Stride, Inc.

Good afternoon, ladies and gentlemen. Welcome to the Stride second quarter fiscal 2023 earnings conference call. At this time, all participants are in a listen-only mode, and please be advised that this call is being recorded. After the speaker's prepared remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star and 1 on your telephone keypad. If you would like to withdraw your question, simply press star 1 again. Now at this time, I'll turn things over to Mr. Tim Casey, Vice President of Investor Relations. Please go ahead.

Thank you. Good afternoon. Welcome to STRIVE's second quarter earnings call for fiscal year 2023. With me on today's call are James Roof, 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 STRIVE Investor Relations website. Please be advised that today's discussion about financial results may include certain non-GAAP financial measures. A reconciliation of these measures is provided in the earnings relief 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 I have described in the company's latest SBC. These statements are made on the basis of our views and assumptions regarding future events and business performance at the time we make them, and the company assumes no obligation to update any forward-looking statements made during this call.

Following our prepared remarks, we'll answer any questions you may have. I will now turn the call over to James. James? Thank you, and good afternoon, everyone.

I've said this now for the past couple of years, that part of our ability to succeed longer term dependent on the macro environment providing a tailwind for our products and services a survey that was released just last week found that more than half of all parents have considered a new or different school for their child over the past year as families continue to see a need for options more and more are aware that our programs offer that alternative and certainly awareness for virtual programs like ours has increased dramatically since the pandemic and we don't see that reversing in addition Families are increasingly engaging in their child's education in ways just a few years ago we didn't see. Parent activism on their child's behalf, whether it be for philosophical, safety, religious, medical, or any other host of reasons, is on the rise.

Now, while our fall enrollment numbers were disappointing to us, we also said we saw increasing in-year demand in the early days of October. Well, that continued with us through December, and we ended the quarter with over 180,000 enrollments. up from 174 000 enrollment at the end of september and in the first few weeks of january we are continuing to see strong demand and growth that q2 enrollment growth is the largest involvement gain in this company has ever experienced so we went from being down eight percent year over year at the end of september to now being down to four percent a number of factors are contributing to these strong results senior demand remains strong during the quarter

And we're seeing record levels of retention of existing students. Once families come to us, they are staying in our program longer. We're seeing many students and families continuing to explore their options throughout the year, not just at the beginning of the year. The same survey I mentioned before, which was conducted at the beginning of January, found that 26% of all parents are currently considering a youth school for their children. And this sentiment is reflected across our enrollment funnel. Lead in application volumes remain strong. Referral and return customers are also trending favorably, meaning the number of customer referrals from existing or prior customers to other customers has always been a pretty significant part of our business and continues to trend very strongly. And many customers who have either been in a program before or have looked at a program but didn't enroll are reconsidering at a very healthy rate. So clearly, the market is not giving them alternatives they're searching for. This is at a time when our position as an option for students and families has never been so important. The schools we manage and the partners in our network have worked hard to ensure we provide availability and access to our programs with as much flexibility as possible. As a result, we're seeing more students choosing strides during the school year. So I believe long-term, our core full-time education offering, both general education and career education, are on solid footing and on a growth trajectory for years to come. We're also beginning to make some progress into expanding our product service offerings. This year, we successfully launched a number of new product pilot programs. We have a number of districts, both large and small, signed up for our updated career platform pilot that began running this past fall. Our next version of the platform is slated to be introduced this spring. We also have secured contracts with districts for our upgraded teacher professional development platform We've successfully rolled out our tutoring platform to a couple of test districts. Our new professional development product offers on-demand training for teachers based on educational best practices. The platform delivers courses in leadership, instructional practices, counseling, and special programs. It's proven because we deploy these training modules to the thousands of teachers we already train each year for our managed programs. And much of it is available now for free. We've received positive feedback on the product so far, and now we're starting to see schools take notice. We've secured an opportunity to deliver our professional development platform to one of the largest school districts in the country.

I said last quarter that our goal for the year was to expand on our top-line growth and aim to achieve a basically flat year-over-year adjusted operating income. Our revised guidance based on these improving enrollment trends continues to show that these are achievable goals.

a big driver behind this strength is the sustained success in our career learning program i continue to believe that these programs can have an outsized impact on the continued skills gaps and labor challenges this country is seeing a recent study demonstrated finding that 75 percent of high school graduates do not feel prepared to make college or career decisions after graduation 72 percent reported that they were only sometimes or rarely exposed to a variety of career options Meaning that for many students, it's not just about the ability to do a job, but rather exposure to the career itself. I strive to be a part of fixing that. Our career programs offer students opportunities in 10 industries with over 400 career courses, including career exploration and more in-depth experiences. Students also recognize that schools need to be providing this important aspect of education. More than 60% of students in the same study feel that it is the responsibility of the school to expose them to these opportunities. Too often, it is the responsibility of family and friends, which can disadvantage many students. Our offering is to close these gaps and provide an alternative to schools who have shifted their focus away from preparing students for their careers. We also continue to see more companies willing to hire non-traditional candidates.

Recent Gartner article on the top workplace prediction expects that the trend towards relaxing formal education and experience requirements in job coaching will continue in 2023.

This includes employers reaching out directly to external candidates with non-traditional backgrounds, something our new career platforms address immediately.

I think we have a unique opportunity in front of us to lead innovation around a number of educational products and services. That isn't limited to new products. I previously mentioned that we rolled out an approved K-5 curriculum last year.

At the time, we saw significant improvement in customer satisfaction. Recently, That same product was awarded the Children's Home Learning Product of the Year Award. This award is to the best digital learning products for children aged 4 to 18, testament to our unique curriculum design that allows students to work more independently. On top of that, Tech Elevator was awarded the Adult Home Learning Product of the Year Award, which recognizes the best digital learning products for people over the age of 18. These awards confirm our best-in-class product suite and encourage me to continue to prudently invest in our future. I'm also proud of the work environment we are creating in these transitional times. We recently ranked number 18 in the top 100 companies for hybrid jobs by FlexJobs. It's a great report for Stride. Our core business are showing strong demand and improving trends with a favorable macro climate at our back.

I believe we are on the cusp of having more meaningful success in some of our newer products and services.

Now I'll pass the call over to Donna for a recap of our second quarter results and our updated guidance. Donna?

Thank you, James, and good afternoon, everyone. First, let me quickly recap our reported results. Revenue for the quarter was $458.4 million, an increase of 12% from the same period last year. Adjusted operating income was $76.3 million, up $15.6 million, or 26%. And capital expenditures were $16.9 million, an increase of $2.7 million. We are very pleased with the strength in both revenue and adjusted operating income in the quarter. As James discussed, we continue to see strong demand across all of our offerings. This is the first time we have seen enrollment growth from the first quarter to the second quarter. Average enrollment for the second quarter were 177.5 thousand, and we finished the quarter in excess of 180 thousand. This growth supports our belief that students and families are more aware of the school options available to them. It also gives us the confidence to raise our full year revenue and profitability guidance, which I will discuss later. Now let me provide more detail on our second quarter results. Career learning revenue was $183.7 million, up 91%. This strong growth was driven by increasing STRI career prep enrollment and continued strength in our adult learning business. Middle and high school career learning revenue was $153.8 million, up over 100%. This was driven by a 58% increase in enrollment and a 29% increase in revenue per enrollment. The quarterly increase was driven by increased funding, some timing impacts, and the better than expected retention that James discussed. We continue to see a favorable funding environment, and for the full year, we believe revenue per enrollment will increase just over 10% from last year. This increase is a combination of higher funding, better capture, and mixing into higher funded space. Adult learning revenue in the quarter was $29.9 million, up over 42%. We remain on pace to finish the year with greater than 30% growth in this business. Quarterly revenue for our general education business was $274.8 million. The decrease from last year is due primarily to the decline in enrollments we previously outlined, somewhat offset by an increase in revenue per enrollment. Gen ed enrollments were 111.2 thousand, down from 145.6 thousand. However, in both career learning and gen ed, we actually finished the quarter with enrollments that exceeded our first quarter numbers. a phenomenon the company has not experienced previously. Revenue per enrollment for Gen Ed increased 17% from the second quarter last year. Similar to career learning, we anticipate finishing just over 10%. Gross margins for the quarter were 37.1%, an increase of more than 100 basis points compared to last year. As we said last quarter, we're seeing a more normal seasonal pattern of our expenses this year in line with pre-COVID years. Additionally, I am pleased to say that we are starting to see some of the efficiencies we discussed last quarter have a positive impact on expenses. However, inflationary pressures still exist. Given these factors, we now believe we will finish the full year with gross margins that are flat to last year. a significant improvement on what we thought last quarter. Selling general and administrative expenses were $102 million, up $11.4 million from last year. Most of the increase is due to scaling our adult learning business and our continued investment in new products. Stock-based compensation was $4.9 million for the quarter. Adjusted operating income for the quarter was $76.3 million, and adjusted EBITDA was $100.5 million. Entrance expense for the quarter came in at $2.1 million, and our effective tax rate for the quarter was 27.1%. And finally, diluted earnings per share totaled $1.19. Turning to our balance sheet and cash flow items. Capital expenditures totaled $16.9 million, up $2.7 million from last year. Free cash flow was $147.4 million, up $41.7 million from last year. This increase is tied to revenue growth and the timing of receipts from states that regularly pay us on a lag. We expect to continue to see positive cash flow for the rest of the fiscal year. We finished the quarter with cash and cash equivalents of $318.3 million. Turning to our guidance, for the third quarter of fiscal year 2023, we are forecasting revenue in the range of $445 to $465 million, adjusted operating income between $70 and $80 million, and capital expenditures between $16 and $19 million. For the full year, we are raising our revenue and profitability guidance and narrowing our CapEx guidance. We now expect revenue in the range of $1.775 to $1.815 billion up from $1.71 to $1.79 billion previously. Adjusted operating income between $180 and $200 billion up from $160 to $190 million previously. capital expenditures between $70 and $75 million, and an effective tax rate between 27 and 29%. Thank you for your time today. Now I'll turn the call back to the operator for Q&A. Operator?

Thank you, Ms. Blackman. Ladies and gentlemen, at this time, any questions, simply press star 1. And if you find that your question has already been addressed, you can remove yourself from the queue by pressing star 1 again. We'll go first this afternoon to Jeff Silver of BMO Capital Markets.

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

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

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

So there was some impact of timing for both the, primarily related to our revenue. And so some funding adjustments that we would normally expect to see later on in the year, we saw some of that a little bit earlier this year. The other thing, more importantly, is that with respect to our rates, as you know, like last year, our attention ended up being higher than we had forecast. We were a little bit conservative in our forecasting earlier in the year, and so we had a catch-up sort of later in the year. And so when you look at sort of our year-over-year comparison, Q1 to Q2 was an easier comparison. versus last year because we had that sort of catch-up last year in the late third quarter, fourth quarter.

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

It's a benefit for the full year.

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

Okay. I appreciate that. I can follow up with the details offline. If I could sneak in one more question. I'm actually at an ed tech conference and we're hearing a lot about, you know, AI, chat, GPT, et cetera. A lot of the folks think, you know, it could be a positive in terms of helping them prepare their lessons plans, et cetera, but there's a lot more people would seem to be worried about students abusing tools like this. I'm just wondering, you know, if you've seen anything, are you hearing anything? Are you doing anything?

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

I really appreciate the call. Thanks so much. Thank you. We take our next question now from Steven Sheldon with William Blair.

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

So I think there's sort of a good news, bad news to this. I think we mentioned we actually were planning for higher enrollments in the beginning of the year, i.e., that meant we were sort of a little overhired in some places. Obviously, this normalizes some of that. So, you know, sort of like bad news early, better news now in that situation. Also, in our situation, unlike maybe a brick and mortar environment where, you know, You've got 25, 30 desks in a classroom, tough to squeeze in that many more. We can add a few to different classrooms and class sizes, and we have a little bit more flexibility there. We have yet to see across our network significant stress on our system that would be unusual, meaning every year there's some level of stress in our system. I think you see that across the nation. you know, today just with the teacher shortage. So, but I don't think we see any unusual stress. You know, and if you think about across 30 different states and 70 different programs, you know, we're talking about, what, 6,000 extra enrollments from last quarter. you know, spread across that, you know, across any different classroom size, you're not really talking about a real significant number. So I think for right now, at least we see it's manageable. It's obviously not a bad problem to have, but we are certainly monitoring it. And, you know, we're going to continue to make sure that we're staffing appropriately.

Very helpful. I just wanted to ask about, I think you talked last quarter about some cannibalism from general ed enrollment switching to Career learning enrollment. Did that trend kind of continue as we look at the fiscal second quarter and any rough quantification of how much of a shift that's been as we think about the first half of this year?

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

But it's also worth noting that the growth we saw from count date to the date, some of that growth came in Gen Ed as well.

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

Hey, good evening. Congrats on the really strong result. I guess, let's talk about enrollment so far in January. I know what happened last quarter, unprecedented, but what are you seeing so far, 24 days? I mean, could potentially third quarter be higher as well?

Definitely don't want to predict where third quarter is going to end. Historically, third quarter is a quarter that declines as well. And in fact, the third quarter tends to be harder for us because you have the withdrawal that happens and you have less schools that have available spaces to actually backfill those withdrawals. So just logistically, the third quarter actually is, generally speaking, harder for us than the second quarter. Having said that, the first three weeks of this month so far, we continue to see strength in our funnel. We continue to see strength in applications and demand. We continue to see growth in enrollments through the first few weeks of the month of the new quarter. But it's going to be hard I think, to continue that trajectory, at least, that we saw on Q2 through the end of Q3. I don't think it's impossible to grow from Q2 to Q3, but it will be certainly very hard to keep the same trajectory. And, you know, if you look year over year, sort of the implication is we're sort of, if we can keep going here, we can certainly get close to some year over year good comps.

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

Yeah, so in the adult space specifically, which has the 42% growth year over year in the quarter, one is I think we're executing well. I've got to give a lot of credit to we've got a number of businesses in that that we have, I think, really strong leadership. They run fairly independently, and I think they're just doing a really strong job. You may remember that we have one portfolio company in that adult education space galvanized that had been doing poorly. And I think I indicated previously in previous quarters that it looks like this is the year we're turning that around. We're seeing that. So that obviously helps, you know, the whole portfolio. So I think really strong execution. The market, I think we've said this also before, generally speaking, in recessionary type of markets, that tends to bode well for adult education. So I think we're seeing a strong macro environment for it. And, you know, I think we've got the wind at our backs for those, and we hope certainly to see continued growth.

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

So one thing worth pointing out when I talked about sort of the year over year comps, and that last year we were more conservative with what we thought would happen with retention. And so as we got later in the quarter in Q4, we had a catch-up because the retention was better than we had anticipated. And so the year-over-year for Q4 will certainly be less than what we saw in the first half of the year.

So, sorry, just following up on what Donna said, because I think it's a really important point. I think we're seeing, if you look sequentially, Q1 to Q2 to Q3 to Q4, historically, over the past several years, sequentially, we gain strength in revenue per enrollment through the year. Some of that's really just sort of the conservative nature of our estimates and things like that. And so I think that's appropriate. And so we sort of have some strength through the year. And I think this year, Similarly, we will have some strength sequentially through the year, which does imply, by the way, that we will continue to have double-digit gains. However, I think as Don is indicating, in Q4 of last year, that sequential strength, if you will, took a sort of a step up in Q4. It makes the Q4 comp harder. So even if we continue to have that sequential strength through Q4 of this fiscal year, the year-over-year comp in percentage terms is probably going to be hard, you know, to be very high in terms of percentage terms. So I think that's where you sort of get the full-year percentage. There's going to be some dilution, if you will, in Q4 probably in the full-year comp in percentage terms.

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

And ladies and gentlemen, just a reminder, star one, please, for any questions. We will next now to Tom Stengelhurst at Citi.

Yeah, good evening. It's Tom here from Citi. Thanks for taking the question, and congratulations on the results. The first question I wanted to ask about was... I mean, maybe I got sort of pushed the wrong way almost. I noticed Pearson last week indicated that revenue was down for them, and I think overall enrollment fell in the same sort of quarterly period. I'm interested on market share. I know geographically you don't necessarily map onto exactly the same areas, but within the trends you saw, would you say that there is a share gain implicit in what you've done?

Yes, I'm going to answer this. You know, totally fair question. I'm going to answer it slightly maybe from a different angle than what the way you're presenting it. I think that the short answer is yes, we, I think, almost by default gain market share, almost irrespective of our growth relative to connections, by the way. And that's for the very simple reason that we're seeing Across the landscape of the US, virtual programs are getting shut down in brick and mortar schools. So therefore, the whole pie is starting to shrink a little bit right now. And therefore, as we sustain or grow as we've done, our market share sort of mathematically by default will grow. So I really won't speak to some of the other specific competitors and what they're doing and what they're seeing, but we are certainly seeing strength in our funnel, in our demand, And we see that continuing through the year. We see that the overall macro trends around these programs continuing to be strong. And I think that it will work in our favor as brick and mortars continue to sort of either shrink or shut down their programs. But we certainly, I think, we consider that we have gained market share just because of, again, the shrinking overall programs across brick and mortar districts.

That's great. And then the second question. I mean, obviously, fantastic news that you're looking for revenue per enrollment up 10. I think previously it was 7 to 10. And then potentially growth margins, you know, flattish relative to upwards of 200 base point compression. I was wondering whether you could just unpack the drivers of those changes again and specifically comment on whether whether some of that is also a function of just that spectacular sort of enrollment performance across the second quarter that, you know, actually growing the base that having more students in the mix, you know, automatically help both of those metrics. Thank you.

So there are a couple of things that are happening. So we've got strong funding increase. You've probably heard us talk previously about capture. So we're capturing more of the rate, increasing attendance. There's some mix involved. We also get some pass-through revenue where we actually have to spend the revenue that we receive. So there are a number of factors that actually impact our rate. But as James said earlier today, you know, we're in a strong funding environment. And the fact that we're actually growing in states that pay a higher rate and shrinking in states that pay a lower rate, that certainly has an impact on that PPR.

Also, I want to give some credit. I think the team, and Donna specifically, her team has done a really fantastic job. We talked about driving efficiencies in our business, and that was going to be both at the gross margin line and the operating line. And I think we've done that. And so, you know, we entered the year in a little bit of a hole and we had to dig ourselves out. We committed to digging ourselves out. And while the macro environments helped us, the enrollments have helped us, we've also driven some efficiency in this business. And I think that's also helped. So I think it's a real combination of factors.

And if I could just follow up, I'm sorry for being painful, but when you talk about capture, is that Is that the element that's linked to strong enrollment and therefore your ability to actually extract the funding that you're expecting? Is that how I should interpret that?

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

Capture is our version of a yield metric, okay? And so for every $100 that's available to us, on average we are able to quote unquote capture or yield $75. We're always trying to yield more, 75 to 80, 80 to 83. And through a number of efforts and a lot of that through engagement, as Donna was saying, there's a lot of different mechanisms for how that yield plays out. But essentially, it's a yield game that we're trying to improve. And, you know, we're constantly focusing energy on how to improve that yield. And so, you know, so I think this year we're having some improvements in the yield, essentially a yield metric.

Perfect. Well, that's super encouraging. Thank you very much. And ladies and gentlemen, just a final reminder, any questions? Star one, please.

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