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Stride, Inc. (LRN)

Q3 2023 Earnings Call· Tue, Apr 25, 2023

$92.16

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Transcript

Operator

Operator

Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Stride Inc Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Tim Casey, VP of Investor Relations. You may begin your conference.

Tim Casey

Analyst

Thank you, and good afternoon. Welcome to Stride's third quarter earnings call for fiscal year 2023. With me on today's call are James Rhyu, Chief Executive Officer; and Donna Blackman, Chief Financial Officer. As a reminder, today's conference call and webcast are accompanied by a presentation that can be found on the Stride Investor Relations website. Please be advised that today's discussion of our financial results may include certain non-GAAP financial measures. A reconciliation of these measures is provided in the earnings release issued this afternoon and can also be found on our Investor Relations website. In addition to historical information, this call may also involve forward-looking statements. The company's actual results could differ materially from any forward-looking statements due to several important factors as described in the company's latest SEC filings. These statements are made on the basis of our views and assumptions regarding future events and business performance at the time we make them, and the company assumes no obligation to update any forward-looking statements made during this call. Following our prepared remarks, we will answer any questions you may have. I will now turn the call over to James. James?

James Rhyu

Analyst

Thank you, and good afternoon. The underlying systems and institutions in the U.S. and across the world can be fragile. We have seen this repeatedly over many decades. Headlines in the banking and technology sector are just recent examples. But each time we see these cracks in the economy, the U.S. has been resilient. And more often than not, we search forward through innovation. These cycles have enabled the U.S. to progress in amazing ways. The ways in which we travel, bank, shop and even eat have changed dramatically. It wasn't that long ago that we did most of our banking shopping and transacting in person. However, it has not permeated all sectors equally. One of the sectors that has not evolved as dramatically is the education sector and most notably the K-12 education sector. With our recent experience going through a pandemic, I would have hoped we would have emerged with more fundamental change in the system, particularly given the customer feedback we have heard. But I see kids in school largely the same way as they have for decades. Sure, there are some minor tweaks that technology is enabled but no real substantive change. That both disheartens me, but also gives me hope that Stride can begin to move the needle on the system that will power the future of this nation. From how we think about the trade-offs of skills versus knowledge, trade versus professions, college versus jobs, practical versus theoretical, should kids still be on a traditional belt schedule or should they have flexibility? Should all students really be spending the exact same amount of time on each lesson? Should we enable our students to use their time efficiently in a manner that meets them at their point of need? And should we empower parents to…

Donna Blackman

Analyst

Thank you, James, and good afternoon, everyone. First, let me quickly recap our quarterly results. Revenue was $470.3 million, an increase of 11.5% from the same period last year. Adjusted operating income was $80.2 million, up $10.8 million or 15.6% from last year's third quarter. And capital expenditures were $15.2 million, a decrease of $3.2 million. We remain very pleased with how the year is coming together. Our results this quarter for both revenue and adjusted operating income exceeded the high end of our guidance. We continue to see strong retention and new enrollments in the third quarter. We finished the quarter with total average enrollment of 181,800, up nearly 8,000 enrollments from the first quarter. This reinforces what we've said before about the continued demand for virtual options and service our belief that we remain on a path to achieve our fiscal year 2025 revenue and AOI targets. Now for some more detail on our third quarter results. Korea learning revenue was $180.7 million, up 71% from the third quarter fiscal 2022. Continued growth in the adult learning business and strength in our middle and high school programs both contributed to the increase. Middle and high school career learning revenue was $150.8 million, up 81% from the third quarter fiscal year '22. This was driven by a 60% increase in enrollment and a 13% increase in revenue per enrollment. As we've mentioned previously, in the first half of the year, the revenue per enrollment improvement was somewhat timing driven, and we now have a harder comparison in the back half of the year. That said, we now think we'll see overall revenue per enrollment growth in the mid-teens for the full year. Adult borrowing revenue in the quarter was $29.9 million, up over 32% from the third quarter of…

Operator

Operator

[Operator Instructions] Your first question today comes from the line of Jeff Silber with BMO Capital Markets.

Ryan Griffin

Analyst

This is Ryan Griffin on for Jeff. I was just curious if you can give any color on some of the early indicators and how it relates to Gen Ed or Career Learning? And then if those are coming through the same funnel, do you have any updates on segregating those funnels at any point in the future?

James Rhyu

Analyst

Yes. So right now, they're still primarily coming from the same funnel. I think we do have some initiatives that we're planning for this fall season that will hopefully open up some incremental core at specific funnels. But for right now, we're seeing the demand that's really from the same funnel. And I think that sort of the comments we've already made about the fall, probably not going to give that much more context around them. I think we've given a lot, probably more than we normally would give at this time just because it's so we're on in the season. Remember, anything that we're talking about now we're talking about something like less than 10% of overall total enrollment volumes for the season. So while very encouraging, I think, early on, still very early.

Ryan Griffin

Analyst

And then just one follow-up on the margins. I think in the past, you've spoken about some of the efficiency initiatives and about how you're also lapping some of the cost inflation you've seen this year? Just wondering if you can give any color on what we might expect from the cost to the P&L and what that implies for margins next year?

Donna Blackman

Analyst

So one of the things we so early talked about this year is looking at some of those efficiency efforts to offset those inflationary pressures. And so looking at automation, looking at our looking at our size and scale as some of those examples of some of those efforts. And so those are always looking at how do we continue to deliver student outcomes in the most efficient way possible. And so we will continue to look for ways to do that. And so while many of those efficiency efforts mitigated the impact of inflation. It's not like next year, we sort of pulled back to the way we're doing things. We're always looking at how we continue to improve. And so with that, we think for this year relative to last year, our margins will be relatively flat.

James Rhyu

Analyst

I also would point out that just sort of a, I think, a data point that suggests that we're doing is actually paying dividends is we started the year with gross margins below the prior year. We said that we were going to really sort of tighten our belts and look for efficiencies. We did it. And in the second and third quarter, where we both saw gross margins above the prior year. And I think that -- I think Donna has mentioned this before, but most of those are sort of, I'll say, I'll call structural in nature, meaning they should have legs into subsequent years. So I don't think they're just quick one-off things that we won't see any benefit into next year.

Operator

Operator

Your next question comes from the line of Greg Parish with Morgan Stanley.

Greg Parrish

Analyst · Morgan Stanley.

Congrats on a strong quarter. I want to talk about the makeup of the students joining midyear here. I don't -- I ask the enrollments have grown 8,000 since this first quarter and factor in attrition and even larger numbers. So what's really driving these students out of brick-and-mortar in the middle of the school year here?

James Rhyu

Analyst · Morgan Stanley.

I mean, obviously, there's a ton of different reasons why kids are leaving. What we're hearing from families, I think particularly post pandemic, I think, continues to be sort of a simple premise that I'll summarize in a sort of, I think, a simplistic way, although it's really a lot of different reasons driving it, which is that I think school districts, in spite of the experiences they had in the pandemic I think, are still struggling to treat their family like customers to listen to the feedback that they're getting from them that they got during the pandemic, et cetera. I think families we're expecting in many cases, for districts to hear them maybe a little bit more clearly through the pending post pandemic. And I think when they solve the districts reverting back to pretty much status quo, i.e., pre-pandemic type of everything. A lot of the feedback that we get is that's been disappointing for many families. Obviously, not all families, but there are increasing numbers of families who I think want something different. And I think the pandemic sort of ignited a little bit of maybe an enthusiasm for parents to really go out and explore something different. And I think that the in-year demand that we keep seeing is really that sort of tension between parents expectations during the school year for what they see in their districts and then they come to us. And I think that we've talked about our NPS scores, I think, are pretty robust. And so I think that they find that we offer them something that's just a little more flexible it sort of meets in at their point of need a little bit more. So I think that's sort of generically -- I mean, there's so many situations, whether it's safety-related or academically related or courseware related, but I think that's sort of the general theme of it.

Greg Parrish

Analyst · Morgan Stanley.

And then thinking about next year, and clearly, this year was kind of unprecedented the way enrollments have come in coming out of the pandemic. But how do you go about capturing these students in the summer that maybe are kind of on the fence and last year defaulted back the brick and mortar, but clearly, the demand is still there. So how do you go about sort of capturing them before the clear starts?

James Rhyu

Analyst · Morgan Stanley.

Yes. I think it goes along sort of the same theme in the sense that we're right now, we're reaching out to families out next fall and very specifically reaching out to them talking to them about things that we've heard them say. We've heard them say that they want more socialization. We're talking to them about some of the programs that we're going to be instituting for the fall around socialization. We're going to be trialing new ways of letting the students communicate with each other. So I think what we're trying to do is listen to what our customers are saying, build in improvements to our programs and then proactively reaching back out and saying, "Hey, listen, we've heard you and we're making these improvements." And we'll do that. We've already started doing that for the fall. We'll do that through the summer. We've done it now for a couple of years. I think we continue to see improvements in retention rates because of it. And so I think we just continue to do that and really listen to our customers and listen to what they want and try to meet their needs as best as we can. And I think that just continues to promote stronger and stronger retention for us.

Greg Parrish

Analyst · Morgan Stanley.

I just want to ask about the broader funding environment. And thank you, Donna, for the color on revenue per enrollment to finish this year. But I just want to think about sort of high level how to think about funding for next year?

James Rhyu

Analyst · Morgan Stanley.

I think high level, I sort of often talk about sort of the generic heat map that we have around the U.S. for funding. And our generic sort of the heat map that we see funding across the U.S. continues to be largely green. There's one or 2 sort of yellow red spots, but by and large, it continues to be green. So I think that's consistent with what we've said long term that we believe the funding environment continues to be strong and certainly within the range of 1% to 2% average funding increase across the board.

Operator

Operator

Your next question comes from the line of Alex Paris with Barrington Research. Your line is now open.

Alex Paris

Analyst · Barrington Research. Your line is now open.

Congrats on the quarter. And James, based on the momentum of the year-to-date period, I think you said in your prepared comments that you're cautiously optimistic that enrollment can increase next year. First off, is that correct? And then second, I think I heard you just say revenue per enrollment should be positive along the long-term trends of 1% to 2%. And then similarly, I heard Donna say gross margin's flat next year. Would gross margins expand given those metrics rising enrollment positive funding?

Donna Blackman

Analyst · Barrington Research. Your line is now open.

Let me jump in real quick. I want to make a clarify something. Whenever some or gross margin, it's flat gross margins this year, flat versus last year. I want to add that point of clarity.

James Rhyu

Analyst · Barrington Research. Your line is now open.

Let me sort of try to take this to growth. Yes. Listen, I think I've said this for each of the past 2 years, our intent is to grow every year. And we've grown revenue in each of the past 2 years that I've said that. I think I was a little bit more specific in my comments today that our intent is to grow enrollment for next year. The early indicators look good for us. I think last year, we did deal with some execution issues. I think that we're improving our execution. So I have optimism based on the facts and circumstances I understand I can see today that we have an ability to grow enrollments in the fall. As I said, we're still less than 10% into the season. So a lot can change. But based on what I can see and what our plans are and our intent is, it's to grow enrollment. The funding environment -- so rate per enrollment is somewhat of a proxy, but remember, mix and all these other things come into play. I was referring to the funding environment that sort of overall across the landscape of programs that we serve. The funding environment continues to be positive by and large, again, one or 2 outliers, but by and large, continues to be positive, and we would expect on average, that funding to be 1% to 2% higher long term. And the -- I think the view of next year, at least of that is consistent with that sort of long-term view based on everything we know today.

Alex Paris

Analyst · Barrington Research. Your line is now open.

So with positive new enrollment positive funding leverage of fixed cost, is there room for gross margins to experience in fiscal '24?

James Rhyu

Analyst · Barrington Research. Your line is now open.

Well, here's -- I think what I would say is that I think without getting specific gross margin targets because a lot of that plays into our mix because sometimes if we mix into certain schools that have higher ratio or lower ratio requirements or things like that, there's a lot of play without knowing the mix, it's hard to say. What I do think, though, is that it does come into play in terms of adjusted operating income leverage. So I do think that the more we can grow enrollments and the funding environment stays strong that I think it translates into better leverage for our profitability for sure.

Donna Blackman

Analyst · Barrington Research. Your line is now open.

And also from an efficiency standpoint, as James noted, are structural, right? And so we'll continue that into next year as well.

Alex Paris

Analyst · Barrington Research. Your line is now open.

Great. And then just a big picture question with regard to marketing. Marketing must have changed over the last three years pre-COVID versus post-COVID. Pre-COVID, I think it was a missionary sale to some extent. How has it changed? And what's your go-to market now? Has it changed notably?

James Rhyu

Analyst · Barrington Research. Your line is now open.

Yes. It's a great question. And I think the short answer is yes, it has changed. I think it's changed in both messaging and tactics, meaning, I think you're right. I think -- I probably didn't use these words, but that sort of missionary messaging, I think, is a pretty good description of a lot of how we did go to market or we have gone to market. And I think a lot of that still can apply. What I think we've honed in tactics are that we -- there are several broad themes that seem to resonate but within those broad themes, there are a lot of very specific tactics that also resonate and a lot of different messages within those themes. So one theme of safety, by the way. Safety is a theme that resonates with a lot of families. That could be a bullying message, that could be a gun violence message, there could be -- there's a lot of messages within that. But themes like that. And so while I think we were going for some of that more sort of sentimental messaging previously. I think we're trying to hone in to a more specific message these days and the tactics around that around whether it's social media or digital marketing as opposed to sort of the broader -- maybe broader media TV type messaging as well. Those tactics are shifting as well. And we're finding them to be pretty effective for us. So it's both the messaging and the tactics.

Operator

Operator

[Operator Instructions] Your next question comes from the line of Tom Singlehurst with Citi. Your line is now open.

Tom Singlehurst

Analyst · Citi. Your line is now open.

It's Tom here from Citi. A congratulations on the results. I had a couple of questions on the school side and then 1 on adult learning, if that's okay. You talked about the funding environment sort of being largely green. I'm just interested in the sort of broader political risk, whether you can -- I know it's difficult across the entire sort of footprint but I was wondering whether -- so maybe difficult to generalize. I was just wondering whether you can give us a quick run through of how you see sort of the landscape in terms of risk around changes in the policy environment? That would be my first question, so I'll come back with a second if it's okay.

James Rhyu

Analyst · Citi. Your line is now open.

Yes. So I would say the broader political environment for us, I would -- in general terms, prepandemic to post pandemic actually has improved. I think -- and I think it continues to sustain that improvement. We see across the sort of the landscape of education, we see policy that both directly and indirectly looks to be in our favor generically. One fairly predominant example is laws around voucher type of programs and there's different names for you, obviously, but they seem to be gaining more traction that tends to benefit our types of programs, not exactly targeted towards our programs, but the ability for families to have greater choice in how educational funds get applied and used where we are one of the options that they can apply to tends to be good for our business. So that's one that there's several states that have enacted laws in that favor and I think more to come in the future. So I think from the broad political risk standpoint, I think we see less overarching risk in general than we did pre pandemic today. So I think our risk profile has improved. And that doesn't mean that there are not pockets of risk. There are pockets of risk. But I think just as a general statement, we feel like our general risk profile has improved over the past several years.

Tom Singlehurst

Analyst · Citi. Your line is now open.

The second question is on the competitive landscape. Pearson have announced effectively that they're going to follow a similar strategy to yours and explore launching career-focused structural schools. I mean, obviously, invitation is the sincerest form of flattery, but I'm wondering whether that has any impact on the competitive tension within the market? Does it make a difference? Or how should we think about the competitive landscape?

James Rhyu

Analyst · Citi. Your line is now open.

Yes. So I guess what I would say is I'm hopeful that Pearson's successful. I think it grows the pie. I think we're more interested in having a larger pie as opposed to splitting up a smaller pie more ways. I think that whether it's a career program, which I do think this country needs a lot more of, and I think that all the research all surveys indicate that that's true. I mentioned some of my comments earlier today. But I think competition is good for our industry. I think that it will create greater awareness. It creates greater validity for our programs. So I'm actually encouraged by the competition, not just because it's whatever you said, imitation is a form of flattery, but more for, I think, the validation in the marketplace. Clearly, the opportunity keeps growing for all of us and I think it's healthy. So I welcome it. I'm hoping Pearson is very successful at their programs. I think it's going to grow the pie for all of us, and I think there's more than enough to go around.

Tom Singlehurst

Analyst · Citi. Your line is now open.

And one final one quickly. Given we haven't talked about it yet, adult learning and in particular, Tech Elevator and MedCerts, I mean, they seem to be going great, which is obviously great. I'm just wondering whether we're overdue sort of allocating capital -- more capital to that area. Can you just talk about your philosophy on that?

James Rhyu

Analyst · Citi. Your line is now open.

Yes. I wouldn't say we're overdue. What I would say, I think, is that we continue to look for ways to allocate capital to all parts of our business that have opportunity. Those are included. And that means both internal investment as well as sort of more strategic M&A type investment. We have a pretty robust pipeline of companies that we monitor that for the right deal, the right price, we would certainly deploy capital for an acquisition. But we also think that there are internal investments that we can make as well to deploy capital to expand product line to invest behind different services not just for the adult learning category, but for the K-12 category. I talked a little bit about our Learning Hub investment. I think that can be really significant across the broad spectrum of both K-12, core education but also supplemental, tutoring, et cetera. So I just think that there's a lot of opportunity to invest and I don't think that there's a singular category of investment that's more attractive than others. I think that we want to play within the education, training, skilling space broadly, and we'll look to invest behind those themes where the equation is right for us, where valuations have historically been really, I think, pricing folks like us out of the market, we're not going to try to -- we're not going to overpay. We're going to try to be really disciplined. So I think that the valuations have to be reasonable enough to give us what we believe is the right return for our shareholders.

Operator

Operator

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

Pat McIlwee

Analyst · William Blair. Your line is now open.

This is Pat McIlwee on for Stephen. So last quarter, you mentioned that you were comfortable with your teacher capacity. And more recently, James, I think you actually mentioned that you're somewhat oversubscribed in terms of teacher capacity. And with that being said, can you just talk a little bit about the trends you're seeing there in terms of teacher salaries and staffing? And if some of that wage inflation you've seen in the past quarters has begun to subside at all?

James Rhyu

Analyst · William Blair. Your line is now open.

Yes. I mean I guess here's what I would say. I mean, I mentioned, I think what you just said, I mentioned at ASU GSV just the day, which is what you might be referring to. But what I would say is that, first of all, a shut out to our teachers, we have the best teacher workforce, I think, in the country. They are phenomenal. I get notes from teachers all the time, many of them thanking me for giving them an opportunity to serve kids in the way that we allow them to serve kids. So -- and I think because of that and because of our unique model and because of some of the sort of the flexibility we provide, yes, we don't have a teacher shortage. I mean I know a lot of districts are starting with it, and I'm actually hopeful we can help some of these districts. We've helped a number of districts this past year with feature shortage. We hope to continue to help more districts with their teacher shortages. I really emphasize with those districts that have that shortage. I think it hurts kids and hurts the customers and I think that it's incumbent upon all of us to help that situation. But for our programs, by and large, we do not have a shortage. We have had the ability to hire more teachers than we need. So when I say we've been oversubscribing, we have more applications and more opportunities to hire teachers than the teachers that we actually need to run our programs. So for us, at least, we happen to be, at least this past year in a pretty good situation where we're not struggling to meet the teacher side of the equation. Now in previous years to this…

Pat McIlwee

Analyst · William Blair. Your line is now open.

And switching gears. Last quarter, you mentioned some pilots for new products like the career platform, teacher development solutions. And today, you talked about launching the Learning Hub. Understanding that it's still very early on. I just wanted to ask quickly if you could talk a little bit about how those pilots have been going.

James Rhyu

Analyst · William Blair. Your line is now open.

Yes. So we've run a series of pilots. As you mentioned, our career platform, our new career platform pilot over this past year, it went off. We learned a ton and I think we're going to get some real good traction here in our next iteration this summer. I think it's a space that we continue to be hugely bullish about. We continue to see huge need around -- we continue to see select point solution products in the marketplace that I think are underserving the needs of high school kids. We think our end-to-end product can really, really fill a gap in the marketplace. And all the feedback that we've gotten through our pilots has only reinforced that. So I think that, that's for us, at least very reinforcing, very positive and very validating. We continue to also on other pilots, the Learning hub that I mentioned. We've run some select pilots for that product, again, got great feedback. We hear -- we've heard superintendents, principles, educators, I'll say there's a need for a product like this in the marketplace. So again, pilots like that have been very validating. We've also run some other smaller pilots around products that may be less fanfare driven, but for our core services are pretty meaningful. We just launched a couple of weeks ago, a pilot actually is very exciting. That's sort of essentially like a virtual world for our students. Today, everybody is talking about virtual reality and things like that, and it's not even that. It's just a -- it's a virtual space that our students can mingle and they can talk to each other and communicate and they can socialize, they can play eSports games and things like that. And so that has gotten tremendous feedback as well. So, so far, at least, we've been very fortunate that most of the pilots that we've run, we've been able to learn a lot from and most importantly, have been very validating for us.

Operator

Operator

This concludes today's Q&A session as well as today's conference. Thank you so much for attending. You may now disconnect.