PowerSchool Holdings, Inc. (NYSE:PWSC) Q4 2023 Earnings Call Transcript February 26, 2024

PowerSchool Holdings, Inc. misses on earnings expectations. Reported EPS is $0.17 EPS, expectations were $0.2. PowerSchool Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, greetings, and welcome to the PowerSchool Fourth Quarter 2023 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, 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 fourth quarter and full-year ended December 31, 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 and 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. With that, I'll turn the call over to Hardeep.

Hardeep Gulati: Thank you, Shane, and thank you, everyone, for your time today. PowerSchool finished 2023 with another outstanding quarter of execution, innovation, and profitability. Once again, we delivered double-digit revenue growth that was within our guidance, while exceeding our guidance for adjusted EBITDA. For every quarter since our IPO, now 10th quarter in the row, we have met or exceeded the guidance we provided for both revenue and EBITDA. We crossed $700 million of annual recurring revenue as of December. And for the year, we grew our top line double digits while expanding our adjusted EBITDA margin by 210 basis points to 33.2%. And we continue to translate our success into cash through our durable financial model, reaching a record free cash flow margin in 2023.

Looking at the slide four, of the presentation, you will see our fourth quarter results. Total revenue grew 13%, and subscription and support revenue grew 16%. ARR increased 18% to $701 million. Adjusted EBITDA, of $59 million, was ahead of the high end of our guidance. At our Investor Day, in September, we laid out four key components of growth strategy; cross-selling and growing our large expanding customer base, continued advancement of our platform through innovations and acquisitions, increased our global reach, and investing in building personalized education solutions. This quarter exemplified how we executed across all four. Starting with cross-sell and new logo traction, we saw many customer wins in the fourth quarter that were driven by our differentiated and comprehensive platform of solutions.

And we are seeing continued momentum as we enter 2024. As summarized on slide seven, we saw several cross-sell deals in Q4. Chicago Public School, the third largest school district in the U.S. and user of several of our products, chose to add our professional development solution within our Educator Effectiveness Cloud to support their 20,000 teachers with effective career growth support. Wylie Independent School District, in Texas, expanded from their usage of Naviance by adding four of our solutions, assessments, insights, staff evaluation, and professional development. Similarly, the Atlantic City Board of Education, New Jersey, user of our student information system and enrollment solutions, added insights, behavior, assessment, and curriculum planning to bring their product count to six.

We also had a large multimillion dollar cross-sell expansion with a virtual school organization who uses our SIS that added our Schoology LMS, assessment, Naviance, ContentNav, and Connected Intelligence platform. In the quarter, we also continued our partnership with the Puerto Rico Department of Education by booking further services related to their territory-wide attendance tracking system, on top of our assist and enrollment solutions after our successful go-live last fall. Date-driven solutions that provide valuable insights into student, school, and district performance and operations continue to meet a large and growing market beat. In 2023, we saw a 50% increase in the number of deals for our data products, with the total annualized value of those deals increasing over 60% year-over-year.

In the fourth quarter, we saw this through dozens of customer wins, including cross-sales with Cherry Creek School District, in Colorado, and Toledo School District, in Ohio, who both selected Connected Intelligence. And finally, our statewide vendor-of-choice win with the Indiana Department of Education close just after the end of the year, in January. This is the largest win for our Special Programs product line in double-digit millions, which will enable the Indiana DOE and all of its school and district in the state with advanced special education case management, eligibility, and progress tracking, individual education plan development, and service reporting and documentation. Moving on to the slide six and our platform expansion successes in the quarter, in January, we acquired Allovue, an innovative, advanced budget management, planning, and analytics SaaS startup, specifically focused on the K-12 education market.

We are seeing this as a top-of-the-mind need for many districts as they focus on more effective and efficient use of their ongoing budget as the extra COVID-related federal stimulus funds wind down. We have partnered with Allovue over the last few years as a strategic add-on to our K-12 ERP systems. Allovue also allows us to expand our reach into the broader K-12 finance software market as it integrates with other ERP systems. We are excited to add the Allovue capabilities to the PowerSchool solutions and the analytics platform so we can provide even more comprehensive analytics that include financial planning, as well as enable districts to create more accountability and transparency by seeing the education improvement ROI of their budget investments.

Our international expansion initiative made further strides during the quarter, also shown on slide six, with a great international win with Maarif Education, in Saudi Arabia, which is a great case study on how PowerSchool can land and expand with our platform in international markets. Maarif already uses nine PowerSchool solutions for their international schools and, in the quarter, they added two of our recent innovations; Connected Intelligence and MyPowerSchool. Maarif also expanded the rollout of the PowerSchool platform to 13,000 additional students in their national schools, leveraging the localization framework and the right-to-left translations we have built for the Middle East region. We continue to expand our international reach in Q4 by signing four additional channel partners, all of which are strong technology resellers and integrators focused on the Latin America region, a strategic growth market for us given our highly successful nationwide Schoology rollout in Uruguay during the pandemic.

With these four, we finish 2023 with 14 new international channel partners, ahead of our goal of 12. Also during the quarter, we hired a general manager for our international efforts, who has a strong background in global enterprise sales and operations. Our focus through 2024 will be to onboard our resell partners, sign on new ones, continue expansion with the growing global customer base, and develop sales opportunities and pie as we build towards our goal of having an international business that contributes 10% of our revenue by 2028. Turning now to our innovation momentum, on slide seven, as we shared at our Investor Day, in September, one of the biggest growth opportunities which significantly expands our TAM to $100 billion is providing a personalized education for every student journey.

With the advancement of generative AI, we now have the ability to personalize education at scale, and provide conversational, adaptive, and tailored engagement for every one in the education ecosystem, teachers, administrators, parents, and students, all of whom contribute to the successful education outcome. There is a weakness in the generalized AI technologies and standalone supplemental AI tutors in that they don't have the details of what the individual student needs are, the context of what's happening in the classroom, and with the homework nor the access to the daily engagements a student has with all the personas. With us being the most comprehensive K-12 platform in the market, we at PowerSchool have solutions that process and understand all the key elements in education, including the student, classroom, school, teacher, and district operations.

And as the most pervasively deployed education platform in North America, we are interacting with all the personas in education millions of times per day. Combining these unique differentiator has resulted in our very exciting, recently launched comprehensive personalized AI platform for K-12 education, PowerBuddy. PowerBuddy is an AI assistant for everyone in education ecosystem, students, parents, teachers, district administrators, and even counselors. As the conversational AI tool that utilizes K-12 and district data, PowerBuddy changes every element of education engagement, and enables personalized and highly effective support for everyone. For students, PowerBuddy is a personalized digital helper and tutor that knows their curriculums, grades, homework, areas of improvement, learning styles, interests, and more.

For instructor, PowerBuddy is a teacher assistant that can help create lesson plans and assessments. Parents can leverage PowerBuddy to inquire about their child's performance and receive personalized resources. And district administrators can use PowerBuddy as a virtual data analyst that can efficiently access district performance information by talking to their data. PowerBuddy is an AI that will be integrated to each product across our platform. So, it efficiently and seamlessly brings AI to every customer through the products they already use. On slide seven, you will see a link to a video that showcases PowerBuddy and how it will be used by our platform, various personas and use cases. To make it affordable for every district and enable phased adoption, we will be offering PowerBuddy for individual use cases and products like assessments, learning, insights, communication, content creation, college and career readiness, teacher coaching, and other use cases with the ultimate goal to launch PowerBuddy for personalized homework, that will be available to both districts and individual families to support their child.

We have already started monetizing our AI platform. PowerBuddy for assessment to create test questions and passages using generative AI has been purchased and adopted by districts representing over 50,000 students. And we already have a strong pipeline for future opportunities. Our recent launch of ContentNAV, which utilizes AI to provide a centralized, dynamic, and easy to explore repository of digital instruction content for all grades level and for a wide variety of PowerSchool districts and external sources, is in the market now with deployments with several districts with over 500,000 students and millions of dollars of opportunity in our pipeline. We are further enhancing that solution to leverage generative AI to help build original curriculum, content, class project ideas, explanatory text, and sample stories and passages.

We're also seeing phenomenal interest in the beta test for other PowerBuddies, including PowerBuddy for learning, which is integrated in Schoology, and PowerBuddy for Insights. Many of these PowerBuddy solutions are scheduled for launch in the summer and the winter of this year. Our data as a service solution of connected intelligence is the foundation of the safe, secure, customizable, and effective usage of our AI. We are generating very strong sales and demand for our connected intelligence data lake platform for AI. K-12 organizations like Epic Charter and Challenger Schools are using Connected Intelligence Platform today to create custom AI models for different use cases. We're launching a campaign to allow districts to get ready for AI with Connected Intelligence and PowerBuddy for custom AI, which allows customers to create their own chatbots with custom data sets, such as district handbooks, guides, and other resources for parents, communities, and internal staff.

We are seeing this as a pivotal moment in K-12 education and for PowerSchool. PowerBuddy has the potential to completely transform education globally, and how every persona engages and does their daily function in K-12. We are moving to an AI first innovation investment philosophy, leveraging personalization and conversational elements in all of our new innovations. Our platform of 20-plus solutions is unmatched in the industry and provides us a unique and large opportunity to integrate our powerful AI for K-12 education capabilities into each of our products to generate new streams of revenue. It creates many additional monetizable products that add $30 to $50 off TAM per student initially and a lot more as we move into providing integrated content and services to districts and families.

We have a significant competitive advantage to achieve this growth and further expand our overall differentiation and business model. All this customer, product expansion, and innovation momentum I shared sets PowerSchool up very well for 2024. We are confident of a durable financial model to drive double-digit revenue growth, consistent margin expansion, and free cash flow generation. We continue to be the leader in our category and a best-in-class vertical SaaS company with a clear path to a Rule of 50 profile. With that, let me pass the call over to Eric to cover the financial performance and guidance. Eric?

Eric Shander: Thank you, Hardeep. We had a great quarter as Hardeep outlined, and we exceeded almost all of our financial objectives, delivering profitability above guidance with revenue growth of 13%. Both revenue and adjusted EBITDA were significantly ahead of our initial guidance that we provided at the start of the year. This performance gives us confidence in our 2024 guidance of double-digit revenue growth and continued margin expansion. For the full-year 2023, our top line grew 11%, while our adjusted EBITDA margin expanded by 210 basis points to 33.2%. We achieved all of this while expanding our international presence, acquiring and successfully integrating SchoolMessenger and Neverskip and investing in game changing innovations that will help make personalized education a reality.

A summary of our results are shown on slide eight. Fourth quarter total revenue came in at $182 million up 13% year-over-year and in line with our guidance range that we provided on our last earnings call. Full-year 2023 revenue was $698 million representing a growth rate of 11% for the year. Fourth quarter subscription and support revenue grew 16% year-over-year and accounted for 90% of total revenue in the quarter. For the year, subscription and support revenue grew 10% and represented 86% of total revenue. Our services business generated revenue of $15 million in the fourth quarter, flat year-over-year. For the full-year, our services business grew 3% year-over-year. The moderation in services growth was expected and is due to us accelerating our implementation and driving more efficient deployment cycles, which deliver quicker value to our customers and ensure our attention over the long-term.

Revenue from license and other, which relates mainly to our third-party and license revenue was $3 million in Q4 and was down year-over-year due to higher licensing activity in the prior year. Full-year L&O revenue came in at $25 million representing a 48% increase over the same time period last year. This increase was due largely to upfront license fees from Los Angeles Unified School District and hardware revenue associated with our Puerto Rico Department of Education deal. We ended 2023 with an annual recurring revenue balance of $701 million, an increase over the prior year. The strong performance was driven by the contribution from SchoolMessenger, new logo ARR growth, which was over 50%, continued cross sell and upsell and our typical contracted price increases.

Our net revenue retention rate, or NRR came in at 106.7%, representing a sequential decline of 50 basis points from Q3. This decline was due to the timing of large bookings, specifically the Unified Insights win with the state of Alabama in Q4 of 2022, which rolled off of the trailing 12 months calculation and the movement of the Indiana Department of Education deal from Q4 into January. As we've discussed in prior quarters, large deals continue to be very strategic and important to us. In my operations capacity, given the variability that these large, complex arrangements can create, I've been working with our services team to accelerate our implementations, which improve the time to value for our customers and lead to continued cross sell opportunities as well as quicker revenue recognition.

Adjusted gross profit for the quarter came in at $129 million with a 70.8% margin, representing a 130 basis point year-over-year improvement. For the full-year, adjusted gross profit reached $491 million or 70.4% margin, representing a 230 basis point improvement over 2022. We continue to benefit from greater operational scale and continued process efficiency improvements. Looking at operating expenses, fourth quarter non-GAAP research and development expense came in at $24 million representing 13.2% of revenue compared with 13.8% last year. Including capitalized R&D expenses, the total invested in R&D was 18.6% of revenue compared with 18.9% in the prior year. On a full-year basis, non-GAAP R&D expense declined 3% to $87 million representing 12.5% of revenue compared with 14.4% in the prior year, an improvement of 180 basis points.

Including capitalized expenses, the total invested in R&D was 18.1% of revenue, a 280 basis point improvement over 2022. Non-GAAP SG&A expense increased 22% year-over-year in the fourth quarter to $45 million representing 24.9% of revenue, an increase of 190 basis points year-over-year, in line with our long-term financial framework. The increase was due largely to higher sales and marketing investments around international expansion and increased North America sales coverage across our expanded product portfolio. Non GAAP SG&A expense for the full-year 2023 increased 19% to $171 million. Our fourth quarter adjusted EBITDA increased 12% to $59 million representing a 32.6% margin and exceeded the high end of our guidance range by $1 million.

Full-year adjusted EBITDA was up 18% to $232 million, representing a 33.2% margin, which was 210 basis points over 2022 and 70 basis points higher than the original guidance we provided at the beginning of 2023. Non-GAAP net income in the fourth quarter was $0.17 per fully diluted share, compared with $0.27 per diluted share in the same time period of the prior year, largely due to higher interest expense and non-cash tax expenses. Full-year 2023 non-GAAP EPS was $0.82 compared with $0.85 we earned in 2022. Fourth quarter free cash flow was $32 million representing a margin of 17.7%. Full-year free cash flow grew 25% to $130 million reaching a margin of 18.6%, a 210 basis point year-over-year improvement and a record free cash flow margin for the company, driven by improved working capital and lower capitalized product development costs, which helped offset higher interest expenses.

Moving to the balance sheet, we ended the quarter with $39 million in cash and equivalents impacted by the acquisition of SchoolMessenger. Net debt leverage at the end of the year was 3.4x. We expect our net debt leverage to be in the 2.5x to 3.0x range by the end of 2024. This debt level provides us ample opportunity continue our strategy of acquiring strategic assets that are accretive to our financial profile and help us build an even stronger platform for our customers. As shown on slide nine, for the full-year 2024, we expect total revenue to be in the range of $786 million to $792 million with the midpoint representing a 13% year-over-year growth rate. This guidance assumes stronger S&S growth, the most strategic part of our revenue. License and other revenue will be returning to 2022 levels and our services revenue is expected to be growing in the single-digit range.

For the full-year 2024, adjusted EBITDA we expect to be between $267 million to $272 million representing a 34.2% margin at the midpoint. For the first quarter of 2024, we expect to deliver total revenue in the range of $183 million to $186 million representing a 16% year-over-year growth rate at the midpoint. For the first quarter, adjusted EBITDA, we expect a range of $56.5 million to $58.5 million representing a 31.2% margin at the midpoint. Just as a reminder, a lot of our in-person sales and marketing events occur in the first quarter that are intended to drive top line growth throughout the year. For modeling purposes, we expect full-year 2024 capital expenditures, including capitalized software of approximately $48 million to $52 million and share based compensation expense of approximately $80 million to $84 million.

Fully diluted shares by the end of the year are expected to be in the range of $203 million to $207 million. As we wrap up 2023, we're excited about the business momentum heading into 2024 as it gives us confidence not only in our 2024 guidance, but our pathway to reaching $1 billion-plus in revenue by the end of 2026. This concludes our prepared remarks. Operator, will you please open up the line for Q&A?

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