Q3 2020 Houghton Mifflin Harcourt Co Earnings Call
Ladies and gentlemen, please remain on your life. Your conference will begin momentarily. Once again. Please remain on your lines, you're H M. H conference call will begin momentarily.
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Ladies and gentlemen, thank you for standing by and welcome to the H M. H third quarter earnings Conference call.
At this time, all participants Arnold listen only mode.
After the speaker presentation, there will be a question and answer session.
Ask a question during the session you'll need to press star one on your telephone.
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It is not my pleasure to introduce senior Vice President of Investor Relations, Brian ship.
Thank you and good morning, everyone.
Before we begin I would like to point out that the slides referred to on today's call can be found on the Investor Relations section of our website at H M. H C O dotcom.
A replay of today's call will be available until November 14th 2020, and the webcast will be available on our website for one year.
Or 10-Q was also filed earlier this morning, along with our third quarter Twenty-twenty earnings press release.
Before we discuss our results I encourage you to review the cautionary statement on slide too for a customary disclosures.
Further information can be found in a regular SEC filings.
In addition, please refer to the appendix in our slide presentation for a reconciliation of our non-GAAP measures to the most directly comparable gap measures, which is also posted to the HMH Investor Relations website.
This morning, Jack Lynch, HMH, as President and Chief Executive Officer, and Joe Abbott HMH as Chief Financial Officer will provide a company update as well as an overview of the companies third quarter Twenty-twenty results.
After our prepared remarks, we will open the call to questions.
During the Q&A. Please limit yourself to one question plus one follow up you may get back into the queue. If you have additional questions now I'll turn the call over to Jack.
Thank you, Brian and good morning, everyone.
Today I'd like to update you on progress, we've made and positioning HMH for long term growth, including during the third quarter with the pandemic, having cemented the central role of technology and K 12.
First I want to spend a few minutes on October 1st announcement.
In which we detailed a strategic restructuring to a line or cost structure tore digital first connected strategy.
As we discussed at length and our last earnings call.
This decision was the culmination of the value innovation analysis, we undertook over the last two years.
We sure this framework with you at our industrial update in October 2019, and we have continued to operationalize. It over the course of 2020 at the pandemic has accelerated the shift and education to giggle learning technologies.
The options, we announced will enable us to create a more focused company with increased recurring digital subscription revenue that produces higher margins on how you free cash flow into the future.
Today, we've also announced an extension to that effort.
We have decided to explore a potential sale for HMH books and media to further advance are learning technology strategy.
This is a business <unk> and invested in over many years and it has continually demonstrated resilience.
Luckily this year to the challenges the pandemic and during the third quarter.
As we continue to focus on developing and scaling are digital solutions for teachers and students me believe this is the right time to evaluate a potential sale for HMH books and media.
With the aim of maximizing shareholder value.
Focusing the organization for the future.
We wish your updates with you in the future as appropriate.
As for Q3, we continue to make strategic progress in a challenging market environment we'd.
We delivered strong performance in key adoptions. Despite the pressures of the pandemic. We also generated strong adjusted EBITDA margins, which reflect the results of the decisive cost actions taken this year.
All told HMH continues to have a very strong liquidity position and balance sheet.
Which will enable us to finish the year and enter 2021 from a position of financial strikes.
We have restored our guidance for 2020 and expect to deliver billing for the full year between 1.05 billion and $1.1 billion and we expect our free cash flow to be between a usage of 5 million $15 million for the full year.
We are pleased with how our organization has navigated the global pandemic it to break even.
At the free cashflow level in this market environment is evidence of the decisive actions. We've taken issue can mitigate the pandemics impact on our business.
Looking ahead based on everything we know at this time, we expect to be free cash flow positive in 2021.
We are pleased that during the quarter, we continue to grow both soft billing and usage of our Ed platform.
South billings grew 147% the second straight quarter I'll be accelerating growth Ed platform usage also increased by very strong 388% as our installed base of customers continue to transition.
To increase usage of our digital offerings. This is the second quarter in a row.
Roughly 400% increase in usage of uninstall customer base.
In addition registered users on the Ed platform grew from 13.8 million users in 2019 to 20.1 million users in 2020.
These are key indicators of continued progress and momentum on a digital first connected strategy.
Which is a direct result of our incredible teams focus on intercepting be increasing growth and digital demand.
That's where the connected part Ah digital first connected.
A growing number of districts nationwide continue to opt to connect to our HMH digital products and solutions across core intervention supplemental and professional learning.
This is evidence that are connected strategy is working in the marketplace leveraging our core footprint to cross sell extensions with one salesforce.
These achievements validate the progress we've made and sharpening our focus on learning technology, providing innovative connected solutions.
For our customers that deliver more impact and successful outcomes.
It's why with this momentum and at this pivotal inflection point in education. We believe now is the right time for us to evaluate a potential sale for HMH books and media to further accelerate our drive to digital and become the pre eminent K 12 learning technology.
You play.
We see unique and significant opportunities for growth and value creation, establishing HMH is a K 12 companies focused on learning technology with a business producing higher margins and free cash flow.
H M. H is well positioned to make this transition to learning technology now only because it more talented team, but because of the progress we've made on our strategy over the last three and a half years to enhance and extend our core deliver integrated solutions and achieve operation.
<unk> excellence.
This strategy has been a roadmap to 2020 and I'm incredibly proud of our team for what we've accomplished we built one integrated platform for all our products and services to support all subjects all students in all teachers anywhere whether instruction.
Is provided in person and hybrid or remote environments. There's also be gone to transition to a subscription based business model that generates recurring revenue from our customers and is a powerful value proposition to our shareholders.
And we've established an entirely new operating model and a new way of working.
This is a very strong foundation for HMH that benefits, both our customers and our shareholders with that I'd like to hand, it over to Joe.
For the operating and financial review.
Thanks, Jack and good morning, everyone.
I want to begin by sharing with you more about the progress we've made and realigning our organization through our ongoing value innovation analysis.
As you'll recall, we introduced the value innovation framework at our Investor update in October 2019 is one method, we used to drive our strategic priorities.
We've continued to operationalize it through the course of 2020 as the COVID-19 pandemic has accelerated the ship and education to digital learning technologies.
Value innovation involves a for action framework of Ray's create reduce and eliminate.
These are the four lenses through which we've continued to analyze our business model over the last year to determine strategically which elements of our cost structure need to be better aligned to the factors our customers value most in.
In essence.
Reducing our costs, while creating exceptional value.
Our strategic restructuring enables us to do just that.
Further simplify our business model, while creating and enhancing value to customers teachers students and shareholders.
Sure with you a few practical examples.
And the strategic restructuring, we announce October 1st can be reduced besides of our workforce by 22%, including positions eliminated as part of our previously announced voluntary retirement incentive program.
And neck of newly created position to support our digital first operations.
In total we expect to reduce our expenditures by approximately $65 million to $70 million per year relative to the last 12 months ended September 30th 2020.
Which was already a significantly reduced cost base. After the temporary cost mitigation actions, we took earlier this year.
Does estimate of the relative reduction has been updated from our press release announcing the restructuring after the third quarter expenses came in much lower than we previously expected.
To achieve these cost reductions we eliminated activities enrolls that were print centric across the business in areas such as marketing.
Development and fulfillment and we focused instead on building roads and activities that support our digital first connected strategy.
By simplifying our efforts on a more limited set of connected products and services, we were able to rationalize sales administrative activities previously required to support the more complex and digital blended offered.
We reduced our planned investment in enhancing our legacy technology stack in headquarters supports fan in areas like I T finance and HR in order to free investment capacity to create a digital first infrastructure.
All of these reductions in eliminations allowed us to raise and create the factors that we believe will help us more effectively deliver customer value can execute our strategy.
For example, we increase the number of sales resources to cover the connected sales opportunity.
Customer demand is increasingly shifted the product and solution that are connected on one platform.
Meeting this need is a key lever for our growth.
We've also increased the number of inside sales representatives and transitioned are professional services team to virtual first building on the success, we've had this year and selling in delivering in a virtual environment.
We continued to build our customer success capability across the company focusing on customer experience and customer outcomes and increasing the size of our customer 616 scaling critical capabilities to a line to the rapid growth trajectory of recurring subscription revenue.
To help us continue to drive that scale. This year, we have begun to establish several of the key elements of our subscription based business.
Digital first pricing.
He metrics and best practices to help us build and retain a recurring revenue.
Finally, we'd be go to the planning for our next generation digital and connected operational model.
This includes the technology and processes to create a frictionless experience for our customers and also the back office, enabling technology to support digital billings growth for years into the future.
The actions we've taken through our value innovation approach have dramatically reduced our cost structure, both in terms of fixed and variable costs.
In 2019, we estimated are adjusted fixed costs were $619 million.
Closer to $700 million. If you go all the way back to 2016 before we begin to implement dealer strategy.
Through the value innovation efforts.
In 2021, we estimate we will have lowered our fixed costs to between $500 million to $505 million driven by the actions you've heard about from Jack and meet today.
Also by next year, we anticipate adjusted variable cost will represent 36% of our buildings, which is down two percentage points from 2019.
The transition to virtual delivery of services and reduction in costs associated with the Prince elements of our programs both through redesign and reduced volume is contributing to this expected reduction.
HMH has a stronger capacity to generate sustained and positive free cash flow as a result of the steps we've taken to a line of our cost structure to our digital first connected strategy.
We estimate or 2021 free cash flow breakeven billings level to be in a range of one point O. Two to one point O $7 billion, which is a step change improvement from just two years ago in which we used cash while generating $1.3 billion a village.
The earnings power of the model, we have achieved is very strong.
As you know, we typically expect that every dollar of incremental billings flow through the free cash flow at a rate of approximately 60% to 65%.
Let's move now to an overview of our financial results for the quarter.
Our total company billing for Q3, four $506 million back.
Back to school drove normal quarterly seasonality, but the pandemic and leader adoption opportunities continue to impact the market.
Despite the lower year over your billing. However, we had strong free cashflow generation of $237 million in the quarter.
Our education segment delivered billings of $451 million in Q3.
This was driven by core solutions billings of $254 million with mid cycle adoption opportunities lower relative to the 2019 peak as we expected.
Still we performed well in the Texas literature adoption this year with a leading 34% sure.
We have seen a decline in open territory and international course bending due to the pandemic with many districts opting to extend the current contracts or postponed purchasing due.
Due to budget uncertainties.
Extensions buildings for the quarter $196 million with solid performance and supplemental an intervention where billings growth in our SaaS offerings was a major contributor.
That performance was offset by pandemic related billings declines in height of it.
Which had performed very strongly in last year's Texas reading adoption also creating a difficult comparable for this year.
And in professional services.
For HMH books, and media billings in Q3 were $55 million with growth driven primarily by a $7 million increase in licensing revenue, which includes revenue from our animated Carmen San Diego series on Netflix.
Rounding up the rest of our key financials for the quarter and year. Today are net sales were $387 million in the third quarter and $828 million for the first nine months largely driven by the same factors that drove buildings.
Net loss of the third quarter with $13 million.
Just that EBITDA for the third quarter decline to $97 million, but notably are adjusted EBITDA margin was essentially unchanged compared to the third quarter a year ago. Despite the decline in net sales this year.
Given the significant operating leverage in our business. This is a remarkable result that was driven by the cost reduction in containment actions, we've taken over the last nine months.
We generated $237 million, a free cash flow in the third quarter and had a year to date cash usage of $11 million or nearly breakeven both impressive feat given the headwinds faced and 2020.
From a capital liquidity and balance sheet perspective, we continue to be at a very strong position.
As you know we implemented a furlough earlier this year as a temporary and precautionary measure to preserve liquidity in the face of an uncertain environment due to COVID-19.
We lifted that furlough effective July 30th, indicating our comfort with our liquidity.
And as you can see in our results are business demonstrated is resiliency by generating positive free cash flow of $237 million in the third quarter and bring us to nearly breakeven cash flow on a year to date basis.
A revolver remains undrawn.
And as of September 30th 2020, Hmh's cash balance was $272 million.
As you've heard of detail or value innovation approach has dramatically reduced our cost structure and increased our free cash flow generation potential. So taken together a healthy financial position that puts us on solid footing for 2021 and beyond.
Today, we've also provided our outlook for the remainder of this year.
And our preliminary outlook for next.
We expect billings for the full year between 1.05 billion in $1.1 billion, and we expect our free cash flow to be a usage of between $5 million to $15 million for the full year of 2020.
And based on what we know today and following from our value innovation work. This year, we expect positive free cash flow for 2021.
This outlook reflect the decisive actions we've taken this year to execute our digital first connected strategy that enables us to deliver value even amidst.
Can you to uncertainty in the market.
Looking ahead, we remain confident that HMH will emerge even stronger after these trying times.
Before I close out my prepared remarks, let me summarize the key takeaways about hmh's financials.
First we've taken significant steps to strengthen our business model and reduce our cost structure. These.
These are included the actions, we announced in October as well as the mitigating steps we took in response to COVID-19.
We've markedly improved HMH is free cashflow generation potential.
In our company remains financially strong with ample liquidity that will set us up for success in 2021.
Finally, before handing the call back to Jack.
I want to briefly comment on another item, we announced this morning.
As explained in our form 10-Q the.
The nomination agreement with our largest shareholder acreage will come to it in today.
And in connection with that acreage has requested that we've registered their shares for resale pursuant to an investor rights agreement that was put in place back in 2012, when the shares were first issued.
Those shares had previously been registered to resale, but the prior registration statement was not renewed when it expired in 2018.
Anchorage has been a valued investor and partnered HMH for over a decade and we are pleased that Dan Allen is going to remain on our board, even though he will no longer be serving as anchorages designee demi.
Demonstrating the confidence he has an HMH strategy and management's ability to execute that strategy.
With that I'll hand, it back over to Jack.
Thanks, Joe I want to thank everyone for joining the call today, we've made important progress this quarter and feel confident that the steps, we're taking our placing us in position to capitalize on the market growth and digital learning.
HMH has accelerated our digital first connected strategy.
Have a lined our cost structure to this strategy in a rapidly growing our SaaS sales and digital platform usage.
We'll also sharpening our focus on learning technology, including to a potential sale of HMH books and media.
To maximize shareholder value and focus our organization for the future.
Have you heard Joe discuss detail, we're in a very strong financial position, we feel comfortable with the billings range, we expect to hear given the unprecedented environment, we're operating in and.
And based on what we know today.
We expect to be free cash flow positive in 2021.
This will all build on the strong foundation, we'd establish to a strategy.
Cable us.
Even better positioned to support our employees, our customers and our shareholders. We don't we'll take your questions.
Thank you as.
As a reminder to ask a question you will need to press star one on your telephone.
To withdraw your question press the pound key please stand by while we compiled the Q&A roster.
And the first question come from the lineup.
George Tom with Goldman Sachs.
Hi, Good morning. This is Zack Lopez on for George.
With the fall back to school season behind Us.
How did instructional material compare risks your own expectation.
Where did they beat or Miss <unk> were there any surprises and then if you could break that down by open territory as an adoption state that'd be great.
Yeah in terms of in terms of our expectations, obviously, our expectations with the onset of the pandemic in March were adjusted and we expected that the demand for instructional materials would slack.
And as a result of.
Funding concerns that K.
K 12 schools had.
And you could see that Nope interior told me open territory was down at the end of the second quarter remained down year over year in terms of overall spending.
I will say that the adoptions held up very well and.
And as you could see we performed very well in the largest adoption in Texas without needing 44% sure.
So overall I think we did well I'll be the expectations, we set for ourselves in the first quarter of 2020.
Got it. Thank you just one quick follow up.
If you could just.
Just talk about the traction with cross selling supplemental materials, both digital and physical that'd be great.
Yeah, Great question and that obviously is central to our strategies of connecting for two extensions. We are very pleased with the progress we've made and connecting our core products to supplemental intervention in services.
I, just reference to Texas literature adoption, we had over 90% attach right.
File a program called available which is in our extensions category to our core into literature program in 100% a catch.
Of services to the.
Decor core program and then you can see on the slide that we have with the all of the wins.
Connected wind, which were just a luster too I'm a broader set of wins.
Using one sales organization to sell not only cool instructional materials, but along with that supplemental intervention in services and for us that is.
A unique competitive advantage given our presence in both score and and extensions and when we tie them together, we're essentially helping a teacher to address the needs of each and every student regardless of where the Orange Cheeseman spectrum.
So we're really pleased with the progress made this year on that strategy.
Got it makes sense. Thank you very much.
Thank you.
Just as a reminder to ask a question you will need to press star one on your telephone.
Our next question comes from the line of Jake Williams with Wells Fargo.
Good morning, everyone.
Hi, Jake.
Okay, and can you remind remind us what the kind of run rate <unk> billings is exiting three Q I know in south almost 150%, but just curious like kind of a dollar value is there.
Trailing 12 months, you'll see in our slide there for.
The third at the end of the third quarter has been $110 million.
Okay and in that 110, what's the breakdown between kind of.
Digital versions of the Basil products or digital versions of the textbooks Versailles extensions.
Yep.
Little.
We would call rather than Basil our core solutions as part of that in fact most of the.
Products that you'll see represented there are extensions.
And that is the intervention product line the supplemental product line.
We also have some clayman buildings in the in the.
110 and.
And so we have a.
Predominantly extensions based mixed there with that 110 million a little bit of core is now uhm.
Part of that.
Following on from our HMH anywhere sales.
Got it and a quick follow up if I may.
The three Q billings was pretty close what we're expecting.
Revenue was a little bit lower.
Could this has nothing to do with a timing shift were given the pandemic delays at some districts maybe.
Maybe signed the purchase agreement from three Q, but the actual revenue will be recognized in <unk> or is that something that may be delayed 220 21.
No. This is a pretty consistent.
Pattern that you see when we're selling multiyear contracts Jake.
Is that if our billings mix skews towards multiyear contracts really customers and that's usually a core solutions phenomenon.
No real difference this year, you'll see you'll see that difference between buildings and net sales or revenue and that has everything to do with.
The revenue recognition rules.
That we have there.
And.
You'll see the change in deferred revenue is really the delta between net sales and billing.
Great. Thank you so much.
Sure.
Thank you.
Our next question comes from the lineup, Jason Bazinet Wood.
Good morning, I just had a quick question. If you guys end up going ahead with the sale of the consumer book business is there is there a tax leakage associated with that sale or or or do you think there wouldn't be based on what we wouldn't anticipate a significant impact from tax leakage Jason.
Okay. Thank you.
Thank you.
I'm showing no further questions at this time.
We'll now turn the call back to President and C E O Jack Lynch for any further remarks.
Thanks, everyone for your time and attention today, and we look forward to connecting with you again D. Next year. Thank you have a great day.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating and you may now disconnect.
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