Nerdy Inc. Q3 FY2024 Earnings Call

Good afternoon. Thank you for joining today's Nerdy, Inc. Q3 2024 Earnings Call. My name is Cole, and I will be moderating the call. I will now hand it over to your host, T.J. Lynn, Associate General Counsel of Nerdy. Please go ahead.

Good afternoon, and thank you for joining us for Nerdy's Third Quarter 2024 Earnings Call. With me are Chuck Cohn, Founder, Chairman and Chief Executive Officer of Nerdy; and Jason Pello, Chief Financial Officer. Before I turn the call over to Chuck, I'll remind everyone that this discussion will contain forward-looking statements, including, but not limited to, expectations with respect to Nerdy's future financial and operating results, strategy, opportunities, plans and outlook. These forward-looking statements involve significant risks and uncertainties that could cause actual results to differ materially from expected results. Any forward-looking statements are made as of today's date, and Nerdy does not undertake or accept any obligation to publicly release any updates or revisions to any forward-looking statements to reflect any change in expectations or any change in events, conditions or circumstances on which any such statement is based. Please refer to the disclaimers in today's shareholder letter announcing Nerdy's third quarter results and the company's filings with the SEC for a discussion of the risks. Not all of the financial measures that we will discuss today are prepared in accordance with GAAP. Please refer to today's shareholder letter for reconciliations of these non-GAAP measures. With that, let me turn the call over to Chuck.

Thanks, T.J., and thank you to everyone for joining us today. In the third quarter, we continued to make progress against the primary goals we laid out for the year. The first goal we shared was Scaling the winning product for every Learner. As we have shared in the past, we have historically seen that getting new customers on our platform and into tutoring sessions seamlessly and with little friction involved is highly predictive of customer satisfaction, retention, and ultimately, lifetime value. We identified that the first 30-day onboarding experience was one of the highest impact areas where we could drive durable improvements to retention and lifetime value. We focused a significant portion of our product and engineering efforts towards this area, which has resulted in multiple key enhancements being shipped recently that will benefit both consumer and institutional customers. These improvements to the digital experience focus on the fundamentals of a great customer experience. Our new onboarding assistant enables a customer's tutor placement request to be documented more accurately and efficiently, and we are seeing the improved completion rates and accuracy flow through to high-quality matches, faster time to first sessions, and higher levels of customer satisfaction. Our new tutor match tracker provides greater transparency into the matching process, making it easier for customers to manage their tutoring relationships, confirm scheduling availability, and introduce new members to the full breadth of our learning tools available to them. It also reduces the amount of new client inbound service requests prior to being matched to their tutor, which we expect to pull through to higher levels of customer retention. These user experience pages are delivering improvements across the first 30-day period post-activation for new customers. The specific areas that have improved include time to first tutoring session, first session attendance rates, higher levels of engagement in non-tutoring products like live classes and AI tutor, and a reduction in tutor replacements. These important changes are collectively leading to higher customer retention in new consumer cohorts. Consistent with the early trends we shared last quarter, the shift in our product mix towards memberships oriented around weekly tutoring habits, including our 4 and 8-hour options, coupled with digital experience improvements is positively affecting newly acquired cohorts. Among new customers that are now joining our higher frequency Learning Memberships this back-to-school season, we are seeing higher levels of tutoring sessions per week, higher levels of non-tutoring engagement due to improved discoverability across the platform, higher average revenue per month, and improved levels of retention in the first month. These trends benefited from further in-quarter improvements to the digital experience, which we believe will drive more consistent customer usage and lead to improvements in lifetime value and unit level economics. These positive trends in new customer cohorts were partially offset by lower retention in older customer cohorts that included a higher proportion of low-frequency Learning Memberships, which was a trend we spoke about last quarter. We expect this trend to continue through year-end and then subsequently subside. As we've discussed throughout the year, we made substantial investments in the Varsity Tutors for Schools' go-to-market organization and platform infrastructure. These investments primarily focused on three areas. The first was on converging the consumer and institutional platforms into a unified digital experience, which required significant product and engineering resources and was an initiative we completed last quarter. We believe that will allow us to go much faster in the future. The second area of investment was enabling access to the Varsity Tutors platform for the entire school district in order to serve millions of students and to establish a high volume of school district relationships with the aim of building trust and credibility. As we roll out access to our platform in a new school district, we are laying the foundation to become their preferred tutoring platform when they look to implement paid high-dosage tutoring programs in the future. The third area of investment for Varsity Tutors for Schools was in the expansion of the institutional go-to-market sales organization to drive further market penetration and bookings growth. In the third quarter, we saw and continue to see strong interest in school districts signing up for access to our platform. We successfully enabled access to the Varsity Tutors for Schools platform for an additional 1.1 million students, bringing the total to 4.4 million students at nearly 900 school districts during the third quarter. Student engagement with our platform was stronger than expected as students returned to school, demonstrating the relevance of our offering and the growing need for student support beyond the traditional classroom. As school started, significant effort was placed on trying to capture ESSER-related bookings and to launch platform access at hundreds of school districts. That required us to expend significant internal resources to support these efforts in a short period of time. We believe this was a good long-term investment. However, in the short term, it resulted in the trade-off of resources and focus, which impacted execution in the consumer business. We believe our strategy to offer access to the Varsity Tutors platform is yielding positive results by driving brand awareness and introducing our products to school district partners at a larger scale than ever before. 32% of paid contracts and 22% of total bookings value in the third quarter came from school district partners who initially partnered with us via no-cost access to our platform and subsequently converted to our paid offerings. This strategy of providing access to our low marginal cost products that have high perceived value is allowing us to build a large number of relationships with school districts and positions us to drive sustainable long-term growth within the K-12 market. The investments in the go-to-market function and institutional sales organization, in particular, were made in anticipation of a higher level of bookings. Our thesis was supported by the prior two years of institutional bookings growth, combined with the upcoming end of ESSER funding on September 30, 2024, which we believe could deliver a substantial amount of bookings with K-12 school districts. While we successfully executed 117 contracts during the third quarter, representing an increase of 46% year-over-year, those contracts only yielded $8.5 million of bookings, which was below expectations. We attribute the lower deal size to several factors, including entering back-to-school with a newly hired sales team, being overly focused on the ESSER deadline versus other funding sources, and the complexity involving onboarding free platform access school district partners. The institutional opportunity within K-12 schools represents a significant market opportunity and one for which we believe we're uniquely qualified. To better reflect a more normalized sales cycle in a post-ESSER environment that encompasses multiple different student populations and recurring funding sources within schools, we'll be moderating our level of spend to a level that we believe will support durable and profitable growth. As discussed last quarter, we've been working to modernize and enhance several components of our marketplace infrastructure. We are in the final stages of fully delivering several improvements to our underlying marketplace infrastructure systems, including session scheduling enhancements, invoicing and substitution automation and other improvements that we believe will allow us to provide best-in-class logistical reliability. Due to the resourcing required to support Varsity Tutors for Schools in the third quarter, certain marketplace infrastructure initiatives are taking longer than anticipated to fully implement. Once delivered, we believe that these initiatives will allow us to deliver meaningful gross margin improvements and operating leverage on a go-forward basis while simultaneously improving the customer experience due to the higher reliability levels of our marketplace infrastructure systems. Taking a step back, we believe that the growing awareness and recognition by parents, educators and policymakers that high-dosage tutoring is the most effective way to accelerate learning provides us with confidence in the demand for live tutoring in the years to come. We continue to deliver product enhancements that drive high levels of engagement with our platform, expand our customers' lifetime value and provide durable competitive advantages, which we believe will enable strengthening financial performance in the coming quarters. We appreciate your continued interest in our company and look forward to meeting the evolving needs of learners in any subject, anywhere and at any time. With that, I'll turn the call over to Jason to discuss the financials in more detail.

Thanks, Chuck, and good afternoon, everyone. As Chuck mentioned, we continue to make progress towards achieving the three primary goals we laid out for the year. In the third quarter, we delivered revenue of $37.5 million, a decrease of 7% year-over-year. Revenue declined primarily due to lower ARPM in our consumer business. ARPM was lower due to a higher mix of lower frequency Learning Memberships when compared to the prior year period. Consumer Learning Memberships' subscription revenue of $31.4 million represented 84% of total company revenue. Active members of 39,700 as of September 30 were up 1% year-over-year. ARPM of approximately $302 as of September 30 was up 7% from $281 at the end of the second quarter and resulted in an annualized run rate of approximately $144 million from Learning Memberships at quarter end. Our institutional business delivered revenue of $5.4 million, a decrease of 3% year-over-year and represented 14% of total revenue. Our platform access strategy in our institutional business is allowing us to introduce our products to school districts at a much larger scale than ever before. As Chuck mentioned, our strategy to introduce school districts to the platform and ultimately convert them to our fee-based offerings started to bear fruit in the third quarter, with 32% of paid contracts and 22% of total bookings value coming from school district partners who initially partnered with Varsity Tutors for Schools via free access to our platform and subsequently converted to our paid offerings. We believe that providing access to our platform is allowing us to gain market share and that we are building a strategic and differentiated asset that positions us for continued, sustainable long-term growth within the K-12 market. However, we are taking steps to moderate our institutional investments to reflect a more normalized sales cycle in a post-ESSER environment that encompasses multiple different student populations and recurring funding sources within schools that we believe will allow us to deliver durable and profitable growth as we move into 2025. Moving down the P&L, gross profit of $26.5 million in the third quarter was lower by 9% year-over-year. Gross margin was 70.5% for the three months ended September 30 and compared to a gross margin of 72.4% during the comparable period in 2023. The decrease in gross margin was primarily due to lower ARPM, coupled with higher utilization of tutoring sessions across Learning Memberships in our consumer business, partially offset by lower seasonal utilization in our access-based products in our institutional business. Improvements to our marketplace infrastructure systems, including scheduling, invoicing and substitution improvements are now expected to be fully implemented in the fourth quarter. Once implemented, these initiatives are expected to yield gross margin improvement and operating leverage on a go-forward basis while also improving the customer experience. Sales and marketing expenses for the quarter, on a GAAP basis, were $20.3 million, an increase of $1 million from $19.3 million in the same period last year. Non-GAAP sales and marketing expenses, excluding non-cash stock-based compensation, were $19.7 million compared to $18.5 million in the same period last year. Sales and marketing increases were driven by investments in our institutional sales organization in order to drive customer acquisition, brand awareness and reach. These investments were partially offset by consumer sales and marketing efficiency gains where we saw customer acquisition costs decrease by $1.6 million or 9% year-over-year in the third quarter. General and administrative expenses for the quarter on a GAAP basis were $31.8 million, a decrease of $3.7 million from $35.5 million in the same period last year. Non-GAAP G&A, excluding non-cash stock compensation expenses, transaction costs, restructuring costs and a provision for a legal settlement was $22.6 million compared to $20.5 million in the same period last year. Included in G&A costs were product development costs of $11.3 million, an increase of $1.2 million from $10.1 million in the same period last year. We believe our investments in product development and our platform-oriented approach to growth have allowed us to launch and continuously improve our suite of subscription and access-based products, which are allowing us to simplify our operating model needed to support the organization, allowing us to maximize our investment in the unified platform. Non-GAAP adjusted EBITDA loss of $14 million for the three months ended September 30 was above our guidance range of negative $17 million to negative $19 million and compared to a non-GAAP adjusted EBITDA loss of $8.2 million in the same period last year. Non-GAAP adjusted EBITDA improvements relative to guidance were primarily driven by lower sales and marketing spend, operating efficiency gains and diligent cost controls. Compared to last year, non-GAAP adjusted EBITDA was lower primarily due to investments in the Varsity Tutors for Schools sales organization and product development to drive innovation and support our growth. As of September 30, the company's principal sources of liquidity were cash and cash equivalents of $65 million, and we have zero debt. We believe our strong balance sheet provides us with ample liquidity to operate against our plan and pursue growth initiatives. Turning to our business outlook, we are providing fourth quarter and updating full year revenue and adjusted EBITDA guidance. Fourth quarter revenue guidance reflects higher sequential quarterly revenues from Learning Memberships and Varsity Tutors for Schools when K-12 schools and universities are in session. For the fourth quarter, we expect year-over-year consumer revenue will be impacted by a decline in the number of Learning Membership subscribers due primarily to a higher level of cancellations from older cohorts who purchased lower frequency Learning Memberships, coupled with lower average revenue per member per month. In our institutional business, we expect that the lower bookings year-to-date will result in the flow-through of lower revenues during the fourth quarter versus the prior year. For the fourth quarter of 2024, we expect revenue in a range of $44 million to $47 million. For the full year, we expect revenue in the range of $186 million to $189 million. We expect to deliver a sequential improvement in adjusted EBITDA from the third to the fourth quarter, which we would expect to continue into 2025. Fourth quarter adjusted EBITDA guidance primarily reflects the flow-through of lower revenue year-over-year, coupled with investments in the institutional sales organization and in product development to drive continued innovation and growth. For the fourth quarter of 2024, we expect adjusted EBITDA in a range of negative $7 million to negative $10 million. For the full year, we expect adjusted EBITDA in the range of negative $23 million to negative $26 million. As mentioned, we believe we have ample liquidity to fund the business and pursue growth initiatives. In closing, thank you again for your time and for your continued interest in our company. With that, I'll turn it over to the operator for Q&A.

Our first question is from Andrew Boone with JMP Securities.

Guys, understood the various puts and takes in terms of the 4Q guide. But can you guys double-click in terms of your visibility into stability in terms of the consumer side of the business? How do we think about timing there? And then stepping back more operationally, Chuck, can you talk about driving engagement with customers? How are you guys thinking about getting more frequency on the platform overall so that you do improve retention for consumers?

Thank you, Andrew. That's a great question. We assess the performance of the consumer business by looking at the older customer segments, which included both weekly tutoring participants and those who weren’t regulars. The latter group experienced higher churn rates at year-end, affecting our quarterly results. Conversely, customers engaged in weekly tutoring showed significantly better retention. This is because tutoring fosters habitual participation, like attending French sessions every Tuesday or LSAT prep on Thursdays. As we returned to the school year, we shifted our focus toward promoting weekly tutoring memberships. This approach not only improved retention but also enhanced our average revenue per member on both a combined and year-over-year basis. Additionally, we implemented several product enhancements outlined in our shareholder letter, which facilitated a smoother initial activation process. These improvements reduced friction, simplifying scheduling and tutor management. These enduring product changes have resulted in higher success rates for first sessions and several positive outcomes regarding tutoring engagement. We also upgraded our platform to enhance the visibility of various non-tutoring services, including our AI tutor, live classes, adaptive diagnostics, and self-service tools. This year, we've observed a growth in both individual engagement weekly and monthly compared to last year. Notably, non-tutoring participation has also increased during this back-to-school period due to these adjustments. Such engagement typically translates into improved retention rates. Consequently, after analyzing the early months of this back-to-school season, we've seen a reversal of previous negative year-over-year retention trends, bringing us back to parity. We firmly believe that our ongoing product enhancements will lead to significant retention improvements in the future. As these customer segments evolve, we expect overall retention metrics to shift positively.

We have no further questions in the queue at this time. We have a question from Greg Gibas with Northland Securities.

Curious if we could go a little bit further on the Institutional revenue, kind of what's driving the decline there? And nice to see that you enabled another 1.1 million students up to 4.4 million now. How is progress trending regarding kind of monetizing or upselling those offerings for school districts?

Greg, that's a great question. Over the past few quarters, we've made significant efforts in connection with the back-to-school season and the transition from the ESER program. This was based on our recent booking trends and the successes we've experienced. During this back-to-school period, we noticed a strong demand for our platform access strategy, which allows users to access our platform. However, we found that ramping up a new sales team for the season was more difficult than we anticipated. Additionally, the ESER program did not create the urgency we expected around the September 30 deadline. Looking back, we may have focused too much on that specific deadline instead of engaging in broader strategic discussions that address various funding types and needs of the districts. A positive takeaway is that as our platform and its product capabilities continue to evolve, alongside the integrations we've implemented, we can now meet a wide range of use cases. Whether school districts want to provide tutoring before school, during school, in class, outside of class, after school, or even on weekends with parents, we've made platform and software adjustments to support diverse needs. This also includes accommodating various student groups, such as those in K-5 dealing with math or reading challenges and certain special education students. We recognize that many school districts have available funding, and we're observing that our new sales team has experienced smaller deal sizes, which we attribute to their inexperience and new approaches. As the school year progresses and the team develops, we expect deal sizes to grow. While we feel positive about the volume of deals, we acknowledge the average deal size needs improvement. Nevertheless, the platform access strategy is effective; it is generating deals and helping us establish trust with districts. We have invested a lot of effort into this strategy, and we believe it will yield long-term benefits. Though it has been complex to have all the school districts start concurrently this back-to-school season, we have made great strides in product development and are seeing strong engagement from several districts, reflecting in the statistics leading to deals. Overall, we’re optimistic about the strategic advantage offered by our platform access and how it strengthens our relationships with these districts.

Yes. Maybe just to put some numbers behind what Chuck said, and appreciate the question, Greg. Platform access is allowing us to gain share in the market. We're building a strategic and differentiated asset that we think positions us for sustainable long-term growth within this K-12 market. Student engagement with the platform, as Chuck mentioned, was really high as we entered the back-to-school period, showing clear evidence of the need for support beyond the traditional classroom, and that the platform access strategy is starting to bear fruit. 32% of the paid contracts and 22% of total bookings value came from school district partners who originally partnered with Varsity Tutors for Schools via the free platform access and subsequently converted to our paid high-dosage tutoring offerings. So, we think that that's going to continue into 2025 and well beyond that and feel good about the work that we did during the third quarter to onboard nearly 900 schools.

Yes. And we definitely paid a short-term price in terms of resource allocation as back-to-school launched. But we feel good about the long-term strategic asset that we've built and how that ultimately generates growth and profitability.

I understand. That's very informative. Now, shifting to the consumer side, I would like to get more insight into your expectations for active member growth compared to ARPM dynamics in the fourth quarter on a year-over-year basis. Do you foresee any changes in those dynamics between the two? Additionally, regarding the lower customer acquisition costs you've mentioned, could you elaborate on what's contributing to that? Are those changes driven by different marketing initiatives or updates to your go-to-market strategy where you're experiencing success?

Sure. Thanks for the question. So, the positive trends we're seeing in the new customer cohorts we mentioned on the call, those were partially offset by lower retention in older customers that included a higher proportion of the lower frequency Learning Memberships. That was a trend we spoke to last quarter. We think that will continue through the end of the year and then subsequently subside. We think we'll end the year with about 36,000 active members. You mentioned ARPM. Importantly, we saw ARPM improve from $281 at the end of Q2 to $302 at the end of Q3 as we focused on those higher frequency customers. That trend will continue in Q4. We think we'll end around $310 and then again, continue to accrete as we move into 2025. Within marketing, specifically on the consumer side, we are seeing some efficiency there. Customer acquisition costs decreased by about $1.4 million or 8% year-over-year in the third quarter. When you couple that with consumer sales conversion improvements, our CACs were down about 14% in Q3, which we feel really good about, the durability of that efficiency improvement as we move into 2025 as we're able to target our marketing investments toward higher LTV customers and segments that have quicker paybacks.

There are no further questions in the queue at this time. So that concludes today's call. Thank you all for your participation. You may now disconnect your line.