Yahoo Finance PowerSchool Holdings, Inc. (NYSE:PWSC) Q3 2023 Earnings Call Transcript
PowerSchool Holdings, Inc. (NYSE:PWSC) Q3 2023 Earnings Call Transcript November 11, 2023
Operator: Good afternoon and welcome to the PowerSchool Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Shane Harrison, Senior Vice President, 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, 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 President 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 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.
Hardeep Gulati: Thank you, Shane and thank you, everyone, for joining us today. PowerSchool's third quarter was a continuation of the momentum we have been building over the past few quarters with meaningful growth in revenue and profitability. K-12 organizations are accelerating the adoption of our platform to become more efficient and effective and this is enhancing our ability to execute on our strategies for growth. Our third quarter results are summarized on Slide 4 of the posted earnings presentation. Revenue was up 12% year-over-year to $182 million, exceeding the high end of our guidance. Product-level growth was diversified with double-digit growth in many of our cloud solutions. Adjusted EBITDA was well ahead of our guidance, reaching $62 million, representing 19% growth over Q3 of 2022 and a 34% margin.
We also saw record cash flow in the quarter while continuing to invest in our game-changing product innovations. ARR grew over 9% year-over-year and was up sequentially in Q3 which is seasonally our lowest quarter for new business as districts are focused on back-to-school opening logistics. We continue to see low double-digit growth in the ARR for the full year excluding SchoolMessenger's contribution. These results showcased the momentum we have created in driving sustainable long-term growth. Let me now discuss our customer and product momentum in the third quarter, summarized on Slide 5, where we had meaningful customer activity that demonstrated many of our go-to-market strategies. The biggest notable win in Q3 was with the state of Florida Department of Education for several of our talent solutions that will help the state with their recruiting and hiring processes as the industry is experiencing a shortage of talent.
The Florida Consortium Job Board will serve all 67 districts, 6 special school districts and over 700 charter schools in the state of Florida to source all talent from all over the country in order to fill vacancies for all job types in the state. This is a competitive replacement of an existing solution and speaks to the strength of the innovation and the capabilities of our talent cloud offerings. Florida is a great new logo win and another key new state-level contract. With the Florida win, we have now won a state or a territory-level deal in 9 straight quarters. Additionally, we have been given vendor of choice for a state-level special education solution for another state in the Midwest which we hope to get through signature and approvals in Q4 or early Q1.
These states and large deals are very strategic and provide us an opportunity to further expand our customer footprint and cross-sell across all the district and school in these states. The scalable nature of our platform, the diverse best-in-class footprint and the differentiated innovation are driving the momentum for these state-level deals. Our strong double-digit revenue growth in the quarter was across most of our clouds with strong performance in our Student Information Cloud, Student Success Cloud and Talent Cloud. The mission criticality of our core platform, the organic innovations of data and insight solutions and our timely add-on acquisitions like curriculum planning and attendance intervention are addressing the most urgent critical needs of the districts.
Take for example year-to-date attendance interventions bookings are up 68% year-over-year. Curriculum and instruction bookings grew 200% year-over-year and talent bookings are up 21% year-to-date versus the same period last year. As we shared during our last earnings call as well as on our Investor Day, our data-centric solutions are the key part of our long-term growth algorithm. In the third quarter, 5 of our largest 10 wins by ARR included Insights or Connected Intelligence report. This included cross-sells of both Insights and Connected Intelligence to Modesto City School District, Colorado Springs School District 11 and Cherokee County School District 1. These are technology-minded districts that were already using 5 to 10 of our platform solutions and are a great example of how districts of all sizes are seeing the benefit of using our data-centric tools to aggregate, secure, analyze and present the data for making better decisions for their students and teachers.
A key value proposition for data product is also that we are enabling these districts with a Data-as-a-Service platform to power their AI strategies. With our Connected Intelligence data lake solution, we're enabling more secure and efficient way for our customers to bring AI to their data rather than their data to the AI tools. We continue to innovate on our extensive multiple product AI-centered personalized education road map. In this quarter, we are doing general availability of our first generative AI-based solution for Item & Passage Generation tool as an add-on for our Performance Matters Assessment product after a very successful beta trial. Additionally, this month, we are kicking off beta trials for 2 other AI products. First is the ability for educators to interact with student data sets using natural language to ask questions and uncover key insights.
This functionality will be an add-on to our Connected Intelligence and other products which will save educators and administrators a tremendous amount of time digging through the massive data sets to find the anomalies, focal areas and other insights into student academic and behavior progress. Also this month, we plan to release the beta for our first version of Personalized Homework Assistant, a gen AI tool for Schoology that understands the context of what is being taught in the classroom and provides assistance to the students who may be stuck on a homework concept. Next, I would like to update you on the progress of our recent M&A activity, as shown on Slide 6. Since the end of Q2, we have acquired 2 companies, starting with the completion of the exciting acquisition of SchoolMessenger in October.
As with all our acquisitions, the first stage of our integration process centers on people and UI harmonization. And our particular focus with SchoolMessenger is building the deep integration of their direct communication capabilities into our new MyPowerSchool single pane of glass portal for parents, students and teachers. As most parents can attest, the communication process between teachers, families and their schools is disjointed and often confusing. By adding SchoolMessenger to PowerSchool and particularly the MyPowerSchool portal, we are uniquely positioned to create the most differentiated and comprehensive portal for centralized and efficient school-parent communications. This will supercharge the parent-student-teacher communication and therefore drive meaningfully deeper engagement, a leading driver of student success.
During the third quarter, we also acquired Neverskip, an India-based K-12 ERP and administration software provider. The addition of Neverskip provides us with a localized and high-quality ERP and SIS product for the large India K-12 market that is expandable and scalable with PowerSchool's complementary platform of solutions. This addition expands our reach in India by 1.2 million students. Turning now to our broader global international expansion on Slide 6. As we discussed at our Investor Day, we are approaching targeted regions with a direct sales model, while in others we are building our go-to-market with channel partners. Since our last earnings call in August, we are thrilled to have signed up 6 additional partners, bringing our total to 11 so far, well ahead on our plan to sign 12 by the end of the year.
For the Middle East and Africa regions, we aligned with CCS for the Egypt market and Bahwan CyberTek for Oman and the UAE. In Asia, we signed an agreement with BeeNet, who will resell PowerSchool products in Hong Kong, Singapore and the Philippines. Our first partner in Europe, Gear Education, will focus on selling in Greece and Cyprus. For the Brazil market, a country with over 37 million primary and secondary school students, we are aligned with LearnBase. And finally, in the New Zealand, we selected Glenn Cook Technologies as our latest channel partner. We look forward to onboarding each of these and our other partners in the coming quarters with the goal of driving meaningful growth of PowerSchool outside of North America. These third quarter successes are driven by the strategies we presented at our Investor Day in September when we outlined our vision to personalize education as well as our clear path to $1 billion in revenue and adjusted EBITDA margin in the upper 30s, as summarized on Slide 7.
At the event, we showcased our unique and differentiated position as the most comprehensive vertical SaaS platform for a very durable K-12 end market. We discussed how we remain underpenetrated at roughly 6% of the $10.5 billion addressable U.S. and Canada K-12 software market and how this TAM expands nearly 10x to $100 billion when you consider our opportunities in international expansion and personalized education. We articulated our go-to-market strategy, reviewed key growth drivers and detailed our playbook for expanding internationally through multiple channels. We also showed our product road map, including many of the signing gen AI and personalized education products that we believe will transform the future of the industry. Then Eric wrapped up the day by laying out clear midterm financial targets, including the detailed levers we will employ to generate over $1 billion in revenue by 2026 while expanding EBITDA and free cash flow margins.
For anyone who has not reviewed the Investor Day presentation, we encourage you to do so via our Investor Relations website. Q3 was a great quarter for PowerSchool. Our teams have built momentum in many facets of our business. We continue to build scale and execute efficiently, deliver meaningful value for our customers and develop our global reach. I am confident in driving durable and efficient growth in both our top and bottom lines. With that, let me pass the call over to Eric to cover the financial performance for the quarter.
Eric Shander: Thank you, Hardeep. We delivered a strong third quarter highlighted by double-digit revenue growth, margin expansion and record cash flow generation. We saw balanced demand across our product portfolio during a busy back-to-school season with particular strength in our data and analytics solutions. As summarized on Slide 8, we delivered third quarter total revenue of $182 million, representing a 12% year-over-year increase and exceeding the high end of our guidance range we provided in the last earnings call. Subscriptions and support grew 9% year-over-year to $149 million and accounted for 82% of total revenue in the quarter, driven by a strong renewal season, good bookings activity in which our teams drove ARR through new logos, cross-sell and upsell.
Services revenue totaled $21 million in the quarter, representing 4% growth over the same time period last year which continues to reflect the efficiency and increased productivity of our services organization. Revenue from license and other totaled $12.5 million for the quarter, more than doubling over the same time period last year. The main driver was the delivery of our new solution of attendance and security tracking across all schools in Puerto Rico. We ended the quarter with an annual recurring balance of $640 million, representing a 9% year-over-year increase as we continue to acquire new logos, cross-sell and upsell to existing customers and maintained strong retention rates. As we've discussed previously, the quarterly variability is attributed to seasonality and the timing of our larger and strategic deals.
We continue to expect low double-digit growth in ARR for the full year, excluding the addition of the ARR from SchoolMessenger which closed early in the fourth quarter. Our net revenue retention rate came in at 107.2%, down 150 basis points year-over-year, however, up 160 basis points from Q3 of 2021. As I've discussed previously, we can see a sequential NRR decline in Q3 given that a high volume of our renewals occur during the third quarter and in Q3 of 2022, we had the benefit of 2 very large deals impacting this metric. Adjusted gross profit for the quarter came in at $129 million with a 71% margin, representing a 260 basis point year-over-year improvement driven by continued operational scale and lowering hosting costs. Moving to the third quarter operating expenses.
Non-GAAP research and development expense came in at $23 million, representing 12.4% of revenue compared with 13.9% in the same time period last year. This 150 basis point reduction in adjusted R&D 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 17.2% of revenue compared with 21.5% last year, representing a 430 basis point improvement. Non-GAAP SG&A expense totaled $45 million in the third quarter, representing 24.6% of revenue compared with $37 million or 22.8% of revenue in the third quarter of last year. The increase reflects the investments we are making in our sales and marketing organization and our international go-to-market activities that will drive long-term growth.
Third quarter adjusted EBITDA exceeded the high end of our guidance range, coming in at $62 million, representing a 34% margin which was 190 basis points better than last year and driven by our continued focus on cost management and a strong performance in L&O revenue. Non-GAAP net income in the third quarter was $0.24 per fully diluted share, up $0.03 or 15% from the $0.21 per diluted share we had in the same time period last year. Free cash flow in the third quarter which is seasonally our strongest cash flow quarter, was a record $211 million compared with $174 million in the same time period last year. Our free cash flow margin for the 9 months ended September 30, 2023, was 19% compared with 15% in the same time period last year. Strong collections and working capital improvements contributed to the free cash flow increase.
Moving to the balance sheet. We ended the quarter with $323 million in cash and equivalents, an increase of 197% over the same time period last year. This balance included the upside $100 million term loan which we used to finance the SchoolMessenger acquisition in Q4. Net debt leverage at the end of the quarter was 2.3x compared with 3.6x a year earlier. Now turning to our fourth quarter and full year 2023 financial outlook on Slide 9. For the fourth quarter, we expect total revenue in the range of $182 million to $185 million, representing 14% year-over-year growth at the midpoint which includes our expectations for SchoolMessenger. This outlook also includes our expectation that both services and license and other revenue will be lower than the prior year.
This is due to our services team continuing to improve their productivity levels and the timing of L&O revenue in the fourth quarter. We expect fourth quarter adjusted EBITDA to be in the range of $56 million to $58 million, representing a 31.1% margin at the midpoint. This guidance includes the platform integration investments we are making in the SchoolMessenger business that Hardeep mentioned. For the full year 2023, we are increasing our guidance ranges for both revenue and adjusted EBITDA. For 2023 revenue, we now expect to finish in the range of $697.5 million to $700.5 million, representing an 11% growth at the midpoint. For the full year 2023 adjusted EBITDA, we now expect to finish in the range of $229 million to $231 million, representing a 32.9% margin at the midpoint which represents a 40 basis point improvement from our original guidance at the beginning of the year and includes all of the SchoolMessenger investments we are making in the fourth quarter.
For modeling purposes, we expect full year capital expenditures, including capitalized software, of approximately $40 million to $42 million and share-based compensation expense of approximately $64 million to $67 million. Fully diluted shares by the end of the year are expected to be in the range of 202 million to 205 million shares. Overall, we're pleased with the results we saw in Q3. Our teams are executing the strategies for revenue and profit growth very well. I'm particularly happy with our progress on cash flow throughout the year. We're looking forward to finishing 2023 strong, where we expect to deliver low double-digit growth in ARR and meaningful margin expansion. This financial momentum reflects our strong business model and durability to grow both top line and profitability while continuing to invest significantly in long-term growth with our next-generation product investments which we believe will position PowerSchool, our customers and students all over the world for a long future of success.
I will stop here and ask the operator to please open the line for Q&A.
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