Houghton Mifflin Harcourt Company
Q1 2015 Earnings Call Transcript

Published: 7 May 2015

[Operator:]

Good morning and welcome to the Houghton Mifflin Harcourt's First Quarter 2015 Earnings Call. I would like to inform you that this call is being recorded for broadcast and that all participants are in listen-only mode. I would like to introduce Rima Hyder, Vice President, Investor Relations, for Houghton Mifflin Harcourt. Ms. Hyder, you may begin.

[Rima Hyder:]

Thank you, Karen and good morning, everyone. Before we begin, I would like to point out that the slides we will reference during the course of this presentation can be accessed via the Investor Relations section of the Houghton Mifflin Harcourt website at www.hmhco.com. A replay of today's call will be available via phone until May 14 and the webcast will be available on our website for one year. We filed our financial statements and Form-10Q with the U.S. Securities and Exchange Commission earlier this morning along with our first quarter earnings release. After our prepared remarks, we will open the call to questions from investors. To be fair to everyone, please limit your questions to one plus a follow-up. You may get back into the queue if you have additional questions. Before we discuss our results, I encourage all listeners to review the legal notice on Slide 2 of our Slide Presentation, which explains the risks of forward-looking statements and the use of non-GAAP financial measures. Additionally, please refer to our Form 10-K and 10-Q for a discussion of risk factors that could cause actual results to differ materially from these forward-looking statements. The presentation and discussions on this call include certain non-GAAP financial measures. Please refer to the appendix to the Slide Presentation, which was posted to the Investor Relations Section of our website, the reconciliations of such measures to the most directly comparable GAAP measures. This morning, Linda Zecher, Houghton Mifflin Harcourt's President and Chief Executive Officer will provide an overview of the company's first quarter 2015 results, followed by the presentation of financial results by Eric Shuman, HMH's Executive Vice President and Chief Financial Officer. I will now turn the call over to Chief Executive Officer of Houghton Mifflin Harcourt, Linda Zecher.

[Linda Zecher:]

Thank you, Rima and good morning, everyone and thank you for joining us today. We had a strong start to 2015 and began the year by executing on the priorities we've laid out as part of our capital allocation strategy to carrying key wins across the business and creating opportunities to drive growth across our portfolio. Within our capital allocation framework, we've outlined our intent to focus on investments and organic growth, the pursuit of strategic acquisitions and return of value to our shareholders. In recent months we've taken clear actions to advance each of these three pillars. First we continue to invest in complementary growth areas specifically the consumer and early childhood faces. I am proud to say that our momentum in these segments continued in the first quarter of 2015. On the consume side, we're placing strong emphasis on extending our best-in-class classroom content directly to parents and children. Our ability to leverage our newer and iconic characters to create smart and engaging content for children is proving successful. For example CuriousWorld.com was recently named the number one educational website for kids by Parenting.com and the Curious World App was garnered well over a 0.5 million downloads. Also this quarter, we brought back the iconic Carmen Sandiego through unique collaboration with Intel. Carmen Sandiego Returns, a game developed for use with the Intel RealSense Technology provides us with an opportunity to leverage legacy assets with a strong brand and fan base. Stay tuned for the much anticipated for the IOS version coming later this year. In the early leaning space, we're actively enhancing and expanding our offering for consumers and institutions. We also recognize the importance of advancing the national dialogue around the fundamental roll of quality early education and the long-term success of all learners. That's why in March we held the first and a new series of quarterly symposia. The event entitled Conversations on Early Learning brought together more than 70 influencers, experts and critical stakeholder organizations including the White House to promote conversations around the education during the child's most formative years. Our intention is for the series to convene a national discussion around the importance of early learning and to inform a national framework for change and set actionable guidelines to help achieve this vision. Secondly within our capital allocation framework we recently took a significant and exciting step on our transformation journey by entering into an agreement to acquire the educational, technology and services or EdTech business of Scholastic Corporation for $575 million. With this transaction, which we expect to close in the second quarter of 2015 we would gain a leading position in the academic intervention space, amplify our growth potential and strengthen our ability to profoundly influence the learning paradigm. We believe the acquisition aligns with our previously defined strategic areas of focus. On our recent investor call, we stated that there is a clear and compelling strategic rationale for this transaction. With this transaction we would be expanding our core portfolio and adding significant strength to our existing professional development, assessment and intervention offerings as well as our adjacent market portfolio. We also expect that the addition of the EdTech business will enhance our long-term financial potential. We expect the transaction to be accretive to our net income and free cash flow in 2016 and generate $10 million to $20 million in annual cost savings starting in 2016. We're looking forward to welcoming the talented EdTech team as the transaction close. Finally, our Board recently authorized an increase of our share repurchase program from $200 million to $500 million. The $500 million stock repurchase program may be executed over a period of two years from yesterday's authorization. The $300 million increase in authorization is conditional upon the successful closing of the increase new term loan which Eric will discuss in a few minutes. We continue to actively consider ways to pursue opportunities that are consistent with the company's capital allocation strategy that we deem prudent and appropriate under the circumstances. Now turning to business highlights from the quarter. We recorded exciting wins in both our education and trade segment. Within our core education business, we believe the pace at which we've begun to receive orders is a positive early indicator of our leadership in both the adoption market and open territories. As we noted on last quarter's call, we do expect the adoption market to be lower compared to 2014. However, there is still important large states to be won in 2015 and we're making great progress on that front. Other districts that have announced content provider selections we've already captured 51% of these wins. Highlights include the selection of GoMath! in numerous California districts including Fresno and Long Beach as well as Metro Nashville for its elementary and high school math programs. We also had key ELA wins in Florida School districts including Miami-Dade County and in New York City for math and reading. In addition to these encouraging wins for our K-12 content, our assessment business saw continued strength with the sales of Woodcock Johnson IV. This quarter we also experienced an increase in sales in our Trade division, thanks to our strong backlist sales of J.R.R. Tolkien and Lois Lowry and continued success with What if? and the Newbery medal winning children's book, The Crossover. Our culinary line also had a strong start to the year with the The Real Paleo Diet Cookbook, Cake My Day and the New York Times bestseller The Whole 30 and to add to our list of bestsellers, Fun Home the Broadway musical based on Alison Bechdel's book led the nominee for the Tony Awards with 12 nominations in total. We continue to deepen our trade line up by recently securing the rights to publish Numero Zero by popular Italian author Umberto Eco. We also announced plans to publish 100 years of the best American short stories and anthology series in October of this year. We believe that our extensive heritage as well as our partnerships with some of the world’s most respected authors uniquely positions us to curate the best and most beloved short stories over the past century. In addition to focusing on strategic capital allocation and securing new wins this quarter, we've laid groundwork that we believe will further optimize our growth potential. As we prepare for the busy selling season, we're actively exploring new ways to enhance the customer experience. Our multi-year cross functional customer experience initiative will benefit the experience we bring to Back to School 2015 season. We're laser focused on ensuring that every step in the customer journey from first exposure to HMH to implementation, use and renewal is re-imagined from the customer point of view. We're actively measuring customer experience at each stage by cross referencing customer journey data with operational and business data, we can create offerings that carefully align -- better carefully align with the needs of classroom teachers and our students. And to address our customer's needs beyond content and create new revenue opportunities for HMH, we recently announced the creation of HMH Education Services, this Group is charged with providing an integrated approach to supporting and advising customers on everything from technical planning to curriculum implementation, data analysis and professional development. Those services will include supporting schools, and pinpointing gaps in their current education process and developing customized solutions to benefit students, teachers and parents. By layering this service component into our offering, we expect to deepen our partnerships with customers and help further improve learning environment in schools around the country. We see many opportunities ahead this year and recognize there is a lot of work to be done especially in terms of integrating and optimizing opportunities with the EdTech business of Scholastic upon transaction close. We remain focused on exploring new opportunities in our core markets while building out our early childhood and consumer businesses with a challenge and dedicated team employees as well as ample momentum to build upon, I am optimistic about our potential for 2015 and beyond. With that, I’ll let Eric walk you through the financial results for the quarter. Eric?

[Eric Shuman:]

Good morning everyone. As Linda noted, 2015 is off to an exciting start and we’re pleased with the progress in all aspects of our business, while the first quarter generally represents a small percentage of our overall expected revenues, we are nevertheless encouraged by our performance during the period. Overall our billings grew approximately 3% or $4 million to $148 million from $144 million in the prior year. Net sales this quarter climbed 6% or $9 million year-over-year to $163 million from $154 million attributable to growth in both our Education and Trade Publishing segments. Within the Education segment, the 6% sales growth from $122 million to $129 million was primarily driven by ongoing demand for the Woodcock-Johnson within our assessment business. In addition, we also benefited from the recognition of previously deferred revenue. Trade Publishing sales were also up 5% reaching $34 million in the first quarter of 2015 on strong sales of backless, printless and culinary titles. Operating loss was $131 million compared to $140 million in the first quarter this year, this $9 million or 7% improvement was facilitated by our sales growth as well as the 4% reduction in cost of sales as we incurred less amortization expense related to pre-publication cost and intangible assets. This was partially offset by selling and administrative cost, it rose $6 million or 4% from $137 million last year to $143 million this year. The rise in selling and administrative cost was primarily due to higher professional and legal fees. Net loss for the first quarter was $160 million, a decline of $14 million from the loss of $146 million reported in the same period last year mainly attributable to the timing of the recognition of our non-cash deferred income tax. Our adjusted EBITDA improved almost 3% in the first quarter of 2015 to a loss of $52 million compared to a loss of $53 million in the first quarter last year primarily due to the improvement in net sales offset by higher selling and administrative expenses. Our adjusted cash EBITDA was down $4 million to a loss of $67 million primarily due to higher deferred revenue recognized in the first quarter of 2015 versus the prior year. As of March 31, 2015 we had cash and cash equivalents of $562 million. As is typical in the first quarter of the year, given the seasonality of our business, we use cash to fund our operating activities. This quarter we used $93 million compared to $103 million used in the first quarter of 2014, the improvement is primarily due to the timing of working capital. We expect to begin generating strong free cash flow once again as we enter the busy selling period of the second and third quarters. As we stated in yesterday’s 8-K filing, we are seeking to increase the size of the new term loan to $800 million from $500 million. We are pleased with the early indication of demand, we have experienced for participation in the new term loan. The company expects to use the net proceeds from the new term loan to refinance its existing term loan, finance a portion of the EdTech acquisition, pay fees and expenses and for general corporate purposes including funding its stock repurchase program. HMH expects to close the new term loan concurrently with the acquisition during the second quarter of 2015 subject to completion of successful marketing negotiation and other factors. In light of current positioning in business momentum we believe we are on track to achieve the targets we’ve laid out for 2015, however once the plan EdTech business acquisition and the new term loan closes, the financial profile of our businesses will naturally shift. To help you understand our expectations for 2015, we plan to provide revised guidance after the transaction is closed. With that let’s open the call to questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from the line of Peter Appert from Piper Jaffray.

[Peter Appert:]

Thanks good morning. So it looks like you’re off to a very good start again this year. So congratulations, I’m just wondering if there is any fine tuning in terms of your expectations for market size this year and then related to that preliminary expectations for market opportunity next year?

[Eric Shuman:]

Well as you know, we haven’t given guidance on the 2016 market Peter. But for 2015, our expectation is that the market is the same size approximately $2.7 that we previously indicated.

[Peter Appert:]

Got it. Understood and then what’s your expectation Eric in terms of the composition of sales this year, digital versus print and how that would be different from past year?

[Eric Shuman:]

Yes my expectation is for our major programs, last year they were up approximately 54% digital as we previously stated, we would expect to be in approximately the same ballpark this year.

[Peter Appert:]

Got it. And then last thing, the – like just from a political perspective lot of pushback on the adoption of the Common Core and I’m wondering that has the implications for you guys, are you seeing any relevant considerations in terms of your sales and then again a corollary to that is that actually good for your testing business?

[Linda Zecher:]

We’re not actually in the testing business, actually not what we do. But as far as the content for Common Core, people are really interested in the standards and in many cases, the state has modified the standards to their own state standards, so we really haven’t seen any impact at all on our business from any political things are on Common Core.

[Peter Appert:]

So maybe I misunderstood this Linda, you’re out of the assessment business, you don’t do the Iowa test anymore for example?

[Eric Shuman:]

No.

[Linda Zecher:]

We do the Iowa test yes but we don’t, we are not involved in the standards testing that are in the classroom around Common Core.

[Eric Shuman:]

That is high-stakes testing.

[Peter Appert:]

I got it. My point was more maybe the states are rejecting the high-stakes testing will go back to the prior customized test and I was wondering if that created an opportunity for you guys.

[Linda Zecher:]

We were not seeing, it’s minimal.

[Peter Appert:]

Got it, understood. Thank you.

[Eric Shuman:]

Thank you.

[Operator:]

And our next question comes from the line of Denny Galindo from Morgan Stanley.

[Denny Galindo:]

Good morning.

[Linda Zecher:]

Good morning.

[Denny Galindo:]

You mentioned the New York City wins in your comments, what are you seeing in open territory this year, is it – looks like it’s on track a little bit better than last year or little bit worse?

[Eric Shuman:]

I would say we’re on track right now. I mean open territory really declares its attention a little later than the adoption market. So it’s a little harder to forecast in the first quarter, what is happening in open territory but we haven’t seen any indication of weakness versus where we thought it was going to be.

[Denny Galindo:]

Okay. That’s helpful. The plate spending was actually down quite a bit in the quarter and the now the occurrence of this as a benefit of potentially a smaller adoption market in 2016 or maybe it’s just a timing issue and the play kind of ramp up as part in the year.

[Linda Zecher:]

It’s a timing issues.

[Denny Galindo:]

And how should that trend going forward?

[Eric Shuman:]

I would expect it over the course of the year. We’ll obviously spend more than -- we will spend more money and we'll spend to our plan, which I think we previously given guidance is $110 million to $120 million.

[Denny Galindo:]

Okay. And then your guidance earlier in the year was 0% to 4% or down 0% to 4% in billings and in this quarter I know excess was kind of the you were comping against I guess zero revenues last year and then trade, if you take out trade as well. it looks like billings were down around 3%. So are you still thinking 0% to 4% is the right range for billings in the year or are you coming out at the bottom of the range do you think that there is going to be strong billings later on the year? May be some color on that.

[Eric Shuman:]

Yes Den. We haven’t changed our guidance in billing.

[Denny Galindo:]

Okay. And then on another topic, on the increased buyback you kind of did that in two chucks. First the 200 and then to 500 and I am just curious if you could give us some color behind that decision why did you in two separate pieces? And then a follow-up there is about the timing of repurchases. Do you expect these to look at certain valuation of the shares or are you going to buy evenly over the next two years, which you consider an accelerated share repurchase as part of the secondary you guys are looking at and maybe if you just kind of give some help on how to think about the timing of the repurchases.

[Linda Zecher:]

Well I think the major reason that we increased the share buyback is that we feel very confident in the company’s ability to execute on any education tray publishing business and we expect to generate strong cash flows. We also believe that the capital markets are very favorable right now. We want to take advantage of those. So we increased our term loan. From the buyback perspective, we expect to utilize our share buyback program over the next two years and we will spend significant amount of that cash through public and privately negotiated transactions over the course of next 12 months.

[Operator:]

Thank you. And our next question comes from the line of Andre Benjamin from Goldman Sachs.

[Linda Zecher:]

Good morning, Andre.

[Andre Benjamin:]

Hi, good morning. Couple easy questions hopefully. I just wanted to clarify or reconfirm how we should be thinking about the full-year cost. Is it correct that we should be looking at SG&A and cost of sales as flattish year over year as a percentage of sales or more flattish on absolute basis. I just want to make sure I got that right.

[Eric Shuman:]

Cost of sales this year versus last year will be largely consistent in SG&A this year versus last year should be approximately the same to down a little as a percentage of revenues.

[Andre Benjamin:]

As a percentage not absolute, all right, and then separately I have a bigger picture question I guess. You've reiterated 2015 guidance you're not really getting into much in the 2016 and the big acquisition that you are trying to close hasn’t closed yet. So over the entire of maybe what we should be expect to hear you talk about at your Analyst Day next week and how we should be thinking about the big picture here.

[Linda Zecher:]

I think next week we're going to talk about where we're going across our core business. What we're looking at as far as our adjacent markets with consumer and early childhood. And then we're also going to talk about our expectations of the acquisition and how that’s going to look from an intervention perspective and how that adds to our overall portfolio.

[Andre Benjamin:]

Okay. Thank you.

[Linda Zecher:]

Welcome.

[Operator:]

Thank you. And our next question comes from the line of Drew Crum from Stifel.

[Linda Zecher:]

Hi Drew.

[Drew Crum:]

Good morning everyone. In light of the increase effect that you're seeking to increase the size the term loan, are you signaling further interest in doing more acquisitions?

[Linda Zecher:]

Well we've always been looking at strategic things that we could add to our portfolio to enhance the value to our shareholders, but as of right now, I am pretty laser focused on completing the acquisition that we just made. But obviously we're constantly looking at other opportunities in the market place.

[Drew Crum:]

Got it. Okay. And then Linda as it relates to EdTech business to the best you can update us here plans to participate in some of the larger adoptions in 2016 and whether or not some of the programs like Read 180 have already been approved for participation and some of the big adoptions.

[Linda Zecher:]

I think the biggest adoption in '16, '17 is California reading and California reading has five different areas that you can participate in. We were already participating in three of those areas and Scholastic, the EdTech business was in two of those areas. So that’s actually now going to give us an offering across all five which we’re very excited about. None of those have been -- that is all in progress right now and not completed at this time. So I really can’t give you any more update on that other than with that everything that we’re aware of has been perceived well in California.

[Drew Crum:]

Okay. Thanks guys.

[Operator:]

Thank you. And our next question comes from the line of Jeff Silber from BMO Capital Markets.

[Linda Zecher:]

Good morning.

[Jeff Silber:]

Good morning. How are you doing? I know you’re going to give us some more color on the impacts of the Scholastic acquisition once it’s done, but now it has been a few weeks since the announcement, I was wondering if we can get an update on trends there. I know when we talked earlier, our revenues were down, margins were down, relative year-over-year and any more insight on what’s going on there with the accretion?

[Eric Shuman:]

Since we don’t own the company and its still part of another public company, I don’t think it's appropriate for us to comment publicly on how the company -- on how the EdTech business is doing. So we’re focused on the integration of the EdTech Company once we acquire it, but to give guidance I think would be inappropriate.

[Jeff Silber:]

Okay. Fair enough and then forgetting the EdTech acquisition if I remember correctly your free cash flow guidance for this year was going to be potentially down slightly. First quarter was a little bit better than expected. I know you mentioned in terms of the plate spending being down on a relative basis but again assuming if we ignore the EdTech acquisition free cash flow still potentially down year-over-year?

[Eric Shuman:]

Yes it will be down year-over-year yes.

[Jeff Silber:]

Okay, great. Thanks so much.

[Operator:]

Thank you. And our next question comes from the line of [Nick] [ph] from Barclays.

[Unidentified Analyst:]

Yes good morning guys. Just one question, I was just wondering about your share of adoption 51% declared so far. I think it was 50% of the states last year. You ended up last year gaining good share, but can we conclude that you expect to gain share in that market again this year or is it a bit too early to make that call?

[Linda Zecher:]

I think -- really it’s a bit too early to make that call. We’re only in first quarter, but again we feel very confident in what we’re seeing so far. But we still have a little way to go, but we feel confident.

[Unidentified Analyst:]

Great, thank you.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Lance Vitanza from CRT Capital Group.

[Unidentified Analyst:]

Hi guys, this is Brad in for Lance. A lot of our questions have been answered, but one other quick one on given the planned increase in the term loan to $800 million, we were wondering if there is a target net leverage ratio you guys are trying to manage to?

[Linda Zecher:]

Well, we've always said that we would never go above three times and I think that's still within what we're planning on doing. We feel comfortable with where we're right now. We feel comfortable with the increased loan as it is right now and we really don't have any other guidance beyond that.

[Unidentified Analyst:]

Thank you.

[Operator:]

Thank you. And our next question is a follow-up from the line of Denny Galindo from Morgan Stanley.

[Denny Galindo:]

Hi guys. I just have one more quick modeling question. If we're thinking of modeling SG&A over the next year should that kind of trend like it did last year where it kind of ramps up over 2Q and 3Q and then comes back a little bit in 4Q or maybe any color you can give us on kind of the trend is SG&A spending?

[Eric Shuman:]

Yes, I think if you look historically what the trends are, it will typically be the same year-to-year unless something unusual happens in the course of the year.

[Linda Zecher:]

Which we're not expecting.

[Denny Galindo:]

And it sounds like you had a little bit of extra legal expense this year, is that something about like a legal settlement I guess. So that sounds something that I guess will disappear in 2Q?

[Eric Shuman:]

Yes, there were three relatively small legal settlements we entered into in the first quarter.

[Denny Galindo:]

Okay. All right, thanks.

[Linda Zecher:]

Thank you.

[Operator:]

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Linda Zecher for any closing comments.

[Linda Zecher:]

Thank you very much. We appreciate everyone for taking the time today to join us on the call. We look forward to seeing many of you at our Investor Day in New York on May 12 next week. So if you have any additional -- need any additional information or have any additional questions, please contact Rima in our Investor Relations Department. So thank you and operator that ends today's call.

[Operator:]

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.