Houghton Mifflin Harcourt Company
Q1 2020 Earnings Call Transcript

Published: 10 May 2020

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Houghton Mifflin Harcourt scheduled First Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session [Operator Instructions].I would like to hand the call over to Brian Shipman, please go ahead.

[Brian Shipman:]

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 hmhco.com. A replay of today's call will be available until May 16th, 2020 and the webcast will be available on our website for one year. Our 10-Q was also filed earlier this morning along with our first quarter 2020 earnings press release.Before we discuss our results, I encourage you to review the cautionary statement on Slide 2 for our customary disclosures. Further information can be found in our 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 GAAP measures which is also posted to the HMH Investor Relations website.This morning, Jack Lynch, HMH's President and Chief Executive Officer; and Joe Abbott, HMH's Chief Financial Officer will provide a company update as well as an overview of the company's first quarter 2020 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.

[Jack Lynch:]

Thank you, Brian, and good morning everyone. The COVID-19 impacts every aspect of our work and life. We've seen an immediate surge in demand for our digital solution from our education system experiencing tremendous disruption. Educators are turning to HMH to support while we adapt to remote learning and plan for the new school year ahead.Our financial strength, our people, our portfolio, our digital platform, our online professional development as well as our technical support position us well for what's ahead. Why do we believe this? First, all of the work we have done in the last three years has put us in a strong position from a capital liquidity and balance sheet perspective.Our focused strategy has dramatically enhanced our software capabilities and product differentiation. We recently refinanced and paid down a portion of our debt and extended our maturity, affording us with financial flexibility and an improved balance sheet. As a part of our transformation efforts in late 2019, we also put in place an ongoing value innovation program to streamline our cost structure while aligning our best high impact, high return opportunities.Second, we remain strong, resilient and well-positioned to support all of our stakeholders, employees, customers and shareholders, protecting the safety and well-being of our employee community is paramount. For our shareholders last month, we announced the steps we began taking to mitigate adverse impact of COVID-19 while strengthening our financial condition and positioning us to renew normal operation when market conditions stabilize.As a reminder, these actions include director, executive and senior leadership salary reduction and for the majority of our employees, a 4-day work week with associated labor cost reduction, a freeze on spending not directly tied to near-term billings. reduced inventory purchases, deferral of long-term capital projects not directly contributive to billings in 2020 and borrowing from our asset base, our asset debt credit facility as a preemptive measure to mitigate against capital market disruptions.Third, for our customers, the pandemic has placed HMH in the important role of trusting partner and the vital source of their teaching and learning resources. We put in place comprehensive support efforts for educators, students and school districts, navigating the challenges of closures due to the COVID-19 pandemic, including free resources for educators, students and their parents and we've seen significant uptake in response. Assignments through our digital platform edge has grown dramatically. Technical support calls from customers have grown about 500% and webinars and virtual teaching had a record number of attendees.Fourth, in the immediate term, we see Back To School driving market demand as administrators plan for the return of students to school whether that be a continuation of remote virtual learning or back to school in the traditional terms. In either case, instruction materials are a must have to advance student learning. As you know from June to September is the period where we generate the lion's share of our billings every year and we still anticipate that that will be the case for 2020.Fifth, the pandemic has accelerated the market move to digital learning. Access to digital learning resources is crucial with remote learning. What was once a nice to have is now a must have. Teachers are holding virtual classes from their kitchen tables, using technologies such as Zoom and the assigning work using HMH's digital platform. Now for users of digital solution, we believe that teachers will be reluctant to go back to printed instructional materials, once they return to the classroom.Likewise, where the ratio of students to computing devices was once 2

[Joe Abbott:]

Thank you, Jack, and good morning everyone. Thanks for joining us on the call and I hope you're all staying healthy and safe during this unprecedented time. In terms of our first quarter, as you all know it is seasonally our smallest, and until mid-March business had been trending in line with our expectations for the quarter.However, once school closings became widespread due to the pandemic, we experienced a significant disruption in operational activity from our customers. This affected purchase decision-making which was, in many cases, delayed as well as our customers' ability to receive shipments from us, for purchases they had already made, as district and school employees transitioned to a work-from-home environment.This ladder effect impacted our ability to bill our customers on a normal timetable. But we have been clearing that backlog through the month of April and into May as many customers have made arrangements to receive shipments.So with that context in mind, let's take a look at the highlights for this quarter. Our consolidated net sales were down 2% to $190 million in the first quarter compared to the same period a year ago. Billings which we define as net sales, adjusted for the net change in deferred revenue, were down 15% to $131 million. Net loss for the first quarter was $346 million.An unfavorable change of $229 million compared to the same period in 2019. We took a $262 million impairment charge for goodwill in the quarter which was the primary driver of the unfavorable change. This impairment charge is a direct result of the adverse impact that the COVID-19 pandemic has had on the market price of our common stock.The impairment charge was partially offset by a decrease in selling and administrative costs resulting from our cost reduction actions undertaken in the fall as part of our 2019 restructuring plan, and our mitigating steps this year to reduce discretionary expenses in light of the COVID-19 pandemic as well as lower cost of sales.Adjusted EBITDA for the first quarter improved by $9 million compared to the same period last year to a loss of $17 million despite the decline in net sales. This improvement was a result of our reduced selling and administrative expenses. Our free cash flow was a usage of $187 million compared to a usage of $212 million during the same period last year. The lower cash usage in the first quarter was due to improvements in working capital driven by higher cash collections and lower inventory purchases, along with reductions in capital expenditures.Total capital expenditures were $31 million for the quarter compared to $36 million in the same period last year. Moving on to our year-to-date segment results. Education billings were down 20% to $92 million in the first quarter. Within the Education segment, core solutions billings grew 3% to $22 million for the quarter.We delivered strong selling performance in the Texas literature adoption, with approximately 75% of the market decided. Consistent with our experience in the Texas reading adoption last year, we expect this selling performance will translate into billings in our second and third quarters. Also within the Education segment, billings for our Extensions offerings declined 25% to $70 million for the first quarter. Our supplemental and intervention solutions had a solid quarter.But this was offset by Heinemann which faced very difficult comparisons from a strong performance in 2019. Heinemann also experienced several shipping delays due to nationwide school closings which affected its performance at the end of March. HMH books and media segment billings decreased 3% to $39 million for the first quarter.This was due to 2019 licensing revenue attributed to the Carmen San Diego series on Netflix which did not repeat in the first quarter of 2020, but is expected later in the year partially offset by strong growth in online book sales, particularly in the young readers eBooks category.I will now shift gears from our performance in the seasonally small first quarter to spend a few minutes putting into context the decisive steps we have taken to strengthen our financial position in light of the COVID-19 pandemic and the ensuing business disruption as well as to provide you with some additional color about our financial condition and expectations.In October 2019, as you will remember, we announced steps to further simplify our organization, realigning our cost base and reducing our capital intensity to become a leaner and more cash-generative business. We also strengthened our balance sheet through debt reductions and a refinancing to extend our debt maturities.Since then, we've taken several additional actions to protect the financial health of the company and enable us to weather the COVID-19 crisis and emerge stronger thereafter. These actions announced on March 27 included a significant reduction of operating expenses and enhancements to HMH's balance sheet.We reduced pay for the majority of employees through spending not directly tied to near-term billings, reduced inventory purchasing, temporarily closed fulfillment centers, deferred capital projects and pre-emptively borrowed funds from our asset-backed revolving credit facility we typically accessed during our working capital trough in the second quarter each year.These were all prudent measures to strengthen our financial position in light of the uncertainty posed by the unprecedented steps taken by our customers, representing over 90% of schools in the United States, to transition to a remote learning environment. We have conducted stress testing and scenario planning, and have concluded that if we take no additional action beyond the actions that we announced on March 27, we estimate that our breakeven level of billings, that is the point at which we would generate no free cash flow in 2020, is in a range of $1.23 billion to $1.28 billion.By way of comparison, in both 2017 and 2018, HMH generated over $1.3 billion of billings, a much higher level than the scenario analysis shows, yet the company consumed $82 million and $73 million of cash in those years, respectively. To be clear, this breakeven billing scenario range does not constitute billings guidance on our part and does not represent the billings outcome we are striving for in 2020.But we are sharing this with you today to quantify the significant improvement in cash flow generation capability that has resulted from our restructuring actions in 2019, along with the additional mitigating actions we announced in March. Looking ahead, we expect and are planning for a recovery this summer as our customers prepare for returning to school this fall, whether in physical classrooms or virtual classrooms.We have already seen signs that the demand recovery is beginning. Jack mentioned an important science adoption win in the Los Angeles Unified School District and wins in the Texas literature adoption. These decisions were made after waves of school shutdowns had already begun. The second and third quarters are typically the busiest billings quarters for us.And now that we have entered into this important part of our year, we are learning more every day about the magnitude of the recovery and demand. Now moving on to liquidity. As you know, we typically start each year with significant liquidity to fund the seasonal working capital needs of our business under a range of different scenarios, and 2020 is no exception. We ended 2019 with $296 million in cash and our $250 million asset-backed revolving credit facility was undrawn.During each of the last two years, we drew liquidity from our asset-backed revolving credit facility and paid it back in a matter of months. For 2020, we had already anticipated doing the same. And as the potential impact of the pandemic became apparent, we decided that pre-emptively drawing $150 million was a prudent step to mitigate unforeseen dislocations in the capital markets that might prevent us from accessing our credit line later in the year. We ended Q1 with $255 million in cash on our balance sheet.And excluding the cash from borrowing $150 million of our revolver, we had $105 million of operating cash on hand, $21 million more operating cash than we had at the same point last year. So we believe we are entering into the second quarter of 2020 with ample liquidity and financial flexibility to manage our business through the normal, seasonal working capital cycle that we manage through every year and importantly, to capitalize on the longer-term opportunities that Jack spoke to. So with that, I'll now turn it back over to Jack for some closing remarks.

[Jack Lynch:]

Thanks, Joe. In closing, I would like to summarize the key points we covered today.First, HMH is in a strong position from a capital liquidity and balance sheet perspective and we remain confident in our long-term strategic direction. As Joe and I both shared with you all the work we've accomplished over the last few years, including the decisive actions taken this year make HMH a significantly leaner and more profitable company.We are leading the market in Texas again and performed well in early sales efforts across the other adoption opportunity this year. We are confident this momentum will continue into our busier selling season in the coming months. With school planning for the fall, we continue to expect Back To School to be a meaningful demand driver with instructional material market this summer. And finally, the pandemic is accelerating the market move to digital learning. Digital offerings will lead in the next decade and HMH is in best position across both core and extension with the connected solution and underpinned by smart software and puts the educator at the center, something no other company in the industry can match.With that, we'd like to open up the call for questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from Bill Warmington of Wells Fargo. Your line is open.

[William Warmington:]

Good morning, everyone.

[Jack Lynch:]

Good morning Bill.

[Joe Abbott:]

Hi, Bill.

[William Warmington:]

So I think it'd be helpful if you could walk us through specifically how the move to digital is going to help Houghton and how that's going to flow through you think billings and now what kind of a timetable?

[Joe Abbott:]

Yeah, great question Bill, I think the first thing to say is that we have moved to digital. We have been for the last 10 years and the industry has been in this blended environment where we provide core curriculum or supplemental and there is an analog piece to it that's manifested in a printed book and there is a digital piece of it.So when we talk about digital first, what we're talking about is Digital is the main event. That's what's going to be consumed especially as every kid in the country has access to a Chromebook or an iPad and that's what the crisis has done. it has really accelerated that move from 2

[William Warmington:]

Got it. And then I think I know you guys are not giving guidance going into the fall, you provided some color in terms of what you think could happen. And I thought it might be helpful if you could broad strokes, give us a sense for what billings might look like under some different recovery scenarios as high level as you like.But I think that sort of laid out where you thought the breakeven was which is helpful. And I know you can't predict when the school districts are going to open, but I think you can lay out like if this happens, then we think we're probably going to come in around here, that would be helpful, I think.

[Jack Lynch:]

However, once school closings became widespread due to the pandemic, we experienced a significant disruption in operational activity from our customers. This affected purchase decision-making which was, in many cases, delayed as well as our customers' ability to receive shipments from us, for purchases they had already made, as district and school employees transitioned to a work-from-home environment. This ladder effect impacted our ability to bill our customers on a normal timetable. But we have been clearing that backlog through the month of April and into May as many customers have made arrangements to receive shipments.So with that context in mind, let's take a look at the highlights for this quarter. Our consolidated net sales were down 2% to $190 million in the first quarter compared to the same period a year ago. Billings which we define as net sales, adjusted for the net change in deferred revenue, were down 15% to $131 million. Net loss for the first quarter was $346 million.An unfavorable change of $229 million compared to the same period in 2019. We took a $262 million impairment charge for goodwill in the quarter which was the primary driver of the unfavorable change. This impairment charge is a direct result of the adverse impact that the COVID-19 pandemic has had on the market price of our common stock. The impairment charge was partially offset by a decrease in selling and administrative costs resulting from our cost reduction actions undertaken in the fall as part of our 2019 restructuring plan, and our mitigating steps this year to reduce discretionary expenses in light of the COVID-19 pandemic as well as lower cost of sales.Adjusted EBITDA for the first quarter improved by $9 million compared to the same period last year to a loss of $17 million despite the decline in net sales. This improvement was a result of our reduced selling and administrative expenses. Our free cash flow was a usage of $187 million compared to a usage of $212 million during the same period last year. The lower cash usage in the first quarter was due to improvements in working capital driven by higher cash collections and lower inventory purchases, along with reductions in capital expenditures.Total capital expenditures were $31 million for the quarter compared to $36 million in the same period last year. Moving on to our year-to-date segment results. Education billings were down 20% to $92 million in the first quarter. Within the Education segment, core solutions billings grew 3% to $22 million for the quarter.We delivered strong selling performance in the Texas literature adoption, with approximately 75% of the market decided. Consistent with our experience in the Texas reading adoption last year, we expect this selling performance will translate into billings in our second and third quarters. Also within the Education segment, billings for our Extensions offerings declined 25% to $70 million for the first quarter. Our supplemental and intervention solutions had a solid quarter.But this was offset by Heinemann which faced very difficult comparisons from a strong performance in 2019. Heinemann also experienced several shipping delays due to nationwide school closings which affected its performance at the end of March. HMH books and media segment billings decreased 3% to $39 million for the first quarter. This was due to 2019 licensing revenue attributed to the Carmen San Diego series on Netflix which did not repeat in the first quarter of 2020, but is expected later in the year partially offset by strong growth in online book sales, particularly in the young readers eBooks category.I will now shift gears from our performance in the seasonally small first quarter to spend a few minutes putting into context the decisive steps we have taken to strengthen our financial position in light of the COVID-19 pandemic and the ensuing business disruption as well as to provide you with some additional color about our financial condition and expectations. In October 2019, as you will remember, we announced steps to further simplify our organization, realigning our cost base and reducing our capital intensity to become a leaner and more cash-generative business. We also strengthened our balance sheet through debt reductions and a refinancing to extend our debt maturities. Since then, we've taken several additional actions to protect the financial health of the company and enable us to weather the COVID-19 crisis and emerge stronger thereafter.These actions announced on March 27 included a significant reduction of operating expenses and enhancements to HMH's balance sheet. We reduced pay for the majority of employees through spending not directly tied to near-term billings, reduced inventory purchasing, temporarily closed fulfillment centers, deferred capital projects and pre-emptively borrowed funds from our asset-backed revolving credit facility we typically accessed during our working capital trough in the second quarter each year. These were all prudent measures to strengthen our financial position in light of the uncertainty posed by the unprecedented steps taken by our customers, representing over 90% of schools in the United States, to transition to a remote learning environment. We have conducted stress testing and scenario planning, and have concluded that if we take no additional action beyond the actions that we announced on March 27, we estimate that our breakeven level of billings, that is the point at which we would generate no free cash flow in 2020, is in a range of $1.23 billion to $1.28 billion.By way of comparison, in both 2017 and 2018, HMH generated over $1.3 billion of billings, a much higher level than the scenario analysis shows, yet the company consumed $82 million and $73 million of cash in those years, respectively. To be clear, this breakeven billing scenario range does not constitute billings guidance on our part and does not represent the billings outcome we are striving for in 2020. But we are sharing this with you today to quantify the significant improvement in cash flow generation capability that has resulted from our restructuring actions in 2019, along with the additional mitigating actions we announced in March. Looking ahead, we expect and are planning for a recovery this summer as our customers prepare for returning to school this fall, whether in physical classrooms or virtual classrooms.We have already seen signs that the demand recovery is beginning. Jack mentioned an important science adoption win in the Los Angeles Unified School District and wins in the Texas literature adoption. These decisions were made after waves of school shutdowns had already begun. The second and third quarters are typically the busiest billings quarters for us.And now that we have entered into this important part of our year, we are learning more every day about the magnitude of the recovery and demand. Now moving on to liquidity. As you know, we typically start each year with significant liquidity to fund the seasonal working capital needs of our business under a range of different scenarios, and 2020 is no exception. We ended 2019 with $296 million in cash and our $250 million asset-backed revolving credit facility was undrawn.During each of the last two years, we drew liquidity from our asset-backed revolving credit facility and paid it back in a matter of months. For 2020, we had already anticipated doing the same. And as the potential impact of the pandemic became apparent, we decided that pre-emptively drawing $150 million was a prudent step to mitigate unforeseen dislocations in the capital markets that might prevent us from accessing our credit line later in the year. We ended Q1 with $255 million in cash on our balance sheet.And excluding the cash from borrowing $150 million of our revolver, we had $105 million of operating cash on hand, $21 million more operating cash than we had at the same point last year. So we believe we are entering into the second quarter of 2020 with ample liquidity and financial flexibility to manage our business through the normal, seasonal working capital cycle that we manage through every year and importantly, to capitalize on the longer-term opportunities that Jack spoke to. So with that, I'll now turn it back over to Jack for some closing remarks.

[William Warmington:]

And I also want to say congratulations on the California Science win, it's a great feather in your cap.

[Joe Abbott:]

Thank you.

[William Warmington:]

I wanted to ask if, when you expect there to be a resumption of decisions around California Science.

[Jack Lynch:]

Yeah, I think right now we've seen a resumption, so in Texas for the literature adoption as well as California, and the other adoption states, there has been a resumption (inaudible) already of purchasing behavior.

[William Warmington:]

Great, all right, well thank you very much for the color.

[Jack Lynch:]

Great.

[Operator:]

[Operator Instructions] There are no further questions. I would turn the call back over to Jack Lynch for any closing remarks.

[Jack Lynch:]

Okay, well thank you everyone for your time and your attention today and we look forward to talking to you again at the Q2 earnings call. Have a great day.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.