Q2 2019 Earnings Call
Ladies and gentlemen, please standby your conference call will begin momentarily once again, ladies and gentlemen, please stay on the line.
Thank you and good morning, everyone.
Before we again 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 HMH Seo Dot com.
A replay of today's call will be available until August 17, 2019, and the webcast will be available on our website for one year.
Our 10-Q was also filed earlier this morning, along with our second quarter 2019 earnings press release.
Before we discuss our results I encourage you to review the cautionary statement on slide two.
Which explains the risks of forward looking statements and the use of non-GAAP financial measures in the slide presentation and on today's call.
Please also refer to our most recent forms 10-K and 10-Q for a discussion of factors that could cause actual results to differ materially from these forward looking statements.
In addition, please refer to the appendix of the slide presentation for reconciliations of these non-GAAP measures to the most directly comparable GAAP measures.
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 company's second quarter 2019 results.
After our prepared remarks, we will open the call to questions.
During the Q in 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 HMH achieved record 32% growth in the second quarter, I'm, particularly thrilled with the leading share of our brand new programs delivered to the market this year.
Here are a few highlights.
HMH took the leading position in the 2019, Texas K eight Italia adoption.
With a 56% market share.
HMH also commanded the leading share in the overall, new adoption opportunity outside of Texas, but we saw solid performance nationally in open territory.
Our into map program, the Florida version of which earned in all Green score from third Party Evaluator Ed reports just began selling in open territory states and we see great potential as it enters the market.
Importantly.
Across the board for HMH, we generated strong billings growth both for the quarter and year to date.
Total education segment billings were up 34% for the quarter and 22% year to date.
Breaking that down billings for core solutions were up 65% in the second quarter and 46% year to date as a result of our leading share nationally and extension billings were also up 5% in the second quarter and 4% year to date driven by strong growth in high demand.
HMH books and media billings grew 7% in the second quarter and 8% year to date.
Given HMH has performance in the first half and sustain momentum in July today, we are raising our billings guidance for 2019.
We now anticipate total billings between $1.53 billion to $1.61 billion with core solution billings growth between 40, and 50% and extensions billings growth in mid single digits for HMH book and media our outlook remains unchanged.
Now how are we generating these results.
Very simply relentless execution in steadfast adherence to our strategy a three prong strategy designed to capitalize on the market trends and customer needs. We identified nearly two years ago.
First enhance and extend the core.
As I mentioned earlier, we have made strategic investments in highly differentiated core solutions.
They are yielding strong performance nationally.
Into reading is performing exceptionally well and not just in Texas.
Reading is also performing very well in all the other major adoption states and in the open territory States, where estimated win rate has increased 10% over 2018.
This is especially important because reading it literacy is the largest category in K 12 education.
As in all of our into learning programs on the AD platform. This program combines computer adaptive assessment with reading instruction to help teachers use data and insights to tailor their instruction.
The different groups of students across a range of academic abilities.
We're excited to see the strong customer response in both key adoption in open territory States.
It signals that HMH is investments in next generation solutions are paying off as we create better digital experiences for teachers.
And students and drive value for our shareholders.
For extensions as you know we have been expanding our portfolio via partnership and acquisition.
Last year extensions grew 7% and this quarter it grew 5%, giving us the confidence to raise our outlook for extensions for the full year.
Now onto our second strategic pillar delivering integrated solutions when we sell the core reading program to a school district, we want to sell a supplemental program in the intervention program and professional and development to help a teacher meet all the needs of their students in their class who perform across the team at spectrum.
We are the only company with a market leading position in both core and extensions. So the second pillar of our strategy is designed to leverage that portfolio strength for the benefit of the teacher and their students.
To advance that strategy, we've added a number of innovative new extension solutions to our portfolio, which are gaining traction in the market for an enhanced better together customer experience.
Notice I use the word innovative that's because we are not only the market leader in sales 14 12, we're also the leading innovator in the market.
In fact several of our programs have recently been recognized within the industry. We won 80 universal in math 180, as well as our partner programs Miro learning and ridable have all been selected as winners of Tech and learning 2019 Best of show Awards.
And finally, the third pillar of our strategy operational excellence.
We are continuing the simplification of organizational structures systems and processes that will not only reduce costs, but support our successful transformation to a learning company.
Now on to the highlights of our results for the second quarter and year to date.
Within our education segment core solutions billings were up $106 million or 65% in Q2, and $92 million or 46% on a year to date basis.
This was driven by very strong market share capture in 2000, Nineteens large adoption opportunities.
In Texas anyway, as I said previously we had a 56% win rate for into programs and had strong performance nationally in open territory, where estimated win rate has increased 10% over 2018, we also experienced strength in Florida map get GAAP deals as we worked with customers to extend their use of our go math program in the wake of a cancelled math adoption earlier this year.
We continue to be on track in our preparations for the 2020 adoptions, including Texas literature grades nine through 12, and the California science year to market opportunity.
The Texas Education Agency recently gave HMH into literature for grades 912, a 100% alignment rating for the upcoming adoption.
Turning to extensions.
Billings were up $8 million or 5% in Q2, and $10 million or 4% on a year to date basis.
This was driven by high Newman and the sales growth they continue to generate year after year, while meeting the market demand for teachers centered curricular resources and professional development solutions developed by renowned author educators, such as far as personnel, we see caulkins and Gen Cervelo.
We're also excited by the early success Weve had introducing several SaaS based supplemental learning solutions and pricing strategies into the market in recent months.
Now on to HMH books in media, formerly our trade segment, which grew $3 million or 7% in Q2 and $6 million or 8% year to date.
This growth was driven by the licensing income associated with animated series Carmen Sandiego on Netflix in addition to New York Times bestseller titles, such as maybe you should talk to someone in the giver.
The performance here is a testament to our focus on leveraging our multimedia approach in HMH books, and media and on creating strong brands that resonate with our customers.
We're also thrilled that Carmen Sandiego is nominated for 2019 Primetime Emmy Award in the category of Outstanding Children's program.
By the Academy of television Arts and Sciences. The nomination is just another validation of the caliber of award winning educational entertaining content that we're creating in HMH books and media.
With that I'll turn the call over to Joe who will provide a deeper dive into our second quarter and year to date results Joe.
Thanks, Jack good morning, everyone.
HMH had a record second quarter as Jack said.
Our strong performance both in the second quarter and on a year to date basis has been driven by the continued successful execution of the HMH 2020 strategy, which we set in place at the beginning of 2018.
Before we get into our consolidated second quarter and year to date results.
I'd like to touch on a few important topics that should paint a clear picture for HMH has headed financially for the rest of 2019.
First I will share with you how we think about the direction of our our reported profitability metric adjusted EBITDA.
We were extremely pleased with the billings, we generated during the first half of 2019.
And the way to think about billings as a cash revenue metric, which we define as net sales plus the change in deferred revenues.
As you can see adjusted EBITDA was down $9 million during the first half of 2019.
But what is missing from this picture is the cash component represented by the change in deferred revenue.
As you can see from slide down we experienced an $81 million positive swing and the change in deferred revenue.
From the first half of 2018.
To the first half of 2019.
This substantial change in deferred revenue serves as a leading indicator of net sales growth as we recognize revenue from multi year education segment programs in future periods.
It also serves as a leading indicator of adjusted EBITDA growth.
And margin expansion.
Because our cost base is largely fixed and because the future costs associated with deferred revenue recognition or low.
So while our adjusted EBITDA declined in the first half of this year relative to the first half last year. We expect this measure to increase in sub subsequent years.
And as I will cover again later in our discussion about full year guidance.
We continue to expect adjusted fixed costs and adjusted variable costs in line with the assumptions we provided back in February .
Which indicates our expectations for improved profitability this year versus last year.
The second topic I'd like to touch on is that we expect the increase in year over year billings implied by our revised full year guidance will result in substantial growth in free cash flow in the second half of this year.
Above the level, we anticipated when we provided full year guidance in February .
Our accounts receivable at the end of the second quarter, which was nearly $145 million higher than at the same point last year.
As a leading indicator of cash we will collect in the second half of this year.
We have already begun to convert first half receivables into cash.
And as of August Onest, we had fully repaid the $60 million of revolving credit facility facility borrowings that we ended with in June .
Now moving to the financial highlights of the second quarter of 2019.
Our consolidated net sales were $389 million in the second quarter up 9% and $583 million for the first half up 5%.
Total company billings were up 32% in the second quarter to $489 million and up 20% to $644 million in the first half reflecting growth in both education, and HMH books and media segments.
Education billings were up 34% to $450 million in the second quarter, driven by core solutions billings growth of 65% and extensions billing growth of 5%.
HMH books, and media segment billings increased 7% to $39 million for the quarter.
Year to date Education segment Billings grew 22% driven by core solution billings of 46% and extensions billings growth of 4%.
HMH books and media segment billings increased 8%.
In the first half.
Net loss from continuing operations for the second quarter was $41 million.
An unfavorable change of $12 million compared to Q2 of 2018.
This is timing related.
Due to our incurrence of cost of sales sales and selling and administrative expenses associated with the heavy billings volume in the second quarter.
Ahead of the revenue we will recognize in later periods.
Adjusted EBITDA for the second quarter declined $7 million to $47 million and declined $9 million to $21 million on a year to date basis due to the same timing factors impacting net income.
Our free cash flow year to date was a usage of $345 million compared to a usage of $258 million during the same period of last year.
The increased accounts receivable balance as a leading indicator for cash generation in the second half of the year.
The primary driver of the unfavorable change in free cash flow was an increase in net working capital associated with large billings in the first six months of 2019 for which we have incurred costs, but not yet collected cash coupled with a build in inventory for anticipated future shipments to meet strong customer customer demand for education programs.
Partially offsetting the increase in net working capital was a reduction in total capital expenditures.
Content development spending was $56 million in the first half of 2019 compared to $60 million for the same period last year.
Total capital expenditures were $74 million for the first half of 2019.
Compared to $83 million for the first half of last year.
As Jack mentioned.
Given the strong performance HMH had in the quarter and on a year to date basis, we are raising our billings guidance for 2019.
For the full year, we now expect companywide billings to be between $1.53 billion to $1.61 billion.
Up from our expectation of $1.49 billion to $1.59 billion at the beginning of the year.
Our outlook for content development spend and total capital expenditures remains unchanged.
We have updated our additional assumptions underlying this revised guidance and we now expect core solutions billings to grow in a range of 40% to 50%.
Extensions to grow in the mid single digits.
And free cash flow to increase relative to our February expectations.
All other assumptions remain unchanged, including a modest billings declined for HMH books and media. Despite the strong growth. This business exhibited in the first half as a reminder, we have a tough second half comparable for this segment.
Because we benefited from Carmen Sandiego and Orwell licensing income in the second half of last year.
Now before handing the call back to Jack.
I wanted to revisit the key financial trends in our business that we have been highlighting for you over the last several several quarters.
First we are executing successfully and seeing the results of our strategy and our adoption share.
Billings growth and our cash flow fundamentals.
And we're only in the second year of executing on this new strategy.
Next we're continuing to improve our business model.
And cost structure with enhancements, including the shift to a more software like development model, which makes our content development spend more efficient.
To operational excellence initiatives, which drive savings and our operating costs.
Lastly.
Our multi year market outlook remains attractive.
We anticipate an elevated level of new adoption spending at least through the year 2020 two beer in which Florida will hold its math adoption.
And we see growth returning to the open territory.
Our extensions portfolio continues to grow.
And the new innovative solutions, we have introduced are well positioned to help us drive durable positive free cash flow through the cycle.
And with that.
I will turn the call back over to Jack.
Thank you Joe before we take your questions I'd like to reiterate the main point of our message. This morning.
Our strategy is working.
Number one our new programs are winning in the market.
Number two we are delivering billings growth.
Number three billings growth and operational efficiencies are driving free cash flow growth.
Number four we have created a durable free cash flow generating business built for the long term.
These results make it abundantly clear that customers are now choosing HMH because nearly two years ago, we identified their needs and then developed highly differentiated and innovative solutions to meet those needs.
Today, we are incredibly proud to support educators and the students stay serve while simultaneously fueling the growth of our company.
We are truly a double bottom line business.
Now before we take your questions I'd like to announce that we will be hosting an investor gathering in New York City in October where we plan to go deeper into our strategy with you.
Stay tuned for further details.
Operator, we're now ready to open the line for questions.
Ladies and gentlemen, if you have a question or comment at this time. Please press Star then the one key on your Touchtone telephone.
If your question has been answered you wish to move yourself from the queue. Please press the pound.
Our first question comes from Jeff Goldstein with Morgan Stanley .
Hey, guys. Thanks for taking my question.
I wanted to follow up on the commentary for an increasing cash flow relative to your February expectation is the right way to think of that as just take $30 million change in the mid point of your billings guidance.
And then apply like a 39% of billing firewall costs guidance for that so maybe now you expect about 28 million more in free cash flow than you did prior.
So one is that the right way to think about that and then two what could drive you to see even greater upside to your current free cash last month.
Hey, Jeff morning, and thanks for the question.
Yes. The short answer is yes that is the appropriate way to think about that I think you've been asked the question a couple of quarters ago.
Where you'd kind of done the math and came up with about a $75 million free cash on them are back in February . So you should be thinking about that as flow through on incremental billings growth that we're indicating with our our billings guidance range increase.
And typically we think about incremental margins are about 60, 65%.
On that increased billing. So that's that's a pretty good estimate that youve that you've come up with there.
And I think the second part of your question was about.
What could drive free cash flow improvements and really it has to do with increases in billings were continuing to obviously work on our.
Cost structure as we talked about are operating excellence initiatives.
And continuing to focus on efficiency with our content development spend and those impaired.
Those efforts will progress through the year, but really the big driver as we sit here today will be continued performance on the.
Billing side.
Great.
Okay, and then I know you've been expecting an uptake in open territory now that weren't more removed from the common core rollout of 2013 in 2014.
Have you start to see that in the quarter and what type of tailwind would you expect from that in both the back half and then next one to two years. So essentially could open territory grow briana low single digits, you generally expect for K 12 over the next few years.
Yes.
Good question, Jeff we as we predicted we have seen growth in open territory.
As I indicated in my previous remarks, we have increased our share in open territory for reading by.
10 points of win rate of 10 points.
And I think thats indicative of overall share gain across the board for the company not only in Texas.
Where we got a 56% share in mind you not only.
Leading share in K, five, but also leading share in six eight.
We got a leading share in all the other state adoptions and we did see a return to growth for open territory and we're very pleased with our performance in open territory.
All right thanks for the color.
Our next question comes from Bill Warmington with Wells Fargo.
Good morning, everyone.
What about Brazil.
So congratulations on the performance in Texas.
Thank you.
First question is on the.
On leverage so you paid off the the $60 million revolver in July so you can see the cash coming through there.
How are you thinking about where leverage is likely to end up by the end of 2019 is is something around two times at this point or lower what are you thinking.
Well.
Has everything to do with that your choice of denominator, there to build but I think that.
As we think about it we do expect.
Our.
EBITDA metric to continue to improve through the back half of the year and so what that will do of course is drive leverage down from needs and from where we're out here as of the.
The first half.
Right, Okay, and we do expect that to continue.
But generally.
The other aspect about the about leverage here is that as we said we're going to be applying.
The generation of free cash flow to suit deleveraging.
On a gross basis.
So we'll have our first opportunities to do that in the second half as we move into our cash generation part of our seasonal cycle.
And then my second question is on California Science is if you could talk.
Us through how that.
How the California science process is going to unfold.
And when we should expect to start seeing.
Billings generated from that.
Yes.
Ron as you know the unlike all the other state adoptions.
California Science adoption is a three year adoption.
And out right now we have a leading share in that adoption.
But what we've seen is year one sales.
Kind of being delayed two year too.
And what you see in California is a lot of school districts, Hi, leading programs before they make their their final decision.
So long ways to go before we're done in California, but we feel good about the product and we feel good about our leading position right now.
Okay, well, thank you very much.
Again, ladies and gentlemen, if you have a question or comment at this time. Please press. The Star then the one key on your Touchtone telephone.
Our next question comes from George from Goldman Sachs.
Hi, Thanks, good morning.
A follow up on the California fines adoption can you provide some details on additional granularity on when you might expect in near to the benefits of building the flow through is that going to be back half weighted do you think it's going to be a linear ramp just based on what you're seeing so far.
Yes, I mean in terms of the three year adoption it'll be back half weighted most of.
As in all core adoptions most of the sales come in Q2 and early Q3.
In order for.
Teachers to have.
The mid instructional materials for.
Back to school so.
Yes be back half weighted.
For three years, and we would expect it to be Q2, having Q2 first our Q3.
Got it that's helpful and you mentioned.
Texas adoption, 56% market share or do you have additional market share data on the other.
Categories.
Within the current adoption cycle on side from Petricioli Keith Keith.
Yes, I mean, we have we have the data on all the other state adoptions years lay adoptions or social studies adoption Theres math adoption and while we're not going to go through each and every one of them.
We feel very good about our leading share of the overall overall category of state adoptions.
Outside of Texas.
Got it thank you.
And I'm not showing any further questions at this time I would like to turn the call back over to Jacqueline.
Okay. Thank you all for your questions will be as I mentioned.
In my prepared remarks, we'll be hosting an investor gathering.
In New York City, So stay tuned for the details on that and.
Thank you very much have a great day.
Ladies and gentlemen, it does conclude todays presentation. You may now disconnect and have a wonderful day.