PowerSchool Holdings, Inc. (NYSE:PWSC) Q3 2022 Earnings Call Transcript

PowerSchool Holdings, Inc. (NYSE:PWSC) Q3 2022 Earnings Call Transcript November 7, 2022

PowerSchool Holdings, Inc. reports earnings inline with expectations. Reported EPS is $0.21 EPS, expectations were $0.21.

Operator: Thank you for standing by. This is the conference operator. Welcome to the PowerSchool Third Quarter 2022 Earnings Conference Call. As a reminder, all participants are in listen-only mode. And the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Shane Harrison, Senior Vice President of Investor Relations. Please go ahead.

Shane Harrison: Thank you, operator. Welcome everyone, to PowerSchool’s earnings conference call for the third quarter ended September 30, 2022. 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 today’s call, we have PowerSchool’s CEO, Hardeep Gulati; and CFO, Eric Shander. Before getting started, I’d like to emphasize that this call, including the Q&A portion, will include statements related to the expected future results for 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 the results presentation, which are both posted to PowerSchool’s Investor Relations website at investors.powerschool.com. A replay of this call will also be posted to the same website. Let me now turn the call over to Hardeep.

Hardeep Gulati: Thank you, Shane. And thank you, everyone, for taking the time to join us today. Our third quarter was a testament to how well our teams executed on our market-differentiated strategy and business model. We continue to drive strong revenue and ARR growth with the power and the breadth of our comprehensive platform that provides mission-critical solutions for K-12 organizations to help effectively manage their ongoing demand and challenges. As demonstrated this quarter, the significant cross-sell opportunity of our diverse portfolio of market-leading solutions to our captive large installed base allows us to continue to deliver on the top line growth, while our operating leverage is providing a meaningful ramp in profitability.

Let me begin on a review of Q3 and on Slide 4 with a summary of our financial results, total revenue reached $162 million for the quarter, coming in line with the guidance we provided last quarter. We continue to see record pipeline that gives us confidence to reaffirm our increased full year revenue guidance from the last quarter. In Q3, we grew our adjusted EBITDA 30% year-over-year and drove meaningful margin expansion reaching 32%. This represents our highest margin since our IPO and exceeds the guidance from the last quarter. Additionally, we are raising further our full year guidance for profitability. Subscription and support revenue grew double-digits year-over-year to $137 million. Our ARR increased 11% year-over-year with strength in our retention, cross-sell and new business.

Our consistent performance to market expectations and metrics showcase our compelling differentiated business model to operate in a highly stable and durable K-12 market, largely insulated from the broader macro inflationary and recessionary factors. And also, it’s a testament of our diverse, highly predictable revenue streams that are growing materially and with increased profitability. Let me share with you more details on each of our growth vectors that will help us deliver this consistent performance. Slide 5 shows some of the customer successes in the quarter for these different vectors. The third quarter is generally the busiest time for us as it is not only back to school, but it also is a time where administrators and back office staff are starting their new fiscal year.

For us, that means the heavy few months of product renewals and as well as system implementation. Our renewal team had a record quarter and our sales and customer success teams drove higher incremental new bookings from existing customer when you compare it to the prior year. Our net revenue retention rate for the 12 months ended September 30 increased 140 basis points to 108.7%, our best sequential improvement since Q2 of 2020. During the quarter, we saw great growth in all aspects of ARR with particular improvement in retention and cross-sell increases year-over-year. Speaking of cross-sell and continued market expansion, we saw broad-based customer booking activities that expand our entire product platform as we grew our wallet share with existing customers and continue to add new logos to our customer base.

A great example of that is our large deal at one of the largest online K-12 learning provider, Stride, Inc. They selected PowerSchool for the global student information system and enrollment needs for their online public and private schools and with well over 100,000 enrollments. Already a user of our Naviance and student assessment solution for a small student population, Stride wanted to modernize their homegrown back office system for their entire K-12 online infrastructure. With the expected long-term growth in virtual schooling globally in the coming years with a very large TAM, we are excited to partner with global online companies like Stride to grow this space further. The other key growth factor for us is we have the most comprehensive and diverse portfolio of solutions that provide mission-critical capabilities required for the K-12 education ecosystem.

There is no shortage of headlines about the stresses in our education system around feature shortage, learning gaps, attendance shortfalls, social emotional support, equity and data security. Our differentiated platform with 19-plus products is becoming even more essential to help district deal with these challenges and initiatives that span across operations, talent, and classroom. We are seeing continued high demand and growth in our student solution, our insights and MTSS capabilities, talent management and behavior and critical management solutions. Customers of all sizes continue to select our platform as PowerSchool is the only proven vendor that checks all these boxes. A great example of this is our platform win at Plano, Texas Independent School District with over 50,000 students.

They were looking to replace their existing SIS for an integrated platform solution. Adding our SIS, enrollment, ERP, data insights products to already their existing implementation of several of our talent products will improve not only their internal operational efficiency but also drive better outcomes for teachers and their students. We are continuing to see balanced demand across our product portfolio. We recorded nearly 500 new logos and cross-sell transactions in the quarter, including several sizable wins for SIS, Unified Insights, Talent, Naviance and Classroom products. Building on our proven success in providing classroom solutions at large districts like L.A. USD, Miami-Dade, Fairfax, we are excited about another large district, Baltimore City with 75,000-plus students selecting Schoology as their LMS solution this quarter.

With the addition of Schoology to the PowerSchool Talent and Naviance products at the district, we look forward to exceeding Baltimore City’s expectations and furthering our solutions footprint within their district. As we shared, one of our newest growth vectors is our international expansion. We are seeing similar level of critical need of platform like ours to provide unified comprehensive capabilities to help international, private and even local schools in various geographies around the world. Our dedicated sales initiative in the Middle East started earlier this year and has already shown strong success and proves the opportunity we have able to extend that model to other regions. I’ve decided to share another very strategic platform new win in the UAE at Aldar Education, an Abu Dhabi-based education system that manages several charter and public schools in the region.

Aldar’s Blueprint Public School purchased multiple solutions, including SIS and Schoology from PowerSchool to provide an integrated view of their systems, students and operations. Similarly, we gained a new logo for a platform win in Egypt, The International School of Elite Education or ISEE. One of the key aspects that is driving our growth is our scale, proven track record and box experience, which allows us to quickly meet and support the most critical urgent needs the districts might have. We had our most successful back-to-school in terms of customer experience and impact across different aspects of the school operations. 3 million-plus professional development courses taken, 750,000 substitute teacher position field, 1.3 million jobs posted, 46 million-plus formative assessments delivered and 900,000-plus collagen courier assignments completed in the quarter, leveraging our platform.

Our top line momentum is very compelling, given we continue to do it while also increasing our profitability. In the third quarter, we exceeded the high end of our guidance range of adjusted EBITDA and continue to expand our adjusted EBITDA margins to levels well ahead of our 2022 targets we communicated at the beginning of the year. I will let Eric go into the more details. But the operational rigors we have applied, coupled with the growing scale we are experiencing, we expect continued expansion in our profitability going forward. Let me also share some very exciting news. Today, we announced Eric’s promotion to President and CFO. In this new expanded role, Eric will assume responsibility of our customer renewals operations. Having successfully built our public company reporting and G&A infrastructure, I’m excited to have Eric bring his scale and growth experience to this critical part of our business.

We are also announcing the addition of Tony Kender as our new Chief Revenue Officer. Tony has 30-plus years of expertise in building, scaling and optimizing global sales organization, most recently as CRO at FinancialForce and prior to that, as an SVP and GM at Oracle. We are excited to add him to our exec team and want to thank our current CRO, Craig Greenseid, for his meaningful contribution to PowerSchool and wish him the best as he moves to his new endeavors. We are very happy with the continued business momentum we are seeing heading into the fourth quarter and look forward to finishing the year strong. Our sales pipeline continues to be very strong with 20% growth year-over-year, and sales velocity continues to improve overall. In the funnel, we are seeing a great mix of new customer logos, very large opportunities and abundant cross-sell prospects, many of which we are in the pole position to win.

Our confidence is further reinforced by a continued strong funding environment, further supported by 3/4 of ESSER funding still being available for district to spend over the next few years. It is clear that our value proposition and differentiated comprehensive platform are resonating in the market, which puts us in a better position than the niche providers. Let me pass the call over to Eric and detail the financial performance for the quarter. Eric?

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Eric Shander: Thank you, Hardeep. Our third quarter performance was outstanding, highlighted by the strong sequential improvement in our annual recurring revenue, net revenue retention and profitability. Our teams continue to execute on the growth strategy by increasing sales to both new and existing customers, while delivering best-in-class customer support and service. We continue to see strong demand across our product portfolio with strength in our SIS, analytics and behavior offerings. At the same time, we’ve been focused on our internal functions by streamlining processes and controlling costs while continuing to invest in new product development, our international expansion, continued product integrations and other key growth initiatives.

The financial health of the business has never been better, and we remain confident in the resilience of our end market, the durability of our financial model and the tremendous long-term opportunities ahead of us through international expansion and personalized learning. Now let me dive into the quarterly results with more detail, which you will see on Slide 6. Third quarter revenue was $162.4 million, in line with the guidance range we have provided in the second quarter earnings call, and overall revenue was up 9% year-over-year. Subscription and support revenue, which is our most strategic recurring revenue stream, grew at 10% on a year-over-year basis and accounted for 84.4% of total revenue in the quarter, a 100 basis point improvement over the same time period a year ago.

Our services business, which generates revenue through fees related to new product implementations, customization and customer training, delivered revenue of $19.9 million, representing an increase of 8% year-over-year driven by higher implementation, customization and our in-person PowerSchool university training events. Our services revenue came in slightly below our internal expectations driven by a few services projects, and there were a few subscription renewals that were also impacted by Hurricane Ian at the end of the quarter, all of which have already been closed in the fourth quarter. The team helped to drive a successful back-to-school season with over 1,750 new product go-lives that prepared schools and districts for the 2022-2023 school year.

We also hosted several PowerSchool university onsite training events that had great attendance. Our consistent dedication to customer success is translating to better retention, higher customer satisfaction, and continued cross-sell momentum. Finally, revenue from license and other, our least strategic and most variable revenue stream representing 3% of total revenue came in at $5.4 million for the quarter, representing a slight decline of $800,000 from the same time period last year as we continued to place more focus on subscription based partner relationships. We ended the third quarter with an annual recurring revenue balance of $585.4 million, representing an 11% increase over the same time period last year. The strong performance was driven by higher cross-sell coupled with continued strong gross retention.

Our net revenue retention or NRR came in at 108.7%, representing a sequential improvement of 140 basis points and a year-over-year improvement of 310 basis points. The significant sequential improvement in this key metric was driven primarily by our higher LTM cross-sell as well as strong gross retention coupled with our annual contractual price increases. As a reminder of our business seasonality, the third quarter is typically the quarter in which a significant level of our renewals take place. So seeing such a strong improvement in NRR in the quarter was exciting. We expect this metric to slightly moderate in the fourth quarter. However, we anticipate ending the year around 108%, which is ahead of our expectations and a validation of the value our customers place on the power of our platform.

Adjusted gross profit for the quarter came in at $111.1 million with a 68.4% margin, representing a 30 basis point sequential quarterly increase and a 50 basis point year-over-year improvement. The strong performance was driven by our continued focus on cost efficiencies. Now turning to operating expenses. In the third quarter, our non-GAAP research and development expense came in at $22.6 million, representing a 13.9% of revenue compared with 15% in the same time period last year. Including capitalized R&D expenses, total invested in R&D was 21.5% of revenue compared with 21.1% in the same time period last year, highlighting our continued commitment to making investments in market differentiating innovation for our customers. Non-GAAP SG&A expense in the third quarter totaled $37 million, representing 22.8% of revenue compared with 26.3% in Q3 of last year.

This 350 basis point improvement and our non-GAAP SG&A margin reflects savings from our facilities consolidation, lower D&O insurance premiums and savings from our various G&A cost efficiencies driven in the quarter. Third quarter adjusted EBITDA was $52.2 million or 32.2% margin, exceeding the high end of our guidance range for the quarter, representing an increase of 530 basis points from the same time period last year. The third quarter margin was strong and reflects the continued focus we have on driving profitable growth. The margin improvement was driven by the gross margin and operating expense improvements. We will continue to identify additional areas for cost rationalization while still investing in innovation that will fuel our top line growth.

Non-GAAP net income was $0.21 per fully diluted share, which is 40% higher compared to $0.15 last year. Now moving to the balance sheet. We ended the quarter with $108.9 million in cash and equivalents, an increase of 20% over the same time period last year. Cash collections during the seasonally busiest third quarter were strong and our aged account receivable profile is the best ever. In the third quarter, we paid off the $70 million revolver that we drew in the first half of the ear. Net debt leverage at the end of the third quarter was 3.6 times a meaningful improvement over the 4.1 times a year earlier and 4.8 times at the end of Q2. Third quarter free cash flow, a non-GAAP measure was $174.1 million, up 6% from the same time period a year earlier.

As I mentioned, we had a very successful renewal season and our collections team did a fantastic job. Now turning to our fourth quarter and full year financial outlook on Slide 6. For the fourth quarter, we expect to deliver total revenue in the range of $161 million to $164 million, representing an 11.2% year-over-year growth at the midpoint. As a reminder, the seasonality of our implementations and training activity, we expect a sequential decline in services revenue in the fourth quarter. For adjusted EBITDA, we expect fourth quarter to finish at $48 million to $51 million, representing a 30.5% margin at the midpoint. For the full year, we’re raising the bottom end of our revenue guidance range while raising the top and bottom of our adjusted EBITDA range.

We expect total revenue in the range of $631 million to $634 million for the full year with the midpoint representing a 13.2% year-over-year growth rate. An adjusted EBITDA of $192 million to $195 million, representing a 30.6% adjusted EBITDA margin at the midpoint. For modeling purposes, we expect capital expenditures excluding capitalized software of approximately $5 million and share-based compensation expense of approximately $55 million for the full year. Fully diluted shares by the end of the year are expected to be in the range of 200 million to 205 million shares. Overall, we delivered a fantastic third quarter. As Hardeep stated, we are very pleased with the continued business momentum and our performance, which is ahead of our targets and demonstrating the value that our customers are placing on our mission critical platform.

Our teams performed extremely well in driving growth and operational efficiencies. We look forward to finishing the year strong and continued focus on executing our go-to-market operational and investment strategies. This concludes our prepared remarks. Operator, will you please open the line for Q&A?

Q&A Session

Operator: Certainly. We’ll now begin the question-and-answer session. Our first question is from Stephen Sheldon with William Blair. Please go ahead.

Stephen Sheldon: Hey, thanks guys. And congrats on the promotional and the new responsibilities to you, Eric.

Eric Shander: Thank you.

Stephen Sheldon: First one to ask, I know and on sales cycles, I guess, curious what you guys have seen in sales cycles with your K-12 customers and knowing that you’re coming out of kind of peak selling season, but I think there’s been some talk of elongation there and school districts being distracted with other issues right now, such as the teacher shortage and a variety of other issues. So have you seen that at all? And you think that could have a bigger impact on sales activities as we think about the next few quarters?

Hardeep Gulati: Stephen, this is Hardeep, again, thank you for the question. We actually not seeing any sales cycle. So as in fact to the contrary, we continue to see sales cycles improving and almost to the level of 25% to 30% improvement over last year. And I think a lot of it is based on the differentiation we have in the market because we are a much more broader platform with almost 19 plus diversified products. If you think about a lot of the challenges these districts are facing today when it comes to talent management and recruiting teachers, keeping teachers, well, they need of talent management solution to help with that. If it’s about learning loss, they need analytics to understand that and address it. If there’s about social emotional, they need our behavior and classroom tools to help engage with the students.

So a lot of what we selling is actually mission critical. So it’s actually been being more beneficial to help them address the needs they are having today.

Stephen Sheldon: That’s great to hear. So appreciate that. And then as a follow-up, we’d love to just get some more detail on recent acquisitions and how they’ve been performing, thinking about Kickboard, Kinvolved and the others. Have these solutions been plugged into your existing sales motions and I guess what a financial contributions look like now that you’ve owned both for close to a year. Are you seeing a ramp in uptake in monetization there on your platform?

Hardeep Gulati: We actually do. I think we’ve mentioned that in the prepared remark like behavior, which is the Kickboard actually we are seeing record growth. There is a large deal at Gallup-McKinley school districts where we are actually a tens of thousands of students where we are actually implementing our Kickboard solution. We are almost seeing in every quarter about 15 to 20 deals on these products as we are integrating them into our products and bringing them to our sales motion. Similarly on curriculum, that’s another large deal at Hudson County and few others, almost again on about a dozen plus customers already bought that and we had a pretty successful communication starting of the year and even into this quarter even district like San Diego just are going to start adopting over unified communications.