Q2 2021 Houghton Mifflin Harcourt Co Earnings Call
Good day, and thank you for standing by welcome to the H M. H second quarter 2021 earnings call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question. During the session you will need to press star 1 on your telephone.
Please be advised that today's conference is being recorded.
I would now like to hand, the conference over to your speaker today, Chris.
Chris Seminar ski Vice President of Investor Relations. Please go ahead.
Thank you and good morning, everyone. Before we begin please note that slides referred to on today's call can be found and the Investor Relations section of our website.
H M H C O dot com.
A telephone replay of today's call will be available until August 15, 2021, and the webcast will be available on our website for 1 year.
The company's 10-Q was filed with the SEC earlier this morning, along with its second quarter 2021 earnings press release.
HMH encourages you to review the cautionary statements on slide 2 of today's presentation.
Additional information regarding these and other risk factors can be found and the risk factors section and elsewhere and the company's quarterly and annual filings with the SEC.
Furthermore, please refer to today's press release and the appendix of our slide presentation for a reconciliation of our non-GAAP measures for the most directly comparable GAAP measures.
This morning, Hmh's, President and Chief Executive Officer, Jack Lynch, and HMH, Chief Financial Officer, Joe Abbott.
We will provide an overview of the company's second quarter 2021 results now I'll turn the call over to Jack Jack.
Thanks, Chris Good morning, everyone and thanks for joining the call today.
HMH delivered another strong quarter, while executing our strategy and a market where demand for teaching and learning solutions is growing.
Environment is improving and educators are planning for students to return to classrooms. This fall.
We are pleased and our Q2 performance is positioning us for a strong 2021.
We delivered billings growth of 25%.
Our margins continue to expand and helping us achieve $101 million and trailing 12 months free cash flow, a 40% improvement compared to Q1 of this year.
Annual recurring revenue or <unk> from our expanding subscriber base grew 106% as our digital first connected strategy continues to deliver transformational results.
The increase in our net revenue retention rate and our 2.154% was a key driver in our AR growth, reflecting the strength of the relationships. We are forging with our subscribers and putting us on track to finish 2021 with a R. R.
And a range of 10% to 15% of our total billings.
As you read about and if we can update last quarter, we continue to make excellent progress and transforming our capital structure to align with our digital first connected strategy.
Notably we used the net proceeds from our completed divestiture of HMH books, <unk> media to pay down $337 million and debt.
Further enhancing our financial position and ability to invest and growth and efficiency and create shareholder value.
In addition, our credit ratings were recently upgraded by both Moody's and Fitch not only because of the debt paydown, but also due to the strong improvement and our profitability and cash flow.
The momentum we have in executing our digital first connected strategy combined.
Combined with strong billings growth year to date.
And the overall strength of our pipeline.
Gives us the confidence to raise our billings and Unlevered free cash flow guidance for the year, Joe will walk you through this and more detail shortly.
I wanted to spend a few minutes discussing what we seen over the past few months and the K 12 spending environment.
As educators plan of returning students to classroom. This fall and school funding begins to stabilize and we're continuing to see growth and demand for teaching and learning solutions, including intervention solutions that address the achievement gaps created by interrupted learning last year.
Do you believe the most challenging year and education.
Back to school purchasing this year also include some catch up print purchasing.
This is not a surprise print was not a very useful medium and remote learning setting but.
But as districts are now planning for a resumption of in person and learning this fall.
They are a restocking some of their resources.
1 of the HMH has key advantages is that we offer our products and digital and print form and contrast, and many of our competitors, who typically focus on 1 medium or the other.
In terms of state and local funding risk.
We saw continued signs of stabilization and Q2, though not uniformly.
There are many districts that are receiving stimulus funds and are beginning to use those funds for instructional materials.
Conversely, we saw other districts, where budgets have not fully recovered or their stimulus money and.
Has not been received and this is still driving a more conservative level of instructional material purchase planning for the 2021 'twenty 2 school year, which began last month in July.
On a federal level the outlook remains promising.
But the timing and the impact continues to be uncertain.
Factors influencing that include the flexibility and uses of funds such as the ability of districts to use stimulus dollars.
And prior COVID-19 expenditures.
And there is also a great deal of flexibility and timing.
With some stimulus funds available to be committed into 2024.
Looking ahead, it's been encouraging to see the continued emphasis on K 12 funding at the federal level.
Now John.
Just a few reminders and why we are incredibly excited about the momentum we are achieving today and the growth opportunity that lies ahead and our future.
First HMH operates in an extremely large and growing market.
With 54 million students 115000 schools and $740 billion and annual spending with more than $10 billion spent on instruction materials and services.
Within this market.
HMH is the only company that provides a full portfolio of integrated solutions purpose built for the teaching and learning of all students.
And competitively that integrated solution is the most comprehensive in the industry alleviating a major pain point and the industry today, which is the fragmented nature of the point solutions found and many of todays classrooms that require and exhausting level of work by a teacher to it.
<unk> insight and improved student outcomes.
Demand for this comprehensive solution continues to grow because our solutions are proven to work.
They combine the power of evidenced based resources learning analytics services, and a great user experience and how well do they work Here's a great example, and.
And Newport News, Virginia at the end of the 2021 school year more than 11000 of their students and grades 3 through 9 used HMH reading inventory system, 44, where math 180 to address Covid learning challenges during the 2000.2021 school year.
Here.
This resulted in 61% of them achieving gains and their lifestyle reading level, 21%, achieving double their expected annual growth and reading performance and more than 120 learners growing between 1 and 4 grade levels.
Underpinning our success with advancing student outcomes has been and authentically purpose driven culture.
And important differentiator for HMH, our incredible team continues to find innovative ways to bring learning to students and teachers and to support the communities and which we live and work.
Before I turn it over to Joe for a financial review I'd.
I'd like to tell you about the increasing confidence educators have and digital solutions and the progress. We made this quarter on the 3 pillars of our digital first connected strategy.
As a result of our approach we fully expect our billings mix to continue to shift to digital.
Especially as confidence and digital solutions continues to grow.
The result of HMH has just released 2021 educator confidence report highlighted this point.
75% of educators surveyed believe technology solutions that connect instruction and assessment on 1 platform.
We will transform teaching and learning and the future.
From the use of assessments to growing confidence and Ed Tech.
And digital solutions is on the rise 77% of teacher surveyed believe technology will help them be better teachers, and 82% believe adaptive learning will further transform teaching and learning.
Furthermore districts across the nation remain highly committed to maintaining the 1 to 1 investments they made to support students through the pandemic and they're implementing lessons learned about using digital to automate teacher workflows better track student learning.
And personalized learning inside and outside of the classroom.
As for our digital first connected strategy remember there are 3 key priorities that guide our team's execution 1 growing our digital first connected business.
To deepening customer engagement and increasing customer outcomes and 3 optimizing our digital transformation.
So starting with our digital first connected business. This is our unique value proposition as the breadth of our portfolio allows us to connect our core solutions with supplemental intervention and professional services to allow teachers to support the needs of all students across.
The achievement spectrum.
Godless of their academic ability on 1 engaging and highly effective platform.
We continue to see growth and our digital and connected solutions with our connected sales for the trailing 12 months accounting for 49% of our billings and digital accounting for 40%.
Our digital billings per cent is slightly down which is directly tied to the catch up and print purchasing I mentioned earlier on this call.
And students return to in person learning towards the end of the school year and districts restock print materials as Joe will discuss later heightened and strong rebound. This year also contributed these solutions are predominantly analog and nature Honeymoons rebound also explains the slight.
Decline and the percentage of our total sales that were connected we still expect to finish the year with connected sales above 50%.
Number 2 deepen customer engagement and increase outcomes usage of our unique proprietary platform HMH edge.
Can use to grow rapidly with 93% growth and trailing 12 months assignments compared to the same point last year.
And while the rate of growth is impressive and it did slow a bit and the quarter because and the second quarter of 2020, the entire nation transitioned to remote learning environment at that time, the principal way for students and teachers to get their work done was on a digital platform.
Towards the end of this school year, we saw many schools, returning to and personal learning, which slowed usage a bit relative to earlier.
And the school year.
Importantly, we are seeing increased demand for our highly effective learning solutions, while we continue to deepen customer engagement and this drove an acceleration in our growth rate to 106% in the second quarter with a net retention rate and our SaaS business of 150.
4%.
Our third pillar optimizing our digital transformation, we continue to make progress decreasing our variable costs as we deliver more and more of our products digitally for.
For the trailing 12 months, our adjusted variable costs were 32% of billings.
Now I'd like to hand, it over to Joe.
Joe.
Thanks, Jack and good morning, everyone.
Before I walk you through our operating and financial review for the second quarter I'd like to spend a few minutes updating you on our 3 financial priorities.
Our first priority is maintaining a strong balance sheet.
And the quarter, we paid down $337 million and debt using the proceeds from our completed sale of HMH books <unk> media.
And reduced our gross leverage ratio to 1.8 times adjusted EBITDA for the trailing 12 months ended June 32021 and.
In total we reduced our outstanding debt balance to $325 million, including approximately $22 million under our senior secured term loan facility due 2024 and.
And approximately $303 million and senior secured notes due 2025.
We continue to target gross leverage of under 2.0 times trailing 12 month adjusted EBITDA.
While we may opportunistically add debt, resulting in leverage above our 2.0 times target.
And supportive and acquisition for example.
Our intent is to continue to delever to below 2.0 times as soon as possible thereafter.
As you May have seen we recently received a ratings upgrade from Fitch, which follows and upgrade from Moodys earlier this year. These.
And these serve as important validation of our ongoing work to position HMH is a company with a robust and such.
<unk> ability to generate free cash flow.
And we continue to look for opportunities to further strengthen our balance sheet and reduce our interest expense.
Our $303 million and senior secured notes, which carry a 9% coupon become callable in February 2022, and we will be monitoring market conditions for the right time to refinance.
Finally, we plan to reserve approximately $275 million of our year end cash balance to meet our seasonal working capital needs, which supplements our asset backed liquidity facility.
Our second priority is to invest and growth we plan to invest and mid teens percentage of our total billings and development activities to create highly differentiated products that fuel organic growth.
We also plan to add to that organic growth with inorganic growth from small tuck in acquisitions that leverage our business platform.
Including complementary products and services or which provide access to new adjacent customer segments.
We added a strategic flexibility from our debt paydown and positions us well to do this.
And our third priority is investing for efficiency.
We intend to fund projects that we expect to help us deliver greater customer success, while making us a more effective business. For example, our back office automation project, which is currently ongoing.
More on that and the moment.
We also intend to fund projects that deliver operational efficiencies.
1 example of this and our active program to reduce our real estate footprint and <unk>.
Some cases, we will incur onetime capital expenditures to make our space available for sublease, but.
But we expect to generate healthy returns on those investments.
Most recently, we have vacated or sublease underutilized facilities, and both New York and Boston and we will continue to evaluate other facilities.
As employee preferences shift to remote work and as our business continues its shift to digital which requires less physical space and some instances.
Given our strong first half results and robust pipeline today, we're raising our full year guidance.
We now anticipate billings for the full year to be between $980 million and $1.02 billion.
Which is a 9% to 14% growth rate versus 2020 up from our prior expectation of $905 million to $955 million.
We continue to expect that over 50% of our billings will be derived from connected sales this year.
We're also raising our unlevered free cash flow outlook to 12% to 14% of annual billings from our prior at 9% to 11% range, which reflects the high degree of operating leverage and our business and our increased billings guidance.
As our business continues to grow we expect our unlevered free cash flow margin to expand along with that growth.
Our unlevered free cash flow outlook excludes a planned 10 million dollar investment and our back office automation project this year.
This is a 3 year program focused on modernizing the technology, we use to better serve our customers as well as streamline our operational processes as we continue to scale our digital first connected business.
Finally, we remain on track to deliver annualized recurring revenues of 10% to 15% of 2021 billings.
Up from 6% and 2020.
We expect to achieve and net retention rate of over 100%, which will contribute to the growth and our IRR.
And all during the second quarter and first half of 2021.
We continued to capitalize on our strengthened financial position to invest and are learning technology strategy.
We have a strong balance sheet disciplined capital allocation approach and continued focus on growth and investing for efficiency, which are fueling our drive to digital and strong financial results.
Now, let's turn our attention to our second quarter financials.
We've had a strong start to the year as we execute on our digital first connected strategy.
Billings were $327 million and the second quarter up 25% over the prior year period.
Core solutions billings were up $7 million or 5% to $158 million driven by strong open territory demand as a result of the market recovery.
Extension billings were up $58 million or 52% to $168 million driven by strong demand across all product portfolios.
We saw we saw particularly strong growth and our heinemann products due to the expectation of most of our customers that learning will largely be done in person and the upcoming school year.
Professional services also grew due to strong customer demand for virtually delivered connected professional development experiences.
Turning to our other key financials, our net sales increased to $309 million and the second quarter.
Income from continuing operations for the second quarter was $2 million and improvement of $35 million compared to the same period and 2020.
Adjusted EBITDA for the second quarter increased to $86 million from $32 million and the same period last year due to a robust net sales growth and high operating leverage and our business made stronger by the actions we took to reduce costs adjusted EBITDA margins expanded by 300 basis points to 28 per cent.
Free cash flow improved by $29 million and the quarter, bringing our trailing 12 months free cash flow to $101 million at the end of June up from $72 million at the end of March.
And as you know, we typically use cash and the first half of the year and generate cash and the second half of this year.
Our year to date performance is demonstration that our cost structure is scaling well and has a strong forward looking indicator of the robust free cash flow and we expect to generate this year.
Although the market has not fully recovered from the COVID-19 pandemic. We believe our digital first connected strategy will result in a more stable growing recurring revenue stream with higher margins and increasing free cash flow over time.
And with that I'd like to hand, the call back over to Jack for some closing remarks.
Jack Thank you Joe.
Although HMH was founded more than a 180 years ago. Our learning technology story is just beginning.
We are innovating and the market, helping teachers unlock the learning potential of their students with evidence based solutions powered by digital platform learning science and artificial intelligence.
As an innovator with a student outcome driven approach.
We believe HMH is now distinctly different and.
And well positioned for the next chapter in its history, a completely new chapter containing 4 components of value creation.
First HMH has a unique opportunity to expand market share in a very large and growing market through innovation and cross selling and connections across its portfolio of learning solutions.
Second <unk>.
HMH offers the industry's most comprehensive portfolio of learning solutions, and 1 engaging and dynamic platform, providing critical value to educators and students as you saw in the case study earlier, our solutions are competitively unique and.
Thank you that increasing student outcomes.
Third.
We have a clear 3 point strategy in place that focuses on shifting our revenue mix to digital.
And building recurring revenue, while expanding margins, what we call our digital first connected strategy.
And finally, we're committed to maintaining a strong balance sheet and free cash flow generation to complement organic growth and enable flexibility for tuck in acquisitions to further broaden our solutions portfolio.
Now I'd like to take a moment to say how proud I am of our employees. The hard work and dedication has continued to fuel our momentum.
We believe we have a winning formula to create value for students for teachers and the communities we serve.
And for our shareholders, we've driven growth and all the key indicators of our transformation and.
Annual recurring revenue net retention and digital billings and we are well positioned for a great 2021.
With that let's get to your questions.
Thank you as a reminder to ask a question you will need to press star and 1 on your telephone and we're trying a question. Please press the pound Kate please standby, while we compile the Q&A roster.
First question comes from Jeff Silber with BMO capital markets. Your line is now open.
Thanks, so much and congratulations on the great results.
Jack at the beginning you talked about the flow of funds and how some districts have gotten money. Some may have not and is there any way to quantify that and what percentage of gotten the money for this year, what percentage is going to be deferred.
Thank you Jeff.
Yes.
Difficult to quantify that right now.
But as you recall the 200 billion.
And federal stimulus funding is.
Is about.
10% of the overall spend a little bit less and 10% about 9% of the overall spend each year and.
And in some states like for example, Texas.
The state is still holding on to the money or or or substitute and some of the funding that they would ordinarily provide tube.
And to schools and districts. So that's an example of 1 of the states where they.
Federal similar to that flowing and.
And directly to the school districts and in other states.
It's a state by state.
Hi.
Situation right now in terms of.
And the implications that the federal funding.
Increasing the opportunity for school districts to allocate that funding to and structural materials. The other point I think to be made Jeff is that we expect that this funding will continue on and till 2024 and as we said earlier.
Not only for instructional materials, but.
And as for infrastructure, it's for ventilation systems, it's for teaching assistance and.
And the number of uses the funding so we'd like to think of it and as separate separating funding from spending.
And instructional materials, and obviously, 1 is indirectly related to the other but.
Not directly related.
Okay, and Thats really helpful beyond that I know historically.
Curriculum adopt and calendar, what's really important to your company I'm, assuming it's still is can you just remind us.
In terms of its major adoption this year and the next year or 2 what should we be expecting.
Yeah, no. This year the most significant adoption was Florida.
And.
And next year, the most significant adoption will be Florida NAV.
So that's really.
And the most significant what we call the big free adoption, and California, Texas and Florida.
For this year and Florida next year this year for Elas and next year for me and that's the that's the calendar right now near term and have you made any announcements on the Florida law sites.
Yeah, I think it's really no change from what we said last quarter Jeff.
We essentially look at that adoption and <unk> category. So $6.12, our performance was in line with our expectations.
And K 5.
Below our expectations and then intervention was part of the Ela adoption and in Florida and we are.
Completely exceeded our expectations in intervention. So net net I think good performance and Florida.
Okay and then my last question I think Jeff.
Excuse me.
When you had talked on.
And the.
Unlevered free cash flow as a percentage of billings guidance for this year I think you had said.
And that as trends continue to improve that number can go up and forgive me. If I misheard you can you just confirm that and is there any way to quantify potentially how large that could be thanks.
Yes, Jeff.
Yes go ahead.
This is <unk>.
Consistent with what we've talked about and our business, where we have a very high degree of operating leverage. So as you saw the billings guidance for the year and go up from our prior guidance. You also saw the expansion of our Unlevered free cash flow margin commensurate with that.
<unk> talked about and the path incremental billings flowing through to free cash flow, that's unlevered free cash flow or levered free cash flow and a rate of about <unk>.
65%.
And so that should give you a sense for.
The operating leverage and the business and what you can expect and billings continues to grow.
Okay, that's really helpful. Joe Thanks, so much.
John.
Thank you.
As a reminder, ladies and gentlemen, Thats star 1 to ask a question.
Our next question comes from George Tong with Goldman Sachs. Your line is open.
Hi, Thanks, This is David non for Georgia power.
And I had a COVID-19.3 year of billings guidance was $1.5 to 165 billion covering 2020 through 2022, what are your latest thoughts on billings through 2022.
Yeah.
Joe do you want to take care and yes, we will do.
Hi, and good morning. Thanks for the question. So I think the first thing to remember when you're when you're trying to compare those periods is that.
Want to take.
Take our pro forma approach for the recent sale of our books and media business.
As you know is averaging around $190 million to $200 million of annual billings there for the last several years. So that's important when you're kind of comparing periods and look while we have not put out longer term billings guidance, there and what we can say is that.
As you look out.
No really no structural reason why pre pandemic levels of billings aren't achievable just remember.
And that the timing is not entirely clear as to when the full recovery and spending will occur amongst our customers and so that's why we've been able to provide you an update on what we think for this year.
And but not really able to provide your timing in terms of how ultimately billings growth and subsequent years.
Okay and thank you that's very helpful. And then just a quick 1 on margins margins to improve as digital increases and mix.
Do you see and the long term EBITDA margin target.
Yeah, again, not putting any specific targets out there on a long term basis, but.
Just like Jeff's question earlier.
You can think about the flow through of billings to EBITDA and a very similar fashion to the way we've kind of talked about.
And the growth in.
And cash.
Cash flow as well as you see billings.
Billings get higher of the operating leverage comments that I was making before our consistent. Additionally.
Also remember that as our business mix shifts more to digital which we fully expect.
We would also expect the benefit to margins to occur there. So no specific targets, but certainly the trend and supportive of margin expansion as billings growth.
Alright, thank you.
Thank you.
And at this time and I'm showing no further questions at this time I'd like to turn the call back over to Mr. Jack Lynch, President and Chief Executive Officer for closing comments.
Thank you very much we appreciate everyone joining us on today's call. Thank you very much for your interest and HMH and we look forward to speaking with you again on our next call have a great day and thank you.
This concludes today's conference call. Thank you for your participation you may now disconnect everyone have a wonderful day.
Okay.
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