Houghton Mifflin Harcourt Company

Good day and thank you for standing by. Welcome to the HMH first quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star then 0. I would now like to hand the conference over to your speaker today, Senior Vice President of Investor Relations, Brian Shipman. Please go ahead.

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 15, 2021. And the webcast will be available on our website for one year. Our 10Q was also filed earlier this morning, along with our first quarter 2021 earnings press release. Before we discuss our results, I encourage you to review the cautionary statement on slide two 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 gap 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 2021 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.

Thanks, Brian, and good morning, everyone. Today, I'd like to briefly walk you through the results for our first quarter. Then, in the wake of our divestment of HMH books and media, I would like to devote a good portion of our time this morning to our strategy as a K-12 learning technology peer play and how we believe HMH is uniquely positioned for growth. And then Joe will discuss our financial strategy and cover our financial performance for the quarter. Starting with Q1, the headline is we're off to a very solid start. We delivered billings growth of 11%. We achieved trailing 12 months free cash flow of $72 million, an improvement of $77 million over Q1 2020. We advanced our digital-first connected strategy and achieved 80% growth in annual recurring revenue year over year, as well as 142% net retention for our subscription business in the trailing 12 months. During the quarter, we're also pleased to have strengthened our platform and technology leadership bench with fantastic new appointments. Greg Collins, a software veteran who comes to us from Rapid7 and Intuit, will lead product management and strategy for our ed platform. And Selva Mahimadis has been promoted to Chief Information Security Officer. These enhancements to our leadership team reinforce our commitment to building innovative solutions that deliver successful outcomes for students and teachers in all learning environments. At the end of Q1, we announced a definitive agreement to sell HMH Books and Media to HarperCollins for $349 million. We expect to complete the transaction in the second quarter and we'll use the net proceeds to further pay down our debt. As you'll hear from Joe, we're in an incredibly strong financial position with an enhanced credit profile and balance sheet. Given the materiality of the federal funding of K-12 schools for COVID recovery, I want to spend a few minutes outlining how the funding will impact the market we serve and HMH. First, in total, there is one-time federal stimulus funding for K-12 education of $200 billion, $127 billion of which came in the recently approved American Rescue Plan. This will be spent over three years. For context, annual spending on K-12 education in a normal year is $740 billion. So, equally spread over the next three years, the $200 billion is about $67 billion a year, or 9.1 percent of the total K-12 spend. Allowable uses of federal funds are flexible, open-ended, education technology, health and safety measures, physical improvements, addressing learning loss, and other activities necessary to maintain school operations. At least 25 percent of the American Rescue Plan funds, that's the $127 billion recently approved, must be used to address learning loss and provide opportunities for extended learning, including summer enrichment, as well as before and after school programs. For HMH, our emphasis in supporting schools in COVID recovery will be intervention programs to help educators close the gap created by the most challenging year in education. Importantly, our leading intervention solutions can help students gain up to two years of growth in one year. Here is just one example of a school district making great progress with our intervention solutions during an incredibly challenging year. At Paulding School District, halfway through this year, 25% of students achieved double their expected annual growth in reading. 49% have already met their year-end growth goals. And 31% improved their expected college and career readiness performance levels. We believe we have a great set of intervention solutions to address the extraordinary challenges educators face as a result of the interrupted learning caused by COVID. In the guidance we provided back in February of this year, we considered the impact of the funding that was being proposed and ultimately passed in the American Rescue Plan in March. That's our first quarter results, and Joe will take you through the financials in a bit. But before he does, I want to pivot and share more with you about how we're thinking about our digital-first connected strategy, particularly given the HMH books and media divestiture, which is a transformative transaction for HMH. We're now singularly focused on K-12 learning technology. There are three key messages I'd like you to take away from this strategy discussion. HMH is the learning technology leader in a large growing market. Second, we are highly differentiated from our competitions by our platform, our organizational capabilities, and our purpose-driven culture. Third, we have a clear strategy in place to intercept a growing share of this expanding market. These are the key messages. Now let's get into it. First, we'll start with the market, then show you how we differentiate ourselves in this large market, what is our growth strategy, and what is our financial strategy, beginning with our market. I don't need to remind any of you how massive an opportunity the U.S. K-12 market is. Fifty-four million students in the U.S., 115,000 schools, $740 billion spent in the sector annually. greater than $10 billion spent on instructional materials and student enrollment in K-12 schools is projected to increase by 1.6% from 2016 to 2028. Of the large market for instructional materials, here you can see that digital is growing at a CAGR of 6.6% and in 2020 grew 4% while print declined 13%. Why? Digital saves teachers time. It helps teachers easily assess grade and track student achievement. And finally, it helps to personalize instruction. And within that large growing market, HMH is the largest learning technology company in the sector with a presence in 90% of the schools, 179% growth in our digital platform ed, 250 software engines. over 80% growth in subscription annual recurring revenue, and numerous awards, recognizing our role as an innovator in the K-12 market. But being the learning technology leader is not just about technology. It's creating and implementing programs to improve student achievement. Here are just a few examples of how we bring about customer success. In the Ann Arbor School District, students using System 44 in grades three through eight averaged a significant gain of three points in total fluency on the phonics inventory. In New York State, a four-month study showed that diverse populations of students in grades three through six made statistically significant gains using Lucy Calkins' units of study. In Savannah Chatham, over a three-month period, students read over 75,000 minutes with Amira and have doubled their reading fluency, achieving double the progress of those not using the program. And we have scores of these customer success stories because of the premium we place on evidence-based programs that are proven to work. Finally, one last comment on market attractiveness. Each of the market segments we serve is large, and while we are the largest company in K-12 by far, we have a lot of room to grow with only 10% of the total addressable market. That is exciting potential. The opportunity for growth is exciting, but as you know, there are a lot of companies in the K-12 industry vying for customers. So what sets us apart from our competition? What are our key differentiators? Three things. when taken together, create a highly differentiated company, a platform supporting a comprehensive portfolio, organizational capabilities designed to achieve customer success, and finally, a purpose-driven culture. First differentiator, HMH is the market's most comprehensive solution. Only HMH, provides a full portfolio of integrated solutions purpose-built for the teaching and learning of all students, core, supplemental, intervention, services, and assessment. Most of our competitors provide a piece or two of the puzzle, but not the entire solution. That's okay in the print world, but in digital, it's chaos. with a need to exchange data and a user experience that makes it simple to go from a core to a supplemental solution without feeling like you're driving down a superhighway until you reach a patch of dirt road. Increasingly, as the demand for digital grows, the need for one platform to serve all students will become clear. That's the first differentiator that sets HMH apart from our competition. the only comprehensive one-stop solution. The second differentiator is simply our emphasis on customer success, which in K-12 is all about improving student achievement. For HMH, it's the combination of proven-to-work programs with the teacher training and customer support and learning analytics, all designed to help teachers use our solutions to produce great outcomes. The third major differentiator is our purpose-driven culture. We do work that matters. We have incredibly talented people who are drawn to HMH, not only because of what we say our values are, but because of what we do. We are authentically purpose-driven, and you can see that in the time we volunteer to give back to our communities and schools. You can see that in employee research resource group participation. You can see that in our care for the environment. You can see that in our culturally responsive content. Good people who care about the social impact they have on the education of our nation's children. So to summarize our differentiators, HMH has a comprehensive solution, evidence-based programs centered on customer success, and a purpose-driven culture taken together This is what sets us apart from our competitors in the K-12 market. So how do we execute a strategy to grow our share of the market and thereby increase our social impact, increase the double bottom line? That's our digital-first connected vision, which has three pillars. First, growing our digital-first connected business. Second, deepening customer engagement and increasing customer outcomes And third, optimizing our digital transformation. Let's take these one at a time. Digital first. This is recognition that the value proposition of digital products and platforms is gaining broad acceptance. And you can see that in our numbers. 179% growth in edge usage. 80% growth in ARR. It's important for us to shift our revenue mix to digital, not merely because we need to support growing demand from educators, but because of the tangible benefits in saving teachers time, assessing and monitoring student achievement, and personalizing instruction. Today, 42% of our portfolio is now digital. Part two of Digital First Connected is connected. leveraging our scale to benefit both our customers and our shareholders. For our customers, teachers, they have kids in their class that range across the achievement spectrum and ability. Having one platform to go to with one way to assign work and one way to measure student mastery and one platform through which intervention products exchange data with core products and vice versa, that's what teachers want. less time managing the software and the data, and more time with their students. And for our shareholders, when we use one Salesforce to sell the entire product portfolio, we can cross-sell and up-sell to get a larger share of the $200 per year per student instructional spend. Now, whereas we will see a shift in our mix of print to digital and grow our digital-first connected pillar of our strategy, we're driving a shift in the mix of our non-recurring revenue to recurring revenue as more and more of our customers rent our products versus buy our products in the deepened customer engagement pillar of our strategy. We want more renters, also known as subscribers, giving us less top-line volatility and more valuable recurring SaaS business. To grow in recurring revenue, we deliver great user experiences and great outcomes for our customers and ultimately deepen customer engagement with HMH. That is our second strategic pillar. The third pillar of our strategy is optimizing our digital transformation. Key to that is decreasing our variable cost as we deliver more and more of our product digitally and reducing our fixed costs as we automate our internal operations, becoming even more agile and responsive to the needs of our customers. So that's the strategy. And what's incredibly powerful about it is that we have multiple paths to grow our share within a more than $10 billion market and simultaneously extend the impact we can have on student achievement. With that, I'd like to turn it over to Joe to discuss our financial priorities supporting our strategy, and then he'll run through the numbers for Q1. Joe?

Thanks, Jack, and good morning, everyone. We've outlined three financial priorities to guide our team's execution and focus. The first is maintaining our strong balance sheet. Our target leverage ratio is less than 2.0 times trailing 12 months adjusted EBITDA. We have already taken a number of steps, to reduce our gross debt, including the announced sale of HMH books and media. And we've reduced our leverage ratio to less than 2.7 times for the trailing 12 months, ended March 31st of this year, giving pro forma effect to the planned pay down of debt with the net proceeds of that transaction. While we may on occasion add debt, resulting in leverage ratios above the 2.0 times target, our intent is to rapidly deleverage to below this level. As you may have seen, we recently received a ratings upgrade from Moody's, which is an important validation of our ongoing work to establish HMH as a pure play K-12 learning technology company with a robust and sustained ability to generate free cash flow. On the heels of our debt pay down, we also look forward to opportunities to reduce our interest expense even further. Our $306 million in senior secured notes, which carry a coupon of 9%, become callable in February 2022, and we will be monitoring market conditions for the right time to refinance. Finally, we are planning to reserve around $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 for growth. We plan to invest a mid-teens percentage of our total billings in development activities to create highly differentiated products that fuel organic growth. We also plan to pursue small tuck-in acquisitions that leverage our business platform, including complementary products and services or access to new adjacent customer segments. And our third priority is investing for efficiency. We will invest in internal growth projects, such as our back office automation project, which is currently ongoing. And we will fund other projects that deliver operational efficiencies, help us deliver greater customer success, and free additional capital to invest in our growth. We're confident that HMH is well positioned for growth in 2021 and beyond. Today, we're reiterating the guidance that we provided to you at the end of March when we announced our divestiture of HMH Books and Media. and we're adding a few additional elements of guidance. As a reminder, in 2021, we anticipate billings for the full year to be between $905 and $955 million, which is 1% to 6% growth over 2020. We're adding our expectation that over 50% of our billings will be derived from our connected products this year. We also continue to expect unlevered free cash flow margins in a range of 9% to 11%, which, as you will recall, represents three to five points of margin expansion compared to 2020. We're adding our outlook for annualized recurring revenue generated from our subscription offerings, which we expect to contribute 10% to 15% of our total billings for the year, up from 6% in 2020. We believe a net retention rate of over 100% will contribute to that growth in ARR. With that, I'd like to turn to our first quarter results and walk you through the financials. The first quarter, as you all know, is seasonally our smallest. Still, we're off to a solid start. Total billings were $104 million, up $11 million from 2020. Core solutions billings for the first quarter were up $17 million to $40 million, driven by strength in international and are connected into programs domestically. Extensions billings were down $6 million to $64 million, driven by lower billings from professional services, while the rest of the portfolio was largely unchanged. In terms of the other key financials, our net sales were $146 million in the first quarter. Net loss from continuing operations for the first quarter was $49 million, a $289 million improvement from the first quarter of 2020. Recall that we took a large goodwill impairment charge in the first quarter last year due to the decline in our stock price. Adjusted EBITDA for the first quarter improved $34 million to $15 million and marks the first time since HMH went public that our first quarter adjusted EBITDA has been positive. Typically, the seasonality of our business makes this a negative quarter, but our value innovation efforts last year have dramatically improved our profitability. Our free cash flow usage was $125 million. compared to a usage of $202 million during the same period last year. The $77 million improvement in usage of cash in the first quarter was due to billings growth in the quarter, coupled with lower expenses due to the restructuring actions taken in 2020. Importantly, for the trailing 12 months ended in March, our free cash flow was $72 million, reflecting the dramatically improved cost structure of the company And it's all the more remarkable given that the pandemic impacted our billings for this full 12-month period. All in all, we feel that HMH is in a very strong financial position today and that we're well positioned to execute our digital-first connected strategy. Now, before turning the call back over to Jack for a wrap-up, I'd like to take a moment to thank Brian Shipman for his impactful and dedicated service to HMH and its shareholders over the last four years. Brian is leaving HMH to pursue another professional opportunity, and we're sorry to see him go. Brian, we wish you the best of luck, and we'll miss you. Investors may direct inquiries to our Investor Relations email address, investor.relations at hmhco.com. With that, Jack, back over to you.

Thank you, Joe, and thanks, everyone, for joining us for today's call, which I recognize was a bit longer than usual, but we hope that you found it instructive. Before moving to Q&A, let me just sum up the key points you heard today. First, HMH is the industry's leading learning technology company with a highly differentiated end-to-end platform solution. Second, Cross-selling and connections across their portfolio that improve customer experience is HMH's unique opportunity to increase our share of the addressable market and provide critical value to educators and students. Third, we have a clear three-point strategy in place. Focus on shifting our revenue mix to digital and recurring revenue while expanding margins. And finally, We're committed to leveraging our strong balance sheet and free cash flow generation to complement organic growth with tuck-in acquisitions. With that, let's get to your questions. Joe, let me suggest that our panelists can go.

Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, if you have a question at this time, please press star then 1. And it looks like our first question will come from the line of Jeff Silber with BMO Capital Markets. Your line is open. Please go ahead.

Thanks so much. Really appreciate the thorough presentation. I found it really helpful. And just let me also publicly say, Brian, Really appreciate all the help you've given over the years, and best of luck in terms of going forward. A couple questions. You talked about the federal funding, and I know it's a big dollar amount, and it's great to see not only for your company but for this country overall. But how quickly can that money be put to work? Let's say you're getting the, you know, $67 billion being thrown out this year. How quickly will companies like you be able to benefit from that?

Yeah, Jeff, great question. Thank you for asking it. We're seeing increased demand really as a result of our strategy and the quality of our solutions. However, we are beginning to see the first signs of federal dollars in the market, but as yet not broad-based across the overall market. So, you're going to see it trickle in over the course of this year before it ramps up to a pace that you'll see a good amount of that $200 billion spent over the next three years.

Okay, probably so more of an issue going forward, but, again, some minor benefit this year. Okay, that's really helpful. And my follow-up question, it sounds like the company started off the year better than expected. I know some of your initial guidance had included some impact of the federal funding. It may not be a big deal this year. But why not raise guidance? I've had a few people ask me that question, so I figured I'd pose it to you.

Yeah, thanks, Jeff. It's Joe. Listen, as we said on the call, we anticipate really solid financial performance this year. But, you know, when you do look at that stimulus effect, you know, it is something that is going to be spread over multiple years, not just 2021. So we're very, you know, cautiously optimistic about potential upside this year. But we feel it's prudent to be consistent with our historical approach and not raise guidance after the first quarter. Okay. Fair enough. Thanks so much. I'll get back to you.

Thank you. And our next question comes from the line of George Tong with Goldman Sachs. Your line is open. Please go ahead.

Hi, thanks. This is David for George. Could you provide an update on the California and Florida adoption cycles and how HMH is positioned in those cycles?

Yes, I'd be happy to. Nothing to add from last quarter on California. That is an adoption for science that we believe is stretching over multiple years, typically it's three years, and we expect it to continue on for three plus years as a result of the effects of the pandemic. So no change from the comments last quarter. And as it relates to Florida, same thing, really no change. Just as a reminder, we, in terms of 6-12, performing in line with our expectations. K-5s, underperforming our expectations. and then in intervention exceeding our expectations. And I think this is a great example where we talk about a connected comprehensive solution as a key differentiator vis-a-vis our competition. Our performance in Florida really shows the strength of that portfolio when you can sell not only in core but services as well as intervention and assessment. So we feel good about Florida. and uh and good about florida as a showcase for our strategy okay thank you very helpful and then could you also talk about traction with cross-selling supplemental materials with core curriculum yeah yeah you see in uh the results uh 51 of our sales in q1 were quote unquote connected sales And that's a list you can almost think of using the publishing vernacular. That's kind of our front list, if you will. We don't refer to it that way, but it's about 20 or so products that are in the bag of our salespeople, and 51% of all of our billings were. So we feel great about the cross-selling that our sales organization is doing, cross-selling core to supplemental, or poor to intervention or supplemental to intervention, and taking a greater share of that $200 per year per student spend for instructional materials.

Great. Thank you.

Thank you. And again, ladies and gentlemen, if you have a question at this time, please press star, then 1. Our next question comes from the line of Jason Bazinet with Citi. Your line is open. Please go ahead.

Thanks. I just had a longer-term question. Where do you think ARR as a percentage of your overall billings can go in, say, five years?

Yeah, Jason, you know, it's obviously an area that we're very focused on. You can see the growth in ARR. And the market is like subscriptions. And The reason why the market likes it is you have to prove your value each and every year. And in K-12, that means show me how you're improving student outcomes. So we haven't disclosed nor have we come up with a number in five years of what ARR will be. But we see a steady shift from non-recurring to recurring billings over the next several years.

Okay. Thank you.

Thank you, and I'm showing no further questions at this time, and I would like to turn the conference back over to Jack Lynch for any further remarks.

No, I just wanted to thank everyone for joining us on our call today, and we look forward to speaking with you again on Q2 earnings call in August. So have a great day. Thank you.

This concludes today's program. Thank you for participating. You may now all disconnect. Everyone, have a great day.