Stride, Inc. (LRN) Q3 2021 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Stride Third Quarter Fiscal Year 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mr. Tim Casey, Senior Director, Investor Relations. Please go ahead.

Thank you, and good afternoon. Welcome to Stride’s third quarter earnings call for fiscal year 2021. Before we begin, I would like to remind you that in addition to historical information, certain comments made during this conference call may be considered forward-looking statements. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. They should be considered in conjunction with cautionary statements contained in our earnings release and the Company’s periodic filings with the SEC. Forward-looking statements involve risks and uncertainties that may cause actual performance or results to differ materially from those expressed or implied by such statements. In addition, this conference call contains time-sensitive information that reflects management’s best analysis only as of the day of this live call. Stride does not undertake any obligation to publicly update or revise any forward-looking statements. For further information concerning risks and uncertainties that could materially affect financial and operational performance and results, please refer to our reports filed with the SEC. These reports include, without limitation, cautionary statements made in Stride’s 2020 Annual Report on Form 10-K. These filings can be found on the Investor Relations section of our website at www.stridelearning.com. In addition to disclosing financial results in accordance with Generally Accepted Accounting Principles in U.S. or GAAP, we will discuss certain information that is considered non-GAAP financial information. A reconciliation of this non-GAAP financial information to the most closely comparable GAAP information was included in our earnings release and is also posted on our website. This call is open to the public and is being webcast. This call will be available for replay for 30 days. With me on today’s call are James Rhyu, Chief Executive Officer; and Tim Medina, Chief Financial Officer. Following our prepared remarks, we will answer any questions you may have. I would now like to turn the call over to James. James?

Thank you. Good afternoon, everyone. Since I became CEO three months ago, I’ve heard one consistent question. What will happen with education after the pandemic is over? Well, we’re soon approaching that point it looks like and I don’t think any of us know. But many critical thought leaders seem to believe the shift to online learning is not temporary. In fact, a lot of the key trends we’re seeing from recent research on education, careers and economy support this idea. A recent New York Times article carried the headline, “Online Schools Are Here to Stay, Even After the Pandemic”. The premise of the article was that the ongoing pandemic has changed the landscape of education permanent. One quote, “a subset of families who have come to prefer online learning are pushing to keep it going”. Additionally, a recent study by the Society for Industrial and Applied Mathematics found that one-third of high school students would choose a fully online or hybrid education, even after things return to normal. These and other researches like them support my long-held belief that the momentum in digital transformation is difficult to reverse, and that the trend toward online and hybrid education will continue, and more students are recognizing that college is not the only effective or most affordable path to a career. The ECMC Group released findings from a study it conducted, that shows today’s high school students are seeking lower cost, quicker paths to careers. In this study, 25% of Gen Z teens said, they were more likely to attend a career and technical education school due to their pandemic experience. This trend is playing out in college as well. Last fall, there was a 7% drop in enrollment to higher education. This means more students will seek out other educational paths. In a recent article in New York magazine, they made the following case. I quote, “People under the age of 40 are fed up. They have less than half of the economic security than their parents did at their age”. For the first time in our nation’s history, a 30-year old, isn’t doing as well as his or her parents at age 30”. So, the paradigm of offering opportunities needs to shift. In our adult learning business, we are seeing people moving toward non-traditional educational paths. Strada Education Network’s surveys have shown that adult learners who are looking for education or training options are focused on gaining certification and licensure rather than traditionally degrees. And they prefer to get this training through online programs or directly from their employer. Importantly, companies are beginning to recognize that non-traditional educational paths can be success -- as successful as college grads. Large corporations like Facebook, Google and Amazon and others have begun programs to hire non-college graduates and in many cases, students right out of high school, into professional high-paying technology jobs. And all indications suggest these professionals are excellent. As such, companies are expanding these programs. These trends support our strategy of providing career skills. The pandemic has accelerated the shift in modality to a more digital approach. As these markets are poised to grow and increasing rates, Stride is well positioned to benefit for many years to come. The immediate impact of these trends are evident in our results for this quarter and in our fiscal 2021 guidance. We’ve raised our guidance for full year in each of the past two quarters. Year-to-date, our Stride career revenue enrollments are up over 120%. The ECMC study I mentioned above also found that 61% of Gen Z teens believe a skill-based education makes sense in today’s world. And our Stride career programs offer a clear solution for these students. The programs provide access to career ready skills and certifications. This allows students to develop skills that can lead directly to a career or better prepare them for post-secondary education. Regardless of which path they choose, we want to provide them with an education that will prepare them for careers in high-growth areas like health care, technology and business. Our adult acquisitions are doing well and growing at double-digit rates even though some of them have traditionally focused on in-classroom teachings. Their shift to online programs have gone smoothly, and we feel good about our future growth prospects. Specifically, our two most recent acquisitions, Tech Elevator and MedCerts are performing against our acquisition plans, but more importantly, these companies serve mainstream markets, have large-scale future opportunities in front of them. As we begin to invest in our Stride brand, we believe we will be able to generate meaningful growth for these products incremental to what they would have been able to do as standalone businesses. As more employers start to take notice of these kinds of pathways, they are looking to partner with training providers to ensure they are hiring the right skilled workers. For instance, MedCerts recently announced a partnership with Equus Workforce Solutions to offer registered apprenticeship opportunities to employers seeking employees in high-demand fields. These types of programs demonstrate that Stride’s offerings can address both learner and employer needs. Beyond that, we can help employers build recruitment pipelines with our Tallo partnership. Tallo now boasts 1.5 million users on their platform. This community of both users and employers will help ensure that we are developing the right training programs while giving them and others a path to employment. And as we said during our Investor Day in November, we expect this growth and the trends we are seeing in the market to lead to overall career learning revenues of $650 million to $800 million by fiscal 2025. And as excited as we are about the prospects in our career in adult learning businesses, we are also focused on our general education business. Unfortunately, for many students, the pandemic has caused a decline in academic achievement. A recent study by NWDA showed that number of students who regressed academically increased significantly nationwide during the last year. Fortunately, for students and families attending established virtual programs like ours, they have been able to attend school uninterrupted. Our partners have provided seamless education in a completely disruptive world. We owe our gratitude to them. The impact translated into academic outcomes as well. In a recent study we conducted, programs managed by Stride handily outpaced schools like the ones in the NWDA study. Not all online programs are created equal. We believe ours is the gold standard. Data backs that up. How does all of this translate into future trends? Just a little over a year ago we conducted a survey that validates the trends we’ve seen for many years that approximately 2% to 3% of families were considering a fully online high school option. We just today received results of our most recent study that indicated that that 2% to 3% had jumped to over 10%. Similarly, consideration for online career programs jumped from 15% to 25%. The shift to online school from home means that more families are seeking out Stride’s offerings and digital solutions. And while online school might not be for everyone, many more families now recognize it as an option. In addition to the increase in awareness, the pandemic has brought about structural changes to other parts of our lives. It wasn’t just students who were impacted. It was parents, families, teachers and administrators. Many of these individuals have come to appreciate the flexibility that comes from working and schooling from home. This shift gives more parents and families the opportunity to support their children’s learning at home while they’re also working at home, or for teachers, they can teach at home. We hired and managed more teachers than ever this year. The flexibility for teachers to work out of their homes is another clear trend that provides great opportunities. Overall, this means that Stride’s offerings are more accessible to more families. Now I know many of you are focused on what will happen with our enrollments this coming fall as the rollout of the vaccine proceeds and most school districts announced plans to get back into the classroom. First of all, let me be clear that we support the reopening of brick-and-mortar schools. In fact, we penned an open letter supporting President Biden’s bipartisan push to get schools reopened. Additionally, it’s far too early in enrollment season to know how many new students will come to our programs in the fall. In fact, less than 10% of our normal overall enrollment volume happens before the end of April. However, we do have some early indications of the rate at which existing families are indicating their return for the fall. As of right now, the percentage of existing families that are responding to our outreach for returning in the fall is at an all-time high, and the percentage that has indicated they are returning is at a multiyear high. So far, we are seeing the opposite of the mass exodus back to brick-and-mortar schools that some have predicted. This is some very early encouraging news. However, I want to stress, this is still very early in our enrollment season. Finally, I want to highlight some existing -- sorry, some exciting upcoming programs from Stride. Recently, a survey we conducted has founded over 65% of parents agree that their children need additional educational curriculum over the summer to make up for lost time due to the pandemic. Given the significant need, this summer, we are going to offer free summer career experiences for students grade 7 through 12. These programs are an excellent opportunity for current and prospective students to gain exposure to career skills while engaging in exciting activities. For example, In our esports experience, students will work on coding skills in the morning while spending the afternoon gaming with their friends. We plan to offer programs in nursing, theater esports and even a jam camp for musicians. We will also offer programs for recent Stride career graduates to further hone their career riding skills they learned in high school. All these programs will help make Stride more accessible to more students while teaching them valuable career skills. So, I believe the trends in our business as well as the overall macro conditions and our addressable market continue to work in our favor and grow as time passes. Thank you for your time today. I’ll now turn the call over to Tim to discuss our quarterly results. Tim?

Thank you, James, and good afternoon, everyone. Revenue for the quarter was $392.1 million, an increase of 52% from last year. Adjusted operating income was $54.9 million, an increase of 146%. And capital expenditures were $11.3 million, an increase of $1.9 million versus Q3 last year. In each case, these results met or beat the expectations we provided in our guidance last quarter. As James mentioned, our general education business continues to perform very well, and career learning remains on a strong growth trajectory as it has been for the past several years. Given the strength in these businesses, we have raised our guidance again for the full fiscal year. Returning to our results for the quarter, revenue from our general education business increased $89.2 million or 38% to $322.3 million. This was due primarily to higher enrollments, partially offset by lower revenue per enrollment. General ed enrollments rose 43% year-over-year, while revenue per enrollment declined 4%. For the full year, we expect revenue per enrollment to be down compared to last year due to state budgetary pressures resulting from COVID-19 and a higher mix of lower-funded states. We do not, however, expect this decline to become a trend into next year. In fact, we are confident given what we know today about state policy that enrollment funding should improve next year. Career learning revenue rose to $69.8 million, an increase of 191%. This was largely driven by significantly higher volumes in our Stride Career Prep programs, formerly now as Destinations Career Academies as well as growth in our adult learning businesses, including the effect of MedCerts and Tech Elevator acquired in November 2020 and Galvanize acquired in late January 2020. Gross margins were 35.5% in the quarter, up approximately 500 basis points from the same period last year. For the full fiscal year, we expect gross margins to be approximately 34%, plus or minus 50 basis points. We believe this improvement will continue into next year. Last November, at Investor Day, I laid out a 2025 goal for gross margin percent of 36% to 39%, and I expect us to get there much faster. Selling, general and administrative expenses in the quarter were $100.5 million, up 58% than the year-ago period. The increase in SG&A was driven primarily by higher costs associated with the growth in enrollments and higher stock-based compensation expense as well as the expenses for our adult learning businesses. We expect SG&A for the full fiscal year 2021 to be in the range of $420 million to $425 million, up from fiscal 2020 due to higher costs associated with the growth in enrollments, higher stock-based comp expense as well as the inclusion of the SG&A associated with Galvanize, MedCerts and Tech Elevator. Our expectation for fiscal year ‘21 interest expense is that it will be between $17 million and $18 million, including approximately $4 million in cash interest and $12 million in non-cash amortization of the discount on our convertible senior notes and another $1 million of non-cash amortization of debt issuance costs. Our convertible notes are subject to new accounting guidance, which can be adopted in FY22 and no later than FY23. Once the guidance is adopted, the debt discount will be eliminated from the balance sheet and the associated non-cash amortization expenses are eliminated from the P&L on a going-forward basis. EBITDA for the third quarter was $62.2 million, up 89% from the third quarter of fiscal 2020. Adjusted EBITDA was $75 million, up 92% from the same period a year ago. Operating income was $38.6 million. Adjusted operating income was $54.9 million, an increase of 146%. Additionally, we are raising our guidance for adjusted operating income to $156 million to $159 million for the full fiscal year 2021, and that’s up from our previous guidance of $145 million to $155 million. We ended the quarter with cash and cash equivalents of $329 million, an increase of $70.9 million compared to the second quarter. We expect working capital to be a significant source of cash in the fourth quarter, primarily due to accounts receivable. So, we expect our cash balance at the end of fiscal 2021 to increase significantly. We believe that our strong free cash flow generation and liquidity will continue to provide the financial flexibility to fund our existing operations and to pursue strategic acquisitions. Capital expenditures for the quarter totaled $11.3 million, below the range of $12 million to $15 million we guided to last quarter. We expect full year CapEx to be in the range of $50 million to $55 million. Our effective tax rate for the quarter was 30.2%, and we expect our full year tax rate to be in the 27% to 29% range. We expect that free cash flow, defined as cash from operations less CapEx, will trail our adjusted operating income. This timing difference is primarily due to working capital changes related to the timing of payments from certain states, some of which are associated with our growth in states that regularly pay in the following year, and some of which is related to delayed payments due to COVID. Now, returning to our updated guidance. To summarize, we expect the following for the full year fiscal 2021: Revenue in the range of $1.525 billion to $1.530 billion; adjusted operating income between $156 million and $159 million; capital expenditures of $50 million to $55 million; and a tax rate of 27% to 29%. In Q3, we saw another successful quarter owing to the tremendous demand for our products and services, both in general education and career learning. We delivered double-digit or better growth in revenue, adjusted operating income and adjusted EBITDA, while significantly improving our gross margins and our robust cash and liquidity position. We remain very excited about the prospects for our business as a whole, and we’ll continue to execute on our high-growth career learning strategy. And with that, I’ll turn it over to the operator. Operator?

Thank you. [Operator Instructions] [Technical Difficulty] And your first question comes from the line of Jeff Goldstein from Morgan Stanley. Your line is open.

Hey, guys. Good evening. Can you hear me okay?

Apparently, you can hear me -- many of you can hear the operator. I think some of you can hear us as well, but we cannot hear you or the operator. So, we’re trying to work through here the technical difficulties, if you just give us a moment.

Ladies and gentlemen, we apologize for that technical delay. [Operator Instructions] And your first question comes from Jeff Goldstein from Morgan Stanley. Your line is open.

Hey, guys. Can you hear me okay now?

Yes. Hey there. We can hear you. We’ve actually had to dial in from a mobile phone here. So, I apologize if there’s a little bit of -- if the sound quality isn’t as good. We still have a little bit of technical difficulty on our end, but we can hear you now. Go ahead.

Okay. Perfect. So, I just had a question on revenue per enrollment. That figure seemed to recover in the quarter within both general education and career learning when comparing it to last quarter. So, I was just hoping you could expand on drivers of that recovery. And if some of that recovery in the quarter was giving you confidence for further improvement into next year?

Let me just try to take maybe half of that question, and then I’ll hand it over to Tim. I think, first of all, a lot of factors happened in year. So, I sort of -- I think, it’s probably better to focus on the full year number. The confidence in next year actually doesn’t really have much to do with this year. This year, we were negatively impacted by, you may recall, California didn’t fund new enrollments and some other sort of mix issues. When we look at next year, really, what we look at is, sort of, I’ll say, the policy landscape across states in which we manage programs. And from that perspective, we think that our overall -- the overall environment looks pretty strong and pretty stable. So, it’s really nothing to do with how this year is shaping up. It’s really based on what we see across the landscape for next year policy-wise. Tim, I don’t know if you want to add anything.

Yes. The only thing I would add in terms of sequential improvement is that as we get into the year, our revenue -- we’ve earned revenue in some cases where we trade small amounts of enrollments, normal course. And that’s really the driver overall in modest sequential stabilization in that metric.

Okay, got it. And then, I appreciate your comments in the prepared remarks around just optimism you have around returning students for next year. I was curious, though, if the churn you saw in the quarter in general education, like this past quarter, was in line, or was that more than you were anticipating, given students could potentially be returning to their traditional schools? I mean, were you seeing that in any particular age group, or is that not the case, and it was all just kind of normal course? I was just curious of your thoughts on churn in the quarter.

Yes. So, I think there’s -- if anything, churn continues to be better than previous years, I think in that respect, it was, I would say, somewhat better than we expected originally when we set out the year. But we are seeing, I think, just a tendency -- and we’ve seen this over the years, the tendency for in the middle of a semester families do have some reticence. Even as schools are opening back up, I think we see -- we saw families have some reticence just to disrupt sort of the flow of the educational program that they’re child’s in. But we were a little bit pleasantly surprised, I would say, and we have been pleasantly surprised throughout the course of the year on the sort of the trajectory that churn has taken for us.

Your next question comes from the line of Jeff Silber from BMO Capital. Your line is open.

The results were much better than expected, both on the top line and bottom line. Can you kind of focus what was the reason for the beat or reasons for the beat?

The reason for the beat is that -- it’s really the point that James just made. Better retention performance during the quarter really is the primary driver of that improvement on the top line, and that really fell to the bottom line.

Okay. So fairly similar to what we saw last quarter as well?

Yes.

Okay. That’s great. I appreciate the color you gave us on the fall. I know it’s still very early. Can you talk about at least the potential for either new states or new schools, how that pipeline is going?

Yes. I think, unlike probably previous years, our approach to new states and new schools is actually evolving. And I think it’s evolving in a positive way, meaning there are increasingly more opportunities for us to enter new programs, new states with partners. We’re approaching it from a perspective that we don’t always need a sort of new policy or law legislation to be passed. So, we are continuing to work to open particularly career education programs. We expect to open a small handful this coming fall. We expect programs in general, in a number of states to -- new states to open or expand. And so, we’re pretty bullish. West Virginia, Missouri, places like that we expect at least some type of expansion or a new program to be open for the fall.

Okay, great. In your prepared remarks, you also talked about academic outcomes. I know it may be too early to get this kind of data. But I’m just curious, in the pandemic, have you seen your outcomes increase relative to some of the traditional schools that went online? Is there any data that shows that?

Yes. For sure. We have -- we definitely -- there is some data trickling in that suggests -- and obviously, not surprising that most of the brick-and-mortar schools took a pretty significant step back on average in academic outcomes. And we did -- in fact, our schools, our data suggest that we outperformed that significantly. So, at least from our perspective and our data would suggest that based on what we see and what we can sort of -- I’d say the data that is available is that our performance has outperformed and outpaced most other promoter schools that did online learning over this past year.

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

First, great to hear about the higher new registration, I guess, indications. Is there any way to roughly frame or quantify how much higher the percentage of families indicating the return compares to the normal trends that you see?

Well, so I’m reluctant to start providing that type of guidance at this point. I will tell you that our response rates are -- have been materially higher. And I think that for me at least, the signs that point positively is the engagement, the engagement levels we’re getting. And particularly, I’ll give you one sort of a tidbit of information. We did track, I’ll say, COVID-related types of enrollments, meaning some families did very specifically indicate to us that they were coming to us this year, specifically for COVID. Now, of course, a lot of families didn’t indicate that. And so, that doesn’t capture maybe the entire population. But, a very significant proportion of those families who said that they came to us because of COVID, have been engaged with us and have indicated that they expect to return in the fall. So, again, in our prepared remarks, I indicated that we’re not seeing sort of this, I’ll say, mass exodus of families just riding it out with us until the brick-and-motor schools came back online, and then sort of all exiting back to the brick-and-mortar programs. So, we see that as a pretty positive trend that families -- at least a significant number of families have appreciated the experience enough to indicate that they are sticking with it.

Got it. Really helpful. And I know you guys can help students that have fallen behind academically try to catch up, especially with some of the personalized learning that you provide online. With some students at local options falling behind over the last year, I guess, we’ve seen that increased demand at all for general education, especially as you think about indications heading into next fall.

Yes. I think, the slide that’s happened -- I was just actually -- before we came into this call, there was a -- I saw Khan from Khan Academy, he was on CNBC mentioning that 15% to 20%, I think it was the number, the stat that he gave, 15% or so of kids have "gotten lost" in the public school systems. And so, not just a slide of the kids who have been in the system, you see a large number of students who have sort of gone missing in a way, right? And so, we do think and we do see that there’s a very large opportunity and good demand for not just our programs, our full-time online programs and kids to come into those programs, but just in school districts more broadly looking for ways to meet that demand or to meet that gap. And so, I think you should remember that we’re not just running full-time programs. We offer a suite of solutions that also help districts with their problems. And I think that in some ways, that’s going to be an ongoing opportunity for us, because I really emphasize with these school districts, they really need to make sure that they can reach a lot of these kids who have somehow gone missing in their systems, and they need to provide some alternatives for them as well. And I’m hopeful that they are looking at alternatives like online alternatives for those kids as well, and we can certainly help there.

Makes sense. Last one for me just on the guidance. It seems like the guidance implies a sequential step down in revenue in the fourth quarter relative to the third quarter. I think, the normal progression over the last two years has been for a sequential uptick. Anything notable to call out on what would drive a sequential decline this year in the fiscal fourth quarter?

Nothing notable to note there. It is fair that if you squeeze out another quarter just like this one, we would be at the very tippy top of our guidance range. So, there’s nothing in particular to call out there. No particular concern or anything like that.

[Operator Instructions] Your next question comes from the line of Greg Pendi from Sidoti.

Just real quick on the summer courses that you’ll be offering, is that going to create any notable shifts in expenses on a year-over-year basis, especially in structure costs?

Yes -- no. The answer is no. We shouldn’t have any material change in costs over the summer due to those programs. Those programs, they’re not -- they do have some marginal cost to us. It’s not significant. We think it won’t change sort of the overall profit or gross margin trajectory that we’re headed on. But, we also think it’s important. It’s important to help with the summer sort of gap, if you will, and bridge kids over the summer. We think it’s an important offering to get kids to have awareness around some of these opportunities that we can provide them. So, I don’t think it’s going to be a material cost. But I think, irrespective, it’s just an important service that we need to provide to country right now.

Great. And then, just one final one, just on the revenue in terms of next year. Assuming -- would it be a positive benefit, if you a higher mix of specialty students next year in your revenue? I’m not saying that you’re foreseeing that, but just given the trends of some students falling behind, is that typically a higher revenue per student?

Not material. So, I wouldn’t portend that our revenue pursuing trend next year is going to be impacted by that. In fact, in any given year, I think sort of falls out with the wash, and our overall revenue pursuing trends get more impacted by things like mix or what happened in California this year and not by the mix of specialized versus non-special students.

And there are no further questions at this time. Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.