PowerSchool Holdings, Inc.

Good afternoon, ladies and gentlemen, and welcome to the PowerSchool second quarter 2023 earnings call. If anyone should require operator assistance during this conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to Shane Harrison, Senior Vice President, Investor Relations. Thank you, sir. Please go ahead.

Thank you, operator. Welcome everyone to PowerSchool's earning conference call for the second quarter ended June 30th, 2023. I wanted to first let you know that we posted a slide deck to the investor relations section of our website that accompanies our remarks here. On the call today, we have PowerSchool CEO Hardeep Gulati and CFO Eric Shander. We apologize for the schedule change today, but Hardeep had a scheduling conflict due to him attending an education summit at the White House that overlapped our original timing. As such, Hardeep's portion of these prepared remarks have been recorded, but we expect them to be available for the live Q&A to follow these prepared remarks. I'd like to emphasize that this call, including the Q&A portion, will include statements related to the expected future results of our company, which are therefore forward-looking statements. Our actual results may differ materially from our projections due to a number of risks and uncertainties. The risks and uncertainties that forward-looking statements are subject to are described in our earnings release and other SEC filings. Today's remarks will also include references to non-GAAP financial measures. Additional information, including definitions and reconciliations between non-GAAP financial information to the GAAP financial information, is provided in the corresponding press release and results presentation, which are both posted on PowerSchool's Investor Relations website at investors.powerschool.com. A replay of this call will also be posted to the same website. I will now turn the call over to Hardeep.

Thanks, Shane. Thanks to everyone for joining us for PowerSchool's second quarter earnings call. We had a great second quarter where we increased the adoption of our expanded platform with large districts and states, saw continued strength in our innovative data solutions, and drove outstanding financial results. The second quarter results are summarized on slide four, where you will see we delivered another quarter of double digit ARR growth and net revenue retention rate expansion. Revenue grew 10% year-over-year to $174 million at the top end of our previously communicated guidance. Adjusted EBITDA grew 26% year-over-year to $61 million, exceeding our previously communicated guidance range, and was a continued expansion of our profitability profile, coming in at a 35% margin. Net revenue retention grew another 40 basis point to 109.5% on a record quarterly sales to our existing customers. Given the continued strength and the strong momentum in our business, we are reiterating our commitment to double digit revenue growth and increasing our margin guidance for the full year. This success is the result of significant momentum we are seeing in many facets of our business, including momentum in bookings, solution innovation, and platform and international expansion. I'll start on slide five with our customer bookings momentum. In our seasonally strongest selling quarter, we saw record results for new and cross-sell ARR business. We continue to see a trend in winning very large deals, which we define as deals that are over $1 million in combined ARR and non-recurring revenue. We've booked a record five such deals in the second quarter, which brings our year-to-date large-deal combined ARR and non-recurring value of $31 million, which compares to $11 million in value in the first half of last year. Our pipeline remains strong with a wide array of opportunities that we will continue to work through in the second half. We are excited to announce another new state-level contract, a new logo win with the State of Montana Office of Public Instruction. Montana selected unified insights and connected intelligence to supercharge their use of longitudinal data to improve the outcomes of nearly 150,000 public K through 12 students. From an ARR by product perspective, the growth drivers in the quarter were diverse with particular strength in our student information cloud, student success cloud, educator recruitment, and workforce development clouds. And as with the prior quarter, our data solutions continue to exceed expectations where there are growth of nearly 100% versus last year, demonstrating the value and the leadership of our differentiated and comprehensive platform of cloud solutions and our unique comprehensive analytics capabilities. This brings me to the momentum in innovation that we are seeing in the business as summarized on slide six. In Q2, we doubled down on innovation, ensuring we are anticipating the needs of our customers, particularly regarding the data analytics and AI. At our recent Edge User Conference in Orlando, we announced three major innovations. First, the expansion of our connected intelligence data as a service platform. Second, our new MyPowerSchool unified user experience for students and families. And third, our expanded generative AI capabilities and roadmap. The strong customer demand for effective data analytics is why we developed Connected Intelligence, the industry's first turnkey, fully managed data as a service platform for education and government agencies on Snowflake Data Cloud. In June, Snowflake awarded PowerSchool their 2023 Powered by Snowflake Growth Partner of the Year Award for Connected Intelligence. Combining connected intelligence with our powerful unified insights analytics layer, we are supporting districts and states with K through 20 longitudinal data systems across PowerSchool and any other data sources, providing our customers with limitless capabilities to understand the trends, factors, details, and gaps to improve education outcomes. In the second quarter, seven of our top 10 deals included either Unified Insights or Connected Intelligence, and four of these deals included both solutions. Notably, we are very excited to further our partnership with the Los Angeles Unified School District, the second largest school district in the U.S. with nearly 500,000 students, ranking among one of the largest deals for us and most comprehensive deployment of our full analytics capabilities in the country LAUSD purchased our entire Unified Insights and Connected Intelligence solutions to power whole child view and drive insights across their data sources for use throughout their district needs. These data products are also supporting broader cross-sell of our other products. As an example, in the second quarter, the Newark Board of Education purchased both Connected Intelligence and Unified Insights MTSS solution along with adding assessment and curriculum planning on top of their existing use of our SIS, e-collect forms, and Unified Insights products. Additionally, the Dallas Independent School District purchased Unified Insights and MTSS to overlay their existing use of PowerSchool SIS, enrollment, and special education solutions. These wins showcase our ability to launch timely products organically and inorganically that are differentiated and address critical market needs supported by our access and deep understanding of the challenges and opportunities in our 15,000 plus customers. We recently published a 2023 education focused report that highlighted many trends in the industry based on a survey of over 1750 educators. And one highlighted finding was that only two in 10 educators say that they have the data they need to evaluate teaching intervention success, which supports the demand we are seeing in our data products. At our EDGE conference, we also announced MyPowerSchool, a new cohesive user experience that consolidates all relevant information and applications into a single streamlined platform that is tailored to specific user personas. MyPowerSchool simplifies how families interact with their children's schools, how teachers interact with their students and families, and how school technology leaders manage their PowerSchool solutions by providing a central point of access based on if the user is a student, family member, educator, or administrator. From assignments and grades to attendance, and also includes our new payments module, MyPowerSchool will consolidate all the information families and students need in a single user interface. This will help support additional cross-sell and improve our existing customer experience. Finally, we are excited about the tremendous opportunity for AI to accelerate our product roadmap and business model. We are already leveraging AI in several of our existing products, including MTSS, and learning navigation to deliver personalized intervention and learnings based on individual student needs and learning goals. At the EDGE event, we demonstrated our latest generative AI functionality that will save educators a significant amount of time in their day-to-day. First, we have embedded within our performance matters assessment solution an automated generator that creates assessment questions that are aligned to a desired learning objective grade level subject and standard which the teacher can use to deliver more frequent formative assessments at scale second we previewed one of the generative AI capabilities that is coming to connected intelligence a talk to data functionality that will help non-technical users offer solutions get powerful data insights easily We have been able to accelerate these generative AI roadmaps throughout our recent announced collaboration with Microsoft Azure's OpenAI service and the usage of their OpenAI large language models. These product innovations are stepping stones towards a very significant opportunity for PowerSchool, given our unique position to monetize generative AI in our solutions, entrenched with our customer base, and opens up a $100 billion personalized app. Moving to slide seven, we are continually investing to expand our business in highly strategic and capital efficient ways. This expansion includes growing our platform as well as expanding our job referral footprint. As a reminder, in July, we announced a significant advancement in our home communication solutions with the planned acquisition of School Messenger, a leading provider of K through 12 communication tool in North America. A unified communication solution further expands our product offerings and has been a top focus for our customers given the need to consolidate fragmented school-to-family interaction technologies. The synergies we see with the addition of these communication capabilities span several of our clouds. including within our Student Information Cloud for deep integration of student and class data into MyPowerSchool for a centralized experience with richer communication content and automation. Within our Personalized Learning Cloud for integrated two-way chat and notification embedded into Schoology and other classroom solutions. And within our Student Success Cloud for improved engagement with families to improve attendance and at-risk interventions. We are also laser focused on our continued international growth and momentum. In July, we announced our latest international channel partner, Samart Telecoms, who will help us support expansion in Thailand and the neighboring regions with plans to serve more than 100,000 students in Thailand in next year. This continues our very focused partnership strategy to have strong commitments from our partners in key regions globally. We continue to see growth in our international pipeline. To summarize, this was a great quarter with record sales and a record-adjusted EBITDA that beat our guidance. Our pipeline continues to grow, supported by several large deals. Our investments in innovation and platform expansion are driving continued demand of our differentiated cloud and analytic solutions, enabling us to consistently deliver long-term durable growth and margin expansion. Let me now turn the call over to Eric to cover the second quarter financial results. Thank you, Hardeep.

We delivered a great second quarter, highlighted by continued execution on our top-line growth and margin expansion, driven by consistent, strong demand across our product portfolio and strength in our market-leading data and analytics offerings. As summarized on slide 8, we delivered second quarter total revenue of $174 million, representing a 10% year-over-year increase coming in at the top end of our guidance range we provided in the last earnings call. Subscription and support revenue grew 9% year-over-year to $147 million and accounted for 84% of total revenue in the quarter. Subscription and support revenue from the Puerto Rico Department of Education deal was minimal in the quarter as our teams continue to work diligently to implement our best-in-class SIS solution for the entire territory. As a reminder, subscription revenue may lag ARR in these larger deals given the complex implementation deliverables whereby subscription revenue typically does not start until the solution is delivered to the customer. Revenue from our services business totaled $20 million in the quarter, representing 6% growth over the same time period last year. We continue to drive the efficiency and velocity of our implementations, which increases the time to value for our customers. Revenue from license and other totaled $7 million for the quarter, more than doubling over the prior period year. The main driver was the exciting Connected Intelligence LAUSD deal, which is $14 million in total value over the three-year contract with approximately $4 million in upfront license fees. As I've mentioned previously, our L&O revenue can fluctuate significantly on a quarterly basis. We ended the quarter with an annual recurring revenue balance of $636 million, representing a 10% year-over-year increase as we continue to cross-sell successfully, attract new logos, and maintain strong retention rates. Our net revenue retention rate came in at 109.5%, up 220 basis points year-over-year, and improving 40 basis points versus our first quarter of this year. This is a record net revenue retention performance. Adjusted gross profit for the quarter came in at $124 million with a 71.4% margin, representing a 340 basis point year-over-year improvement, driven by greater operational scale, reduced third-party costs, and the flow-through benefit from the exciting LAUSD deal. Moving to the second quarter operating expenses, non-GAAP research and development expense came in at $21 million, representing 12.1% of revenue compared with 14.1% in the same time period last year. This 200 basis point reduction in adjusted R&D expense as a percentage of revenue reflects the efficiency and improved cost profile of our R&D model while we continue to invest in game-changing innovation to drive long-term growth. Including capitalized R&D expenses, the total invested in R&D was 18% of revenue compared with 21.7% last year, representing a 370 basis point improvement. Non-GAAP SG&A expense totaled $42 million in the second quarter, representing 24.1% of revenue compared with $37 million or 23.3% of revenue in the second quarter of last year. The increase reflects investments we are making in our sales organization and go-to-market activities that will fuel our future top-line growth. Second quarter adjusted EBITDA exceeded the high end of our guidance range, coming in at $61 million, representing a 35.2% margin, which was 430 basis points better than last year. Non-GAAP net income in the second quarter was 23 cents per fully diluted share, up one penny or 5% from the 22 cents per diluted share we had in the same time period last year. Second quarter free cash flow, which is seasonally a negative cash flow quarter given a significant amount of our renewals happened in the third quarter, was negative $44 million compared with negative $28 million in the same time period last year. This is driven primarily by the change in net working capital and higher interest expense versus last year. Moving to the balance sheet, we ended the quarter with $28 million in cash and equivalents, an increase of 84% over the same time period last year. During the quarter, we drew $10 million on our revolver, compared with a draw of $40 million in the same time period last year, which reflects our strong and improving cash generation profile. We have since paid off the $10 million revolver draw in July. Our net debt leverage at the end of the quarter was 3.3 times compared with 4.8 times a year earlier. As Hardeep mentioned, we're excited about the prospect of adding School Messenger to our platform. We expect the transaction to close in September and will fund the $300 million purchase price with an approximate even split between cash on hand and our existing debt facilities. Now turning to our third quarter and full year 2023 financial outlook on slide nine. Given that the acquisition has not yet closed, our guidance today does not include any expected contribution from School Messenger. During our upcoming Investor Day in mid-September, we plan to provide updated guidance for the full year, including School Messenger, if the transaction is closed by then. For the third quarter, we expect total revenue in the range of $178 to $181 million, consistent with our financial model going into 2023. We expect third quarter adjusted EBITDA to be in the range of $55 million to $57 million, representing a 31.2% margin at the midpoint. This incorporates the return of our in-person, market-leading EDGE User Conference, as well as the delivery of the scanner component of our Puerto Rico contract, which customarily carries a lower margin profile. For the full year 2023, we are increasing our guidance for adjusted EBITDA to a range of $226 million to $230 million, representing a 33% margin at the midpoint. Consistent with our stated goal of delivering low double-digit annual revenue growth, we are reiterating our full year 2023 guidance of $688 million to $694 million with the midpoint representing a 10% year-over-year growth rate. For modeling purposes, we expect full-year capital expenditures including capitalized software of approximately $42 million to $46 million and share-based compensation expense of approximately $65 million to $69 million. Fully diluted shares by the end of the year are expected to be in the range of 203 million to 207 million shares. As a reminder, we will be hosting our inaugural Investor Day on Thursday, September 14th in New York City. We're excited to share updates on our product roadmap, go-to-market strategy, international playbook, long-term financial targets, and much more. In summary, this was a fantastic quarter. We are growing the footprint of our platform of software and data solutions across our customer base, as well as demonstrating that this platform will continue to attract new customers and state-level deals. We're also committed to driving margins higher as demonstrated by our guidance rates for the full year, which is 200 basis points above full year 2022 and ahead of our initial outlook that we provided in February. We will continue to execute in the second half on our strategies around innovation, go-to-market, and customer success with a focus on growth and profitability. This concludes our prepared remarks. Operator, will you please open the line for Q&A?

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 to remove a question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. And the first question comes from the line of Joe Vrewink with Baird. Please proceed with your question.

Great. Hi, everyone. I guess I wanted to start on the data products. Can you maybe just speak to how the progress here compares to your internal expectations so far? And is the early success actually maybe causing a rebalancing of resources or a change in product roadmaps towards this direction of PowerSchool? As a quick follow-up, just from a financial standpoint, does growth in the data products come through at any different margin framework than has been the case for the rest of the unified platform so far?

Great. Thanks, Joe. This is Adip. Thanks for the question. You know, when you look at from our roadmap, we've been at the time of IPO, we actually highlighted data products going to be one of our big differentiators in the market because We have access to all the different systems and variety of data. And as we were seeing post COVID, there's a lot of focus for districts and state to have a better understanding of where the student engagements are, where the learning gaps are, how do you provide the right interventions. And then also there's a big focus now, which is around not just college path, but even career pathways for the students. So the states are looking for, for better visibility. So we have actually been focused on the data products. It is actually beating our expectations. in terms of both the unified insights as well as our connected intelligence product, which is our data as a service platform. One of the key highlights is that we are very unique in being able to provide the unified insights, which have the breadth, as well as this data as a service platform, which is also unique. That's creating the extra demand for us in terms of both from large districts as well as state. We do expect this to continue because we are seeing the interest in the pipeline to be exceptionally strong. And we are putting a fair amount of resources in our roadmap already to continue. So one of the, as I mentioned at the EDGE conference, we highlighted our investment in now almost a K through 20 dashboards through our connected intelligence. And that allows even states like Montana and others to be able to really have a better longitudinal view across all the different elements so they can plan better on career pathways for students. So it's a lot of exciting work here.

and joe this is eric just uh to follow up on the question around the margin profile um so you know as hard to mention we are um you know investing and we are reallocating resources to uh to this um to this you know exciting area so as with any new products that go out and the margins are slightly lower than some of our more mature products but you know that continues to scale and as we continue to see um you know revenue pick up in that area you know, the margin profile starts to kind of rebalance out. But, you know, given the investments we're making in there, the margins are a little bit lower. Again, I think the value and, you know, the beauty of having a platform is we have other products that are more established that are generating a much higher margin. So, in aggregate, we don't see any kind of dilution to the margin profile.

That's great. Thank you very much. Thanks, Joe.

The next question comes from the line of Brent Phil with Jefferies. Please proceed with your question.

Thanks. Just on the revenue guide for the year, you know, you brought the bottom line up. Many investors asking, you know, what you're seeing on the top line, why maintain given the strength of some of these large wins that you highlighted. Can you just give us some color in terms of what you're seeing on that side?

Sure, Brent. I can start and I'll ask Eric to jump in as well. When you look at from, you know, what we've always said, that we are, you know, a low double-digit grower. And that's the really strength of our business is that predictable and sustainable growth. But we've also said that we have a huge opportunity here to continue margin expansion. And that's why you see not only our margin coming better, we have increased the guidance as well. Now, you will see some amount of seasonality around the quarters as well as large yields, which create some level of quarter beats. So, you know, having the Q1 beat and now Q2 beat. Definitely gives you, you know, expectations that, hey, why are we not increasing? So we do have a very strong deal, you know, larger profile for the last two quarters, which is definitely creating that beat. We do think there is more upside, but we don't want to get ahead of ourselves. Again, we want the market to continue to, you know, trust our predictable double digit, low double digit guidance. and that's where we're trying to not get ahead. Now we do have an opportunity with the school messenger around the investor day. We hopefully would actually give you the full perspective for the year as well as how we predict the next year to be.

Some of the larger wins that you've landed, are those tracking to implementation times that are on time or any delay in those larger deals that you've won that may be going a little slower?

Sure, I can get started, and I think I'll let Karik jump in here as well. We are progressing well. In fact, when you look at our implementations for Puerto Rico, we're actually almost at go-live right now. So that's actually a record time to bring almost 275,000 multi-district whole territory deployment go-live. So those go-lives are actually tracking exceptionally well. With LA, we actually did start some of the work with them last year as part of their whole child analytics, which was a small portion, and now they're actually looking at the full entire element of Unified Insight. We very much already have laid the foundation, so we do expect that in the coming school year, they're going to be able to take advantage of that in a matter of a few weeks and months. Most of the large deals are actually tracking very well, and there's no concerns on any go-lives or implementation delays. But as you mentioned, there are a little bit of, you know, a couple of months compared to a week for a smaller district. So there's definitely that revenue, ARR to revenue aspects. But that's why we are also still committing to the full-year guidance. Eric, you want to jump in?

Yeah, I think you answered it quite well, Hardeep. I think the only thing I would just say in addition to that, Brent, is, you know, as I had in my prepared remarks, you know, minimal revenue in the quarter for Puerto Rico in Q2. We obviously, as we hand the system over to them here shortly, then the revenue will start kicking in, so you'll start to see more contribution and in Q3 and for the rest of the year. I think the important thing is, and what we've been really focused on, is just continuing to reiterate the full year guidance. There is gonna be, from quarter to quarter, there can be some lumpiness in terms of when the revenue kicks in from some of these larger deals. But the important part is, from a full year basis, we're very much on track with the low double-digit growth that we're seeing.

And the next question comes from the line of Nat Hedberg with RBC Capital Markets. Please proceed with your question.

Great. Thanks for taking my question, guys. Hardeep, you know, you continue to call out good growth in international markets, good progress on that front. You know, I'm just sort of curious, you know, how do you think about allocating resources internationally? You know, what sort of, you know, we all know it's a huge opportunity, but maybe just kind of walk us through sort of the steps that you're taking beyond some of the initial investments you're making to sort of, you know, plant those seeds and also obviously continue to focus on what is a large domestic opportunity here?

Yeah, great question, Matt. I think I want to reiterate the point I made a few weeks back about our international strategy. The key element there is, you know, it's a huge opportunity. It's almost seven times the size of our U.S. and Canada opportunity, right? So we have a big TAM. There is nobody else internationally who's got the full breadth and depth of the scale to implement and tackle large states, countries, and even large private schools who need these systems. And we are seeing demand really increase after COVID because most of the countries and schools have to deal with the disruption. We are seeing the demand, but we also wanted to be careful, as you pointed out, that there's a huge opportunity in U.S. for us, right? We have almost a $3.5 billion-plus cross-sell TAM just in our U.S. market. So we don't want to you know, completely lean in and we want to focus on very sustainable growth international. With that said, we still believe over the next three to five years, this is going to be a material almost, you know, 10% of our overall revenue. The way we are approaching this is with a very concerted effort with the target markets where we are going to have very exclusive, strong partnerships who are going to commit to revenue and student growth in those regions. What that allows us to do is rather than our own boots on the ground in each region for every aspect, we're going to have partners who are going to co-invest with us in building those markets and actually growing them as well. But these are hard commits. They are committing both in terms of dollars as well as in terms of number of students they're going to actually bring over stuff. And as we have updated over the year, we already have now half a dozen partners with that commitment. And in fact, I mentioned Smart in Thailand. We in fact just signed another partner, CCS, which is actually in Egypt. Egypt actually has 23 million kids in K through 12. And CCS is one of the large technology infrastructure provider. And they have also committed almost a half million students over the next 18 months to bring in that region to PowerSchool. So that's a way for us to be able to invest sustainably and with partnerships to really grow that business. You know, so far, you know, our goal for this year is about having these 12 strategic partnerships in the different regions where we see the highest demand, and we are on track on that.

That's great. Eric, can I ask you just a quick follow-up? You know, you had a lot of good things to say in your prepared remarks, but record NRR, I mean, in your slide deck, it continues to move up and to the right. I'm sort of curious, you know, where could that go, and does your guidance assume that that kind of continues to tick up, or kind of stay consistent with what you've seen, but it's been an impressive trend.

Thanks for the question, Matt. So we were certainly thrilled with it coming in at 109.5%. What I would just encourage everybody to keep in mind is Q3 is our largest renewal season. So 60 plus percent of our book of business is renewed in Q3. any level of churn that you're going to have is typically going to happen and be more pronounced in Q3. So, from a metric standpoint, you know, I think sequentially you could see it flat, maybe slightly down for the full year, we believe, and expect it to be in the 109 plus percent range. You know, look, in terms of where it can go, we've got Some of the industry leading, you know, renewal rates, really, you know, good sticky products. We're seeing a lot of cross-sell momentum. So we are going to be refreshing this for our investor day in terms of our outlook there. But, you know, suffice to say, I think, you know, being in the 110% range and, you know, perhaps a little bit beyond that as we go forward in the upcoming years is certainly what we're going to be working towards.

And the next question comes from the line of Steven Sheldon with William Blair. Please proceed with your question.

Hey, thanks for taking my questions. I wanted to ask about kind of how you're thinking about the sequential trend in ARR heading into the third quarter, kind of given what you're seeing on the renewal side, which you just kind of talked about a little bit, and then the trend in booking. Should we be kind of expecting the same seasonal pattern that you normally see where ARR is pretty flat sequentially, or could there be any support from bookings that happened so far in 3Q, especially around the Edge user conference that was in the third quarter.

Yes, and I'll let Eric comment around the seasonality and the numbers, but you're absolutely right. Q3 is, from a Reynolds perspective, does create that effect from an ARR. But I think, again, we're looking at the full year. We are tracking to a double-digit growth on the ARR. And we see a tremendous amount of pipeline and confidence in achieving that. Eric, I'll let you expand that more.

Yeah, sure. So I think, Stephen, as you rightly noted, typically we will see from Q2 to Q3, we'll see ARR pretty much flat. Although the last couple of years, we've seen it tick up a little bit. You know, as Hardeep mentioned, you know, really strong pipeline. We see a lot of business momentum in Q3. So I actually would not be surprised if, you know, we see ARR tick up in Q3 on a sequential basis. It'll be at least flat, if not up. from our expectations.

Got it. Very helpful. And then a product question, you know, what's the, what's kind of the early feedback you've received on the, my power school dashboard for parents. I know it's still really early, but has there been any potential improvement in the user experience for them? I know parents have been wanting more visibility into how their kids are progressing. Maybe wasn't that easy for them, you know, for parents to have access to that visibility before. And then also, how quickly do you plan to roll out MyPowerSchool for other user types, things about teachers, administrators, et cetera?

Great question, Suman. I think you remember from our user conference, we actually, when we unveiled, we actually literally had phenomenal excitement from our customer base universally. I think this is pretty much any parent, right, who have got kids in school would appreciate that right now. Pretty much in majority of the school districts, you have to go check your report cards or grades in one system. Any assignments, you might be looking at different systems. You have to go to different systems for paying, for enrolling the students, or forms you have to submit. That's a whole different system. Your message and communication on phone lines and other. It's a very fragmented aspect of experience for a parent, which really frustrates parents, and it actually prevents them to engage in their students And as we have seen that if the parents are more engaged, you clearly have a better student outcomes. So this has been one of the requirements. And now we are in a position, given all the broader elements we have in our ecosystem, in our platform, especially with the acquisition announcement of School Messenger with the communication, as well as our payments new product launch, we are able to really provide that full experience for parents to have one-stop shop where they're coming in and having that end-to-end experience. And that is something which we have universally seen as a requirement from a lot of our customers. Some of the solutions we're trying to tackle that don't really have the depth of attendance or grades or report cards. So they only kind of focus on communication part of it. We are able to really provide them full end-to-end of all elements of different things that parents need to access in one place. We already have signed up actually almost close to 100 plus customers on some of our beta as well as the early control of ability launch. And our goal is by in the next six months, we would have actually a lot of them already go live. As we integrate School Messenger after the acquisition is closed, then we will actually be able to really have a full experience and roll out of that detailed timeline when the acquisition is closed, we'll announce that. So stay tuned on that. We will update you on the more detailed roadmap on it.

And the next question comes from the line of Gabriella Borges with Goldman Sachs. Please proceed with your question.

Hi, this is Callie Valenti on for Gabriella. First one for me is just any initial comments on the growth or profitability profile of School Messenger and kind of what is pricing going to look like for customers who want to add that functionality to their existing products?

So, Kalia, I'll – yeah, well, Eric commented a little bit on the stuff. I don't think we are in a position, given that we have not closed, to represent anything on the pricing. I just, I think, would want to reiterate it's a very strategic acquisition. In fact, it's one of the top demand areas we have seen from our customers that they want to hold comms capability integrated into their SIS, the two-way chat integrated into their Schoology, and have one place. for a unified communication so parents don't have to deal with all these fragmented. So it's a very strategic acquisition for us. It's a high demand area from our customer perspective. And actually, both the growth and the EBITDA profile for School Messenger is actually very similar to PowerSchool. And it's going to be actually both growth and EBITDA-accurative. Eric, you want to comment a little bit more on the numbers?

Yes, so I think you just hit the last part. What I would just say is I think it's important that not only is it a strategic asset, but it does come as a profitable company, scaled-out profitable company. So think of the growth and the profit profile of PowerSchool will be very similar for School Messenger, and it will not be dilutive to our financials.

Great, thank you. And then second one from me, just around the Microsoft Azure OpenAI announcement, would it be great to get any early feedback from customers and kind of what your longer-term vision is for that partnership?

Great question, Kelly. So we actually announced, just for everybody's benefit, at the ST conference, the Microsoft partnership around OpenAI. And one of the key elements there, as we have announced and we previewed this at our Edge conference, we're We are leveraging, you know, we already have been using AI for the last couple of years in our systems on at-risk interventions predictability, as well as in our learning navigation around how we create personalized learning pathways. With the Generative AI partnership now, we are actually adding capabilities right into our performance matter assessments, so lesson plans and items could be created through Generative AI, so it saves a lot of time for teachers to create those personalized questions and lesson planning. And the second element of that also is we are integrating that into our data as a service platform or connected intelligence so we can actually use that to allow even any administrator or even a normal user to be able to more easily get those insights with almost like generative AI kind of questions on the data. So that will make our analytics product even more differentiators. Where we are really taking this further is our real differentiator around the fact that we are in the heart of the classroom with all day-to-day activities around the homeworks and the lesson plans by actually bringing personalized learning pathways and personalized homework, which we have a very unique opportunity, to really allow now generative AI to be leveraged right in the context to support child on their homework and being able to really have personalized homework, which actually is a game changer in terms of really allowing kids to be able to have learned better right within the context of the classroom, so you're not asking them to spend more time on supplemental and other areas. You're actually making their teacher's life more easier, and you're making a student help right on their day-to-day homework. So that's a very unique opportunity, and we expect, again, being able to really have a huge market advantage as we roll out these systems.

And the next question comes from the line of Saket Kalia with Barclays. Please proceed with your question.

Okay, great. Hey, guys. Thanks for fitting me in here. Hey, Hardeep. Maybe a quick question for you here, especially since you're in D.C. at the moment, I think. What are you hearing from customers, I guess, on their willingness to spend ESSER funds? And do you see any changes from either the government or school districts or any other sort of constituents as I think we have about another year to sort of earmark some of those funds. Does that make sense?

Yeah, thanks, Kate. And I appreciate everybody's flexibility with our delayed timing. We have a very exciting work we are doing actually with the Department of Education with Secretary Cardona as well as Homeland Security around the whole focus on cybersecurity. And thanks to First Lady and the White House to kind of give a forum for us to share some of the work we have already done, to be able to show even additional things which we actually are offering now, what we call free security as a service, which will make it available for all, not just our customers, but any U.S. school districts or states. in supporting training and education, how we really protect them against all the different cybersecurity threats. I think one of the big advantages we have is there's a lot of legacy systems out there, manual touch points, and not only we provide tools on digital transformation by improving those, but we also help districts be more secure in that process of actually managing those transformations. So a lot of exciting opportunity. In fact, we'll be speaking at the conference tomorrow. Now, to your point about the ESSER, you know, what we see is ESSER continues to be one of the sources of funding for school districts. But a lot of times, as we have mentioned, that ESSER is not the be-all and end-all, right? There is a lot of opportunity for funding around digital transformation. Typically, the ROI for it, our solutions pays for it by itself because you're saving, you know, paper costs and manual costs as well as in terms of just having to deal with trying to do that without automation. So our systems kind of pay for it by even with the normal funding in terms of actually improving the funding spent. What we do see is, again, ESSER continues to provide that cushion. So when you're looking at some of our large deals as well as a lot of our midsize deals, sometimes districts would take advantage of some of the ESSER elements in their buy. But most of the districts would comment to us that these are systems they will do irrespective of ESSER because these are technology systems. It's unlike content or other areas where they might be leveraging short-term spend related to that. Now, definitely, one of the reasons you're seeing analytics as well is because most of districts want to make their spend much more you know, surgical. So rather than peanut butter spread on making tutoring or content available to address learning gaps, they can have more surgical intervention strategies. So we are seeing more demand for MTSS and things like that so that their overall ESSER spending is being more effective. Now, we do see that to be even still a contributing factor because there's districts always have these funding and, you know, data and more intervention strategies which are more surgical are going to be the norm going forward. So I hope I answered that question.

That does. That's super helpful and sounds like a really interesting and great initiative that you're working on there as well. Eric, maybe for my follow-up for you, great to see the services line accelerate again as just some of those bigger implementations, I think, get rolling. Maybe the question is zooming out a little bit. How do you kind of think about services revenue and just non-subscription revenue in general this year? I mean, clearly the subscription machine is working based on what we've seen with ARR. How do you think about some of the non-subscription stuff this year?

So it's a great question, Saket. So as we look at the trend for this year, first the services revenue, I would anticipate the trend line to be very similar to the way it behaved last year. So, you know, we will see typically with the third quarter peaking in terms of the level of revenue, and then it'll trail down in Q4 just given the, you know, not as many implementations are done at the end of the year. And then it'll pick back up in Q1 and then build in Q2, et cetera. So we expect that trend to continue. You know, the margins in this business will remain in the low 20% range. Because, again, this revenue is really geared towards enabling our customers to leverage the technology and the training, et cetera, so that they get the most value out of it. And then I think the license and other, as you all have seen, continues to be the smallest piece of our overall revenue, but it's going to be the most variable piece in terms of, you know one-time items coming in there and partnership agreements so um yeah i think services pretty consistent and then the lno you know we'll try and give as much color as we have it um as we go into each quarter uh you know going forward and our next question comes from the line of brian peterson with raymond james please proceed with your question hey thanks for taking the question this is uh jonathan mccary on for brian he'll just be one from us tonight

So I had a question kind of on M&A. So it's great to see the school messenger acquisition. I'm just kind of curious how that could influence your appetite for additional M&A, and then what's the latest on private market valuations? Thank you.

Yeah, so, you know, we look at these acquisitions in a way that how, one, they're, you know, how they are accurate to our growth and EBITDA profile, how they strategically fit into our portfolio based on where we see the top demand for our customers' needs are, which helps our portfolio to be even more differentiated and comprehensive and also how it actually helps us x rate goals in the long term. So when you look at all of our acquisitions, whether they are small tuck-ins like in the curriculum space or behavior space or in terms of career pathways, you see that each one of them are addressing some of the key demand areas we're seeing in the market. As I said, messaging was one of the critical elements we see as a mission-critical component for a lot of school districts. So this has been where we actually partnered with School Messenger, and we saw clearly the demand and the value of having that more in our platform. So that's why we kind of went ahead with the acquisition. We'll continue to remain acquisitive, but at the same time, we're going to make sure that it fits with our, as I said, our growth profile, as well as our strategic rationale. And then at the same time, we are also making sure that our net leverage average continues to improve as well. So I'll let Eric comment on the second part as well.

Yeah, I mean, look, as you're looking at any of these acquisitions, given the interest rates are at, we have to look at the capital structure. We are being very mindful around our overall debt that we have, which is why we've funded School Messenger with half of our cash on hand with our existing debt facilities. You know, we expect to be around 3.5 to 3.6 times net levered by the end of the year, and we'll continue to work on that. But, you know, look, as Hardeep said, we're going to continue to look for really good assets out there that make sense. And then to your last question around the private markets, you know, we are starting to see them come back a little bit more in line with the public company valuation, so we are seeing some of the expectations come down a little bit.

Thank you.

And the next question comes from the line of Koji Ikeda with Bank of America. Please proceed with your question.

Hey, this is Natalie Howell. I'm for Koji. Quick one from me. I wanted to ask about the Sammart Telecoms partnership. Is a hundred thousand students a commit or is that an opportunity that can be addressed over the next few years?

Nellie, as I was mentioning a little bit earlier that these are hard commits in terms of over the next 12 months, 12 to 18 months of these partners. And typically that allows us to wrap up these regions with schools and stuff. So we already have presence in actually in Thailand with almost a few tens of thousands of students. And now we can actually really grow this to be a little bit with a broader market. But these are good ramp-up ways for us to be able to take that region as well as some of the neighboring, you know, countries in that area.

Got it. Okay. Thank you.

Thank you. And the next question comes from the line of Claire Gerdes with UBS. Please proceed with your question.

Great. Thanks for taking the question. Similar to the second question earlier, so for Eric, you mentioned the trends for non-subscription revenue segments. Is there any updated color you can give us on growth in the subscription segment? I think previously you'd mentioned a reversion to low double digits in the second half just as those larger deals kick in. And then also on the license and other line, I know that's a bit hard to model since it varies so much, but I think previously I'd mentioned that 3Q would be the peak, but wonder if maybe that's changed based on the the $4 million benefit into Q2 from that LA deal. Thanks.

Yeah, great questions, Claire. So, let me just first start with the subs and support. So, we still, you know, as I mentioned in Q2, we had minimal revenue attributed from Puerto Rico. That will start kicking in into the Q3 and Q4, so we do expect that to be in the low double-digit range. I think the other thing that's important too for everybody is you kind of look at the disaggregation of revenue for substance support. You know, the most critical piece of that You know, you're seeing really starting, you know, you look at the SAS part of that SNS revenue, and that's about 80% of the overall revenue. That's growing 10 to 11%. It's really the maintenance part of the SNS revenue that's growing in the low single digits, which is the, you know, lesser strategic component of the SNS revenue. So I think that's also important. So I would just... you know, call out if you're looking at the 10Q to look at the disaggregation of revenue because you can kind of see that trend as well. In terms of the LNO, so we, you know, I still think that you'll see a pretty decent, we're not gonna give a specific number for LNO for Q3 because it's embedded in the overall revenue number. because it is somewhat variable. And again, the timing of some of these items can be somewhat, you know, from one quarter to the next. But I think the piece that's important, and it was in my prepared remarks, is there is, as we modernize the Puerto Rico classroom of the future, right, there is a scanner component of that deal with Puerto Rico. And we do expect a good part of that scanner revenue, which will be one time in nature, to come into the Q3. The LNO, I still think that's going to be a relatively decent number in the third quarter, and a lot of that's going to be attributed to the revenue coming from the Puerto Rico scanner component. So hopefully that color is a little helpful in terms of giving you an idea of, you know, where we're expecting it to trend.

Yeah, I appreciate it. Thank you.

And the next question comes from the line of Brett Knobloch with Cantor Fitzgerald. Please proceed with your question. Hi, guys.

Thanks for taking my question. I guess on the acquisition of School Messenger, you guys bought another messaging solution called Beginning West here in Kinvob. Can you just help elaborate on what this acquisition gives you that maybe that acquisition did not give you? Or how should I think about the combined communication solution that you now have with these two products?

Sure, Brett. This is if I can take that. So when you look at some of the kin vaults when we acquired we if you look at that. It's actually a more of an attendance intervention. And messaging component what a lot of districts have taken advantage of that is where you're doing a very targeted. communication from school about delinquencies as well as truancy in terms of where the kids may not be attending. So you will get a reminder, this is your kid's third attendance miss, and if you miss the next one, this is the repercussions. So you're able to track individual ways on understanding how to drive better attendance. A lot of the school districts were struggling post-pandemic in terms of kids not coming to the school or losing that engagement. And it's one of the very strategic areas. We are seeing a tremendous amount of demand, even with districts like San Diego, which actually rolled this out, and saw very strong feedback from parents and teachers about the value of such a solution. When you look at from overall communication needs, there's also emergency notification, broader messaging from the districts, messaging from schools, as well as teacher and student and parent bi-directional two-way communication as well. What we're trying to bring with Kinwald attendance messaging and intervention along with School Messenger and our two-way chat capabilities around alignment within under a one unified communication umbrella. And what that does, it gives a one-stop shop for parents, districts, teachers, students to be able to understand all the different elements of communication because right now you will get phone calls, you will get messaging, you will get some in-app notifications, And it's like very chaotic all over the place. And this gives us a unique opportunity to bring the most comprehensive communication system under one umbrella and all integrated into their MyPowerSchool experience so they don't have to go anywhere else to get that.

Fairly understood. And maybe just as a follow-up, you know, all I guess kind of enterprises right now is trying to figure out how they can use AI internally to kind of become more efficient, whether that's in the go-to-market teams or R&D. I just was curious to your view of how schools are thinking about AI and generative AI. Are you seeing a pickup in conversations surrounding AI, especially given your recent announcement with Gen AI and kind of Microsoft Azure's open AI capabilities? And what do you expect that to translate into for maybe a pricing power, maybe increased pricing uplift in the future? How should we think about those conversations?

This is a very exciting question, and in fact, we'll be planning to share a lot about this in our analyst day, but I'll try to cover such an exciting topic in a minute. What I'll say is that, look, we are seeing a lot of interest in education actually to present one of the biggest opportunities for generative AI. A lot of the school districts actually see a clear need because if they don't adopt it, they're going to be, they anyway need to rethink their student engagement with these kind of technologies because students are going to start using a lot of that. What we're also seeing is that for us, given we are the system of engagement and we have the system of intelligence with a data product, we are in a unique position to be the platform for all these school districts and state to leverage these and monetize that effectively. So we have a very exciting opportunity. In fact, we're going to share some of that, how the monetization of the Generated AYI is going to happen over the next few years for us. But we see this definitely as a game changer.

And the next question comes from the line of Fred Havemeyer from Macquarie. Please proceed with your question.

Hi. Thank you very much. You know, Hardeep, I wanted to ask, as PowerSchool's now gone through the major purchasing cycle, I wanted to really just take a high-level approach and ask, what are the biggest pain points that schools are now looking at here? Can you just help walk me through where in the PowerSchool portfolio, in addition to data, you're just finding the most traction at this point in time? And then, since you're in DC and you're with the White House, you know, fantastic to see that, fantastic to see the leadership position you're in. Just what are the conversations there like? And what is the White House focused on right now in terms of education? Thank you.

Great, great, Fred. In fact, you know, I'll share with you a little bit more about this thing over the next few days as we work for the White House. But I also encourage you guys to look at the EdTech report we put, education report we put, which we launched at our EDGE conference, which is actually feedback from a lot of our customers. And I think if you look at some of the key trends, I highlight one in the prepared remarks, which was around data. I think a lot of the districts are still kind of flying blind. They have a lot of different systems and a lot of different initiatives, but how do you see the ROI of it? How do you make sure that they're able to get all the data real time? and be able to really have the surgical support so their budgets are more reaching the kids who need the most help. That is a big thing, and our MTSS capabilities, our connected intelligence, we're clearly seeing that that leadership is really driving a lot of the growth in the market because of the unique position and the unique solutions we have in the market on that. The second area we still see is in terms of, you know, the area around the, you know, in terms of the teacher burnout and teacher empowerment. So we're tools around how we are helping with generative to make teachers more efficient, support them, as well as with how they can easily engage through our comms tools with MyPowerSchool. So their communication, which is a big drag on teacher's time, all that stuff is improved. That's why you see our announcements of innovation as well as inorganic stuff all around to improve and reduce teacher burnout and improve their empowerment. The third area is the cybersecurity. This is where the White House is, there is a lot of legacy system. I shared in our press release today, just PowerSchool alone, we are able to successfully defend over one billion cyber attacks for our districts across our solutions. So imagine we are, you know, about 10% of the market, so the actual number of attacks is probably 10 times. And districts and states don't have those kind of resources, and this is where we have a huge opportunity for the digital transformation, as well as getting districts to be able to start using more modern cloud solutions and get that safety. So we have still a lot of upside in terms of the transformation that's ahead of us, and White House and private sectors are putting in investments actually to help districts with those modernization as well. So good to see a very concerted effort around those areas.

Thank you.

And the next question comes from the line of Rich Hilliker with Credit Suisse.

Please proceed with your question. Hi, thanks for taking my question. I wanted to touch on the Persona-based Cloud Bundle. Obviously new this spring, and there was an emphasis at the Edge User Conference. Wondering if you can give us a sense of how much that contributed to the strong bookings performance, specifically in Q2. I know that was a first half number that you guys disclosed today. And then I was also wondering how you think of that as a lever as you enter into your largest renewal quarter here. Thanks.

Great, Rich. As you mentioned, with our cloud launches, what that does is allows districts to kind of more easily adopt multiple solutions rather than individual products. So we're seeing a tremendous amount of interest actually on the Student Success Cloud, which is around MTSS with behavior and attendance interventions being able to really bring that all together. So we saw a strong demand there. Our Student Cloud, as we've been sharing this whole year, our Student Information Cloud continues to actually really be strong. So we are seeing a lot of school districts who are sitting legacy. Great example is Jackson in Mississippi. Bought our entire student cloud to really roll out. It's actually the third largest district in Mississippi. So these are those clouds we are worried. And then the third area is the workforce planning cloud. This includes our whole K-20 view for states to be able to better have view and support the career and college pathways. So these are some of the bright spots in our clouds which we are seeing. We continue to see healthy demand in our personalized learning cloud with LMS and assessments which continue to be driving million students plus adoption in a year. So we do expect our clouds are going to really help us in all elements around that, you know, in terms of growth, and will help us improve the cross-cell. We will share some of this more data at our analyst day so you guys can see how these are coming to fruition.

There are no further questions at this time, and I would like to turn the floor back over to Hardeep for any closing comments.

Great. Thank you, operator. We really appreciate everyone joining and thank you for your flexibility with the change schedule. As we can, you know, with the remarks you saw that we are very happy with our first half 2023 performance and we are also excited about the opportunity ahead of us and the strength of our business to have a predictable growth and continue to have a better margin profile really gives us confidence to continue to be, you know, have a very attractive financial profile. I think what we are most excited, the strategic deals we are doing, shows the leadership we have in the industry. Our innovation will continue to differentiate us even further. And our ability to do strategic acquisitions continue to allow us to even further add to our growth in terms of being able to have a more comprehensive platform. We are very excited to share more about our broader roadmap. And at the investor day, I'm looking forward to interacting with all of you there. So thank you. everyone for joining and looking forward to sharing more.

Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.