquired MedCerts and Tech Elevator. Tech Elevator is growing at over 30% and continues to be on pace to hit both its financial and strategic goals. Similarly, MedCerts' revenue has grown over 50% and is far exceeding our business case assumptions. Strategically, we've been able to leverage these businesses to grow our overall career initiatives. This year, we introduced to much success a pilot that enables high school students to take MedCerts certificate programs. These businesses are run by innovative leaders and remain well-positioned in their respective markets to continue to grow. The macro environment remains very positive for continued demand for software development and Allied Healthcare training. In November 2020, we outlined our five-year financial targets, which we continue to believe we are well on pace to achieve. Underlying all these assumptions is our strong belief that the COVID pandemic has structurally changed the demand for Stride's offerings. We continue to see positive demand characteristics across our offerings. Over the past several months, since our count applications to our managed programs have trended up almost 30% from last year. Today, we sit at enrollment levels higher year-over-year across our managed programs after starting the year down 3%. Many have predicted since the inception of the pandemic that the increased demand for our programs would be temporary. Well, after almost two years and demand remaining strong, I'm not convinced the opposite isn't true and that demand will continue to swell. The pandemic also demonstrated that the U.S. needs to be more open to educational options for families. We are now having conversations with states and school districts that, even two years ago, would not have been possible. Thus, we've increased demand from families and a more receptive educational system, both of which we believe put us on a trajectory to achieve our fiscal 2025 targets. In our General Education business, we are targeting fiscal year 2025 revenue of $1.25 billion to $1.4 billion. A few themes will drive this growth. First and foremost, the overall demand characteristics that I just mentioned. While we used to believe the penetration curve for our programs flattened out around 2% to 3% of the student population, there's growing evidence that we have hit an inflection point up the S-curve and penetration may begin to climb to upwards of 10% to 15%. Second, increasing the number of programs and states that offer our Stride-powered solutions. While our recent focus has been on growing Career Learning programs in states, the pandemic and resulting demand for educational options has led many schools and states to be more open to full-time virtual programs. In fact, we know today that we will be opening a program in at least three new states this fall. And third, the economic and political landscape for the pandemic has produced a recognition of the need for our programs. One easy macro trend we know is putting the wind at our backs in the work-from-home trend. The ability for families to logistically manage virtual learning for their children because they're at home creates significant long-term upside for our business. In our Career Learning business, many of the same characteristics will allow us to achieve $650 million to $800 million in revenue by fiscal 2025. This is a market that is still in its early stages and we believe there is significant growth ahead. We continue to hone our messaging to ensure that parents and students understand the value proposition of our career programs so we can tap into the increment audience for Career Learning. We also have our Adult Learning businesses, which we anticipate will reach at least $140 million to $150 million in revenue by fiscal 2025. These businesses are well-positioned to train the workforce of today and tomorrow, while helping current workers get the training they need to achieve their career goals. These two businesses should drive our ability to achieve close to $2 billion-plus in revenue and $250 million to $350 million in adjusted operating income within the next four years. We believe there's potential upside to that with new product revenue that is not in these goals. As I mentioned earlier, this is an area where I think we can innovate and make some serious inroads. We have an incredible core of assets from which we can launch innovative and mainstream products. In March of this year, we will be introducing our professional development to a broader audience through an inaugural Stride Promising Practices Conference that will be open to everyone. The theme for the conference is career readiness education. It will be held virtually and will be free for all teachers, administrators, counselors, and families. Our professional development experts will share best practices in teacher effectiveness, student socialization, leadership, and special programs. We'll also have an exhibitor hall that will feature our education partners and we will share a demonstration of Stride's platform and content. We hope this conference can help improve the education of students across the country. Finally, as we turn the calendar to 2022, I'm grateful for the dedicated teachers and employees who remain focused on students in the midst of many distractions. Thank you all for what you do. I hope everyone remains safe, and thank you for the time today. Now, I'll pass the call over to Tim. Tim?

Tim Medina, CFO

Thank you, James and good afternoon everyone. First, let me recap our reported results. Revenue for the quarter was $409.5 million, an increase of 9% from the same period last year. Adjusted operating income was $60.7 million, up $10.6 million or 21% from last year’s second quarter. Capital expenditures were $14.2 million, an increase of $3.4 million over last year. We exceeded the revenue and profitability guidance we provided last quarter. We continue to see strong demand for our General Education and Career Learning programs. We believe this demonstrates that families value our virtual programs and are choosing us even when other options are available. Returning to our results for the second quarter in more detail, revenue from our General Education business was down just slightly to $313.2 million. This is due primarily to the expected decline in enrollments offset by an increase in revenue per enrollment. General Ed enrollments were 145,600, down from last year's COVID impacted results of more than 161,000 enrollments. Revenue per enrollment in General Ed increased 11% from the second quarter last year. We continue to see favorable funding and for the full year, we expect to see revenue per enrollment that is substantially higher than our fiscal 2021 results. Career Learning revenue was $96.3 million, up 55% from the second quarter of last year. This is driven by growth in Stride career prep enrollments and growth in our Adult Learning business. Middle and high school Career Learning revenue was $75.3 million, up 47% from last year. This was driven by a 38% increase in enrollments and a 7% increase in revenue per enrollment. Like our General Education business, we expect our revenue per enrollment in our Stride career prep programs to improve significantly over last year. Adult Learning revenue was $21 million. We acquired MedCerts and Tech Elevator mid-second quarter last year, so our results next quarter should give a better year-over-year comparison for organic growth. Gross margins for the quarter were 36%, an increase of 160 basis points compared to last year. As we said last quarter, we've returned to a more seasonal pattern for our cost of revenue. Selling, general, and administrative expenses were $90.6 million, essentially flat from the prior year period. We expect that SG&A expense for the year will be in line with last year as we've continued to focus on efficiencies and automation in our business. Stock-based compensation was $0.6 million for the quarter. This was well below our expectations and we now expect that we will finish the year with stock-based compensation in the range of $20 million to $22 million. Adjusted operating income for the quarter was $60.7 million, above the top end of our guidance from last quarter. Adjusted EBITDA was $82.7 million. As expected, we're beginning to see increases in our profitability, in line with a return to a more normal seasonal pattern of expenses than we had in last fiscal year's quarterly trends. Our effective tax rate for the quarter was 28%. We now think that we will finish the year with a tax rate in the 27% to 30% range. Capital expenditures in the quarter totaled $14.2 million, up $3.4 million from the second quarter last year. We continue to invest in new products, which we believe will expand our addressable market, allow us to become a more mainstream consumer-focused company, and generate higher margins. Free cash flow was $105.7 million, up from $23.8 million last year. This increase is tied to revenue growth and the timing of our receipts. We expect to see positive cash flow for the rest of the fiscal year. We finished the quarter with cash and cash equivalents of $257 million. Now, turning to our guidance for the third quarter of fiscal year 2022, we are guiding to revenue in the range of $405 million to $415 million, adjusted operating income between $60 million and $65 million, and capital expenditures between $15 million and $18 million. For the full year, we are raising revenue and profitability guidance. We expect revenue in the range of $1.62 billion to $1.64 billion, up from $1.56 billion to $1.60 billion previously. Adjusted operating income between $175 million and $185 million, up from $165 million to $180 million previously. Capital expenditures between $65 million and $75 million and an effective tax rate between 27% and 30%. Thank you for your time today. I'll turn the call back to the operator.

Operator, Operator

Instructions have been provided. Your first question comes from Jeff Silber with BMO Capital Markets. Your line is open.

Jeff Silber, Analyst

Thank you so much. You kind of opened up talking about next year when you talked about the potential three new states for General Ed, so let me focus on that. I know it's probably too early for any enrollment indicators, but if you can give us a little bit more color on those three new states, if you're willing to give us enrollment indicators, that'll be great. And then also, I'm just wondering what you're thinking for the funding environment for next year? Thanks.

James Rhyu, CEO

Yes, thanks for the question, Jeff. We definitely have three new states: Georgia, which is already known, New Hampshire, and West Virginia, both of which are also known and prepared for the fall. In the long term, Georgia shows significant enrollment demand. However, in the short term, our arrangement will have a limit, so we won't be able to meet all the demand in that state. Nonetheless, it represents a great opportunity for us going forward. The other states are smaller, but we've put in significant effort to establish our presence there, and they are important for us. They also indicate an increase in the willingness of states that were previously closed off to us to engage in meaningful discussions. Looking ahead into the coming years, the outlook appears favorable for opening new states, and while I won't provide specific numbers, the trajectory looks strong.

Jeff Silber, Analyst

That's great. And I'm sorry, did you address the general funding environment for next year?

James Rhyu, CEO

No, I'm sorry, Jeff. The general funding requirements continue to be strong. We don't see a lot of headwinds at the state level. I think you'll see continued tailwinds around funding. It’s important to note that there are pockets in the education sector in grades K-12, where districts are running low on money and that's flowing to some of our education peers. That flood of money from the federal government isn't going to give us a huge lift next year in funding, but the overall environment remains very strong.

Jeff Silber, Analyst

Okay, great. And I think last quarter you talked about some issues in terms of finding teachers. I'm just wondering if we can get an update on that, how that's going and what you see going into next year?

James Rhyu, CEO

Yes, the national teacher shortage remains an issue across the country. It's not just us; we see this across the entire landscape of the U.S. I think, this year, we found equilibrium now that we're in January. I think we've worked hard throughout the year to get teachers. I think we've established a good approach to accelerate hiring going into next fall, so we will hopefully get ahead of it more than we did this past year. I think the shortage will continue into next year. We see many teachers leaving the profession altogether. However, there's less controversy surrounding the environment within programs like ours, but across the nation, we see actually teachers leaving the profession altogether. The long-term macro trend over teachers works in our favor. The educators entering the profession are more aligned with digital education, which works in our favor. As teachers in traditional school districts become disillusioned, that also gives us an opportunity. Our teacher satisfaction remains very high. So, the general trend for the teacher shortage as a nation remains intact, but the trends for us specifically will improve heading into next year.

Jeff Silber, Analyst

Okay, that's great to hear. I'll jump back to the queue. Thanks so much.

Operator, Operator

Your next question comes from Stephen Sheldon with William Blair. Your line is open.

Stephen Sheldon, Analyst

Hey, thanks for taking my questions. On the enrollment numbers here looks really solid, so I would love to just get some more color on what you saw, especially in the last few weeks in terms of retention rates for the start of the new semester and whether you saw any notable benefit from new students signing up for the first time this semester. So, maybe just high-level commentary on retention rates and new enrollment trends for the second half of this fiscal year?

James Rhyu, CEO

Yes, so retention rates, we saw last year, I think unexpectedly to a lot of us, that retention rates were better than the prior years. There was an assumption that retention would get worse once brick-and-mortar schools reopened. However, we've seen this year that our retention rates remain better than pre-pandemic levels, similar to last year. They're not significantly different from last year, but they remain improved to pre-pandemic levels. So, retention is a good news story for us and continues to be strong this year. For new enrollments, the trend is also strong; since we announced our count date back in October, enrollment demand for our programs is up actually a little north of 30%. We continue to see strength in the demand side of this equation; we see customers looking for alternatives and they see us as a viable option in many cases. As we stand today, year-over-year, our enrollments now have surpassed last year, so we see positive trends on both fronts.

Stephen Sheldon, Analyst

Got it. That's great to hear and really helpful. And then I guess it was a follow-up, I know it's a small business, but what can you share about what you're seeing in the institutional business? How has that been performing relative to your expectations? And how are you thinking about the growth potential there as we consider the next few years?

James Rhyu, CEO

The institutional business over the next few years is really going to surprise a lot of people on the upside. We have had challenges with that business. However, we see order of magnitude, the largest pipeline we've ever built. I think the demand side of this equation is strong and our offerings in the market are getting stronger. We plan to launch some new products in the fall over the next couple of years that will capture digital trends in K-12 education. We're expecting strong growth in our institutional business, and I believe it will be a winner for us long-term.

Operator, Operator

Your next question comes from Tom Singlehurst with Citi. Please go ahead.

Tom Singlehurst, Analyst

Yes, good evening. It's Tom here from Citi. Thanks for taking the question and congrats on the results. A couple of questions. First one, revenue per enrollment; I just wanted to understand and this is just the training, it's like lack of knowledge on my part, but just to clarify whether there's a seasonality to those figures and can you go over again what your expectations are for the full year? I missed that in Tim's commentary. The second one, I'm interested, once again, this is a point on disclosure. I think you mentioned there’s still a bit of an M&A anniversary impact on the growth rates for pure Adult Learning; can you just give us the pure underlying revenue growth? I know you mentioned the impact of M&A, but just whether there's a proper underlying number that we can focus on? That'd be a great question to start off if that's okay.

Tim Medina, CFO

Great. Sure, Tom. Well, I'll start with the second question. This is Tim Medina. What we said in our prior call that I would still repeat here is that we expect the Adult Learning business overall to approach $100 million for the year. We would still say that and so rather than giving you a year-over-year comp, I'd just note that the outlook indicates very strong organic growth year-over-year. On the first question, the revenue per enrollment is expected to not just be higher than FY 2021, but actually go all the way back to FY 2020 levels and surpass them. So, we will continue to state that we expect a full rebound back to above FY 2020 for both Career Learning and general enrollment. There's no particular seasonality to the way our numbers come in. Any anomalies in estimates will cause quarter-to-quarter variations, but no particular seasonality.

James Rhyu, CEO

One thing I would add is our most recent acquisitions, Tech Elevator and MedCerts; they continue to perform very well against our acquisition plan. They're both organically growing north of 25% year-over-year. We've got great leaders in those businesses who are doing a fantastic job in finding opportunities to expand, and they've been tremendous strategic assets as leaders across Stride. We continue to be very bullish on those acquisitions.

Tom Singlehurst, Analyst

And that leads on to the next question, which is, I'm actually going to have two questions on cash flow. But I'll start with the second part, which is given you mentioned M&A, I'm surprised you guys haven't done more transactions of a bolt-on nature. I'm just interested in whether that's just the way it is, and the pipeline's relatively forward. Is that sort of delayed in the last year, or is that a conscious delay?

Tim Medina, CFO

Yes, I think there's no delay. We have a very active pipeline of deals that we look at. Valuations within our sector in the public markets have really trended down, but in the private markets, where many of the deals we consider are, they haven't trended down as much. We want to be responsible deployers of our capital, and when we do, we want to do it at valuations that warrant capital deployment. While there are strategically interesting assets in the space, particularly on the career side that we might otherwise think about, we will only pursue them when the valuation equation makes sense for us and our shareholders.

Tom Singlehurst, Analyst

Okay. And one very final question for Tim, on working capital. I mean, obviously, the first quarter showed a relatively big working capital outflow, I think it's normal. Should we expect a fairly big working capital inflow across the balance of the year?

Tim Medina, CFO

Yes, that is correct. We expect to have strong free cash flow in Q3 and Q4, driven by good inflows of working capital.

Operator, Operator

Instructions have been provided. There are no further questions at this time. This concludes today's conference call and thank you for your participation. You may now disconnect.