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Houghton Mifflin Harcourt (HMHC) Q4 2019 Earnings Call Transcript

By Motley Fool Transcribing - Feb 27, 2020 at 7:06PM

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HMHC earnings call for the period ending December 31, 2019.

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Houghton Mifflin Harcourt (HMHC)
Q4 2019 Earnings Call
Feb 27, 2020, 8:30 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Ladies and gentlemen, thank you for standing by, and welcome to the Houghton Mifflin Harcourt fourth-quarter earnings call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to your speaker, Mr. Brian Shipman, senior vice president of investor relations.

Please go ahead.

Brian Shipman -- Senior Vice President of Investor Relations

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 at the Investor Relations section of our website at A replay of today's call will be available until March 9, 2020, and the webcast will be available on our website for one year. Our 10-K was also filed earlier this morning, along with our fourth-quarter and full-year 2019 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 fourth-quarter and full-year 2019 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.

John Lynch -- Chief Executive Officer

Thank you, Brian. Good morning, everyone. 2019 was a very strong year for HMH. Our record results were driven by successful execution of a strategy designed to produce sustained, positive free cash flow.

Billings for the full year were up a record 21%, in line with the most recent guidance that we raised twice during the year. Importantly, we delivered strong performance in both core and extensions. With the total education segment, up 27% for 2019. These strong billings translated into robust free cash flow.

HMH's unlevered free cash flow margin was up approximately 12 percentage points in 2019 versus the prior year, and we generated $115 million of positive free cash flow. Our next-generation core Into Reading and Into Literature product captured a 56% share in the Texas ELA adoption and a leading share in all other state adoptions. This is validation. Validation of the new, innovative programs we brought to market that are helping teachers differentiate their instruction to meet the needs students regardless of where they may be on the achievement spectrum.

We added to our core ELA offerings. With three new AI-based supplemental products, Amira, Waggle & Writable to help extend teachers reach to advance student learning. We also took significant steps to simplify our business model and accelerate our growth this year. For example, we realigned our cost structure, which will improve the HMH's profitability at any point in our adoption cycle.

We enhanced our capital structure by reducing our debt by over 10%, and refinance the remaining portion to extend the maturity. We also reduced our capital intensity, implementing a shift to a continuous development and delivery model, a model designed to improve the customer experience. Stepping back, when we compare the company we were in 2018, when we began implementing our strategy, to the company we are today, it's clear that our execution is paying off. As Joe will speak to, we dramatically increased our ability to improve free cash flow at all points in our business cycle.

From positive free cash flow in the trough to substantially higher free cash flow in the peak. By leveraging the position we have with core solutions to cross-sell extensions available on one unified platform that underpins all of our solutions. We will capture an increasing share of a $276 per student, per year spend. In 2019, we also delivered a step change in our digital capabilities.

We grew our emerging SaaS-based extensions business dramatically, a great momentum for exceptional growth in the year 2020. And our newest SaaS-based programs recently won Best in Show, Tech & Learning awards, important industry validation of these new AI-driven programs. And we continue to add to the list of cross-sell, core extension wins. All of these achievements validate the traction our strategy is getting in the market as we deliver an enhanced, better-together experience to our customers.

Now turning to the financial highlights in 2019. For our total education segment, we achieved strong billings growth of 27% for the full year. Our core solution billings were up 4% in our fourth quarter in 44% for the full year. We achieved a 56% market share in the Texas ELA adoption due to the strength of our newly released Into programs and a leading share in all other adoptions during 2019, and we saw higher Florida Math billings from contract extensions.

Extension billings were down slightly in the fourth quarter by 1%. But overall, up 11% for the full year. This was our second consecutive year of above-market growth in extensions, driven by continued strength at Heineman nationally. This momentum reflects our focus in, investing in and improving, the overall quality of our products.

Today, we now have digital, adaptive and personalized solutions on a single platform and we are very qualified to meet the needs of students across the entire achievement spectrum. We are very pleased that we received third party validation, acknowledging our efforts on this front. Every single one of our core, next-generation ELA in math programs have received all-green quality scores, the highest rating from the third-party instructional materials evaluator and reports. Turning to HMH Books & Media.

Billings were down 10% for full-year 2019 as anticipated, due to a tough year-over-year comparison from a one-time Orwell deal in year 2018. Our fundamentals, however, remain solid, with low single-digit growth expected over the long term. We continue to deliver award-winning, multimedia content. For example, in 2019, we drove value from an extensive backlist portfolio, including through the release of a deluxe edition of The Handmaid's Tale of this year, Lois Lowry's The Giver was also the #1 best selling young adult title for the 2019 holiday season.

We prepared 200 audio titles for release in 2020. We launched ETCH, a new imprint in our books for young readers group that is dedicated to publishing graphic novels, exemplifying the best in art and storytelling across genres and reflects the diversity of young readers. The seven titles on the ETCH launch list will publish, beginning this September 2020. And going forward, we expect the imprint will release around 15 books per year.

Our Carmen Sandiego original Netflix animated series, the first project produced for the screen by our in-house production company, HMH Productions, received a nomination for our 2019 Primetime Emmy award. Finally, regarding our lifestyle titles. We had two New York Times best sellers this year, including Binging with Babish and the Antoni in the Kitchen. I'll now turn it over to Joe, who'll provide a deep dive into our 2019 financials and our guidance for the year ahead.


Joe Abbott -- Chief Financial Officer

Thank you, Jack, and good morning, everyone. Thanks for joining us on the call. You've now heard Jack talk about how our transformation efforts paid off in 2019 and delivered very strong results. I'd like to now walk you through the financials, as well as our 2020 outlook.

In 2019, we delivered on our financial guidance for the third consecutive year. And our full-year billings were $1.591 billion, in line with the latest guidance update that we provided in October. We raised billings guidance twice during the year. In August, at our half year results and in October at our investor update.

Our content development spend and total capital expenditures were both in the bottom half of our original and updated guidance ranges for these metrics, with the former at $103 million and the latter at $140 million. We also delivered $115 million of free cash flow in the upper half of the guidance range that we provided at our October investor event. Before delving further into the financials, let's take a look at how we are also performing against our long-term billings growth framework and mix of billings. As a recap, we expect a long-term average growth of core solutions to be in the low single digits, with annual growth in any given year, consistent with the changes in the new adoption market opportunity.

In 2019, which we offered a large new adoption opportunity. Core solutions billings were up 44% and contributed 48% of our consolidated billings mix, driven by a 56% share of the Texas English Language Arts adoption, leading share in all other adoptions and strong performance nationally for extensions, which comprise Heinemann, some intervention, supplemental and assessment products as well as professional services. We started the year expecting low to mid single-digit growth consistent with the long-term growth rate of this segment of the market. As you know, we raised our assumption for this category of our billings twice during the year as growth accelerated.

2019 marked the second consecutive year we achieved above-market growth for extensions. And for the full year, our extensions billings were up 11% to $654 million. So, as you heard from Jack earlier, this was driven by continued strength at Heineman in Texas and nationally. We expect Books & Media to deliver long-term average growth in low single digits, consistent with market growth rates.

Billings for Books & Media were down 10% in 2019 as anticipated, as this segment grew well above expectation in 2018. Our outlook for the Books & Media business remains solid, and we continue to expect low single-digit growth over time. Now turning to our 2019 cost structure, an area where we made significant headway this year in containing fixed cost growth. We expect to maintain the improved cost structure going forward, and we will see a full year of benefit in 2020.

In 2019, our adjusted fixed costs were essentially flat, ending the year at $619 million. Our restructuring plan in October 2019 transformation plan, helped us offset on some planned investment through extensions operations. And our cost containment efforts throughout the year helped us to offset inflationary pressures due to merit-based salary increases. Adjusted variable costs as a percentage of billings, excluding noncash and nonrecurring items, were 38%, down from 2019.

The large contribution to billings from our core solutions adoption plans, particularly in Texas, contributed to this lower percentage. Moving on to our fourth-quarter and full-year 2019 results. Net sales for the quarter were $241 million, down 3% from 249 million in the fourth quarter of just last year. For the full year, net sales were $1.391 billion, and up 5% compared to 2018.

Our billings, which we define as net sales plus the change in deferred revenue, declined year over year in the fourth quarter by 3% to $201 million. For the full year, billings were up 21% to $1.591 billion in 2019, driven by a record growth of 27% in our Education segment. Within Education, core solutions billings grew 44% to $758 million and extensions billings grew 11% to $654 million. Slightly offsetting the growth in our Education segment was an anticipated 12% and 10% decline in HMH Books & Media for the fourth quarter and full year, respectively.

For the full-year 2019, our net loss from continuing operations was $214 million, and adjusted EBITDA for 2019 was $166 million as we recognized the selling costs in advance of revenue for multiyear core solutions contracts. Free cash flow, we define as cash from operations less capital expenditures, was $115 million compared to a usage of $73 million in 2018. This significant, $188 million year-over-year improvement was a result of our strong billings growth, adjusted fixed cost containment and a reduction in total capital expenditures. We finished 2019 with $296 million of cash, cash equivalents and short-term investments compared to $303 million at year-end 2018.

So, before moving to our outlook, I'll remind you of the dramatic improvement in our ability to generate free cash flow, resulting from our strategy and the actions we took in 2019. In October, we shared that as we look out over the next three years. We see healthy, new adoption opportunities in the core market sizes that we consider to be mid-cycle. And we expect continued compounding growth of our extensions, and we expect billings in the range of $1.5 billion to $1.65 billion.

We expect efficiency gains on our fixed costs to improve our profitability. And we expect our capital constrained, continuous development model to reduce product development spend as a percentage of billings relative to our legacy model of episodic program development. We expect these changes to dramatically improve our unlevered free cash flow margins to a range of 9% to 14% of billings, as much as 500 basis points of improvement also relative to 2019, which is our most recent peak adoption year. These same changes applied on a pro forma basis through our last trough in our last peak, would have substantially and dramatically improved free cash flow at all of our points in our cycle from positive free cash flow in the trough to substantially higher free cash flow in the peak, and we are a little less than two years into our transformational strategy.

As we continue to grow through enhancing and extending our core, capture more share from our integrated solutions approach and further simplify our business model. We expect to continue to increase our free cash flow and margins over time. So it is important to remember that this is a baseline, but the next time we reach a trough or a peak, we expect substantially with better free cash flow and free cash flow margins. Now turning to our expected financial performance for 2020.

We expect total company billings to be at or below the bottom end of the mid-cycle range of $1.5 billion to $1.65 billion. As it's been our practice for the last three years, we strive to set billings expectations at the beginning of the year, that appropriately recognized the early stage of our selling activities in February. We will provide updates as we progress through our quarterly financial reporting. Consistent with the view that we shared at our October investor event, and we expect our unlevered free cash flow margin to be approximately 9%.

Unlevered free cash flow removes interest expense from the calculation to underscore the underlying cash flow generation of our business before debt service. New for 2020, we are beginning the year, guiding to our expectation for free cash flow, which does include the impact of interest expense, we expect to generate free cash flow of $65 million to $90 million, marking a continued trend of this positive free cash flow. In conclusion, we are entering 2020 with good momentum and having made significant progress in 2019 in transforming our company for the future, driving billings growth through the strength of our portfolio, simplifying and strengthening our business model, reducing our costs and generating sustained positive free cash flow. And with that, I will turn the call back over to Jack for some final comments before we take your questions.


John Lynch -- Chief Executive Officer

We are very proud of what we've achieved in 2019, a year of tremendous strength for HMH, driven by relentless execution of our strategy. We keep our guidance for the third year in a row and raised billings guidance twice during the year. Our full-year 2019 results demonstrate the continued merits of our strategy to drive sustained, positive free cash flow. We accomplished an improved cost structure and an improved capital structure, while also simultaneously reducing the capital intensity of our business.

Our recent wins indicate growing momentum in the business and our outlook for free cash flow of $65 million to $90 million in 2020 will mark a continued trend of positive free cash flow. We are confident that we are entering the year from a position of strength and with greater strategic flexibility to invest in our growth and enhanced ability to generate greater free cash flow at all points of our business cycle. We'll now be pleased to take any questions you may ask. Operator, you may open the line.

Questions & Answers:


Thank you. [Operator instructions] Our first question will come from Bill Warmington with Wells Fargo.

Bill Warmington -- Wells Fargo Securities -- Analyst

Good morning, everyone.

John Lynch -- Chief Executive Officer

Good morning, Bill.

Bill Warmington -- Wells Fargo Securities -- Analyst

So the extensions business had another strong year, total. I did want to get some color on the 1% decline in the fourth quarter. Is that timing, tough comps, something else going on in there?

Joe Abbott -- Chief Financial Officer

No, Bill. This pretty consistent with what we see in this fourth quarter, which is it's not a material quarter for us. Really the most of the activity occurs in the second and third quarter. So 1% is kind of within the balance of -- basically flat, what we'd expect it to be year over year.

Bill Warmington -- Wells Fargo Securities -- Analyst

Got it. And then I was hoping we could get some color on the -- how the California science adoption is going? And then, maybe some updates on -- and anything new on Florida?

John Lynch -- Chief Executive Officer

Yes. Hey, Bill, this is Jack. I think, as you know, this is -- in California, it's a three-year adoption. We are now in year 2.

We feel very good about the program in year 2. But really, at this point of the year 2, too early to comment on the specifics of the adoption. As it relates to Florida, as you know, we are getting ready for a major ELA adoption in 2021. We feel really good about the program that we are going to be delivering for evaluation midyear this year by school districts for purchasing in 2021.

Bill Warmington -- Wells Fargo Securities -- Analyst

Great. Thank you very much.


Thank you. Our next question comes from David Pang with Stifel.

David Pang -- Stifel Financial Corp. -- Analyst

Hey. Good morning, everyone. Just wanted an updated thought on the size of the new adoption market for 2021?

Joe Abbott -- Chief Financial Officer

Hey, David. It's Joe. The -- we have characterized this as a mid-cycle year. So as you know, we've got Texas Literature, which is a major opportunity.

We've got the California Science Adoption. We haven't sized the new adoption market for this particular year, just given the early stages that we are at right now in assessing the overall market opportunity. But you should -- and consistent with our three-year outlook that we provided at Investor Day, you should consider this a mid-cycle core adoption year. Certainly not as large as it was in 2019, but certainly much larger than it was in 2018 or last trough.


OK. [Operator instructions] Our next question will come from George Tong with Goldman Sachs.

George Tong -- Goldman Sachs -- Analyst

Hi. Thanks. Good morning. Returning to California late last year, you indicated that districts are deciding to delay their purchases until after pilot programs. You said it's a little bit too early still, to discuss actual purchasing behavior in California, but can you just provide an update on purchase and timing, and conversations that you are having with districts in California, how they are progressing?

John Lynch -- Chief Executive Officer

Yes, George, that is right. The first year be, in this three-year process, more of a pilot year, although certainly there were districts who made decisions in the first year. Our expectation is that year two, more and more of those school districts who have piloted the program in the first year will be making decisions and then obviously, in year 3 as well.

George Tong -- Goldman Sachs -- Analyst

Got it. And then how would you characterize the overall conversations that you are having in the first year with the districts?

John Lynch -- Chief Executive Officer

Good discussions. We had a number of major school districts who have taken on pilots of the program. We've had customers who purchase the program. So all in all, we feel very good about the program.

George Tong -- Goldman Sachs -- Analyst

Great. And just a follow-up on the open territories. They tend to pause their textbook purchases leading up to a major adoption cycle. Now that we are in the middle of an adoption cycle, can you elaborate on the growth that you are seeing in your open territories?

John Lynch -- Chief Executive Officer

Yes. I think the first point is that 2019, we saw growth, overall in open territory. And I think as we indicated in previous calls, we had a significant growth in our win rate in ELA, which was our newest program introduced in the open territory, 9% win rate in open territory. So we feel very good about the overall market in open territory, a return to growth, and we feel very good about our competitiveness in open territory.

George Tong -- Goldman Sachs -- Analyst

Very helpful. Thank you.

Joe Abbott -- Chief Financial Officer

And operator, I just wanted to jump in. I may have answered about 2020 in response to David's question, and I think his question was about 2021 and the new adoption opportunity. So that also is a mid-cycle year for us, in terms of new adoption opportunity. The major adoption there, of course, is the Florida English Language Arts, grades K-12 that we were just talking about that we'll be submitting for evaluation midyear here.


OK. Speakers, I'm showing no further questions in the queue at this time. I would now like to turn the call back over to you for any further remarks.

John Lynch -- Chief Executive Officer

OK. Thank you very much for listening to our call this morning, and we look forward to speaking to you again in the first-quarter earnings call in May. Have a great day. Thank you.


[Operator signoff]

Duration: 29 minutes

Call participants:

Brian Shipman -- Senior Vice President of Investor Relations

John Lynch -- Chief Executive Officer

Joe Abbott -- Chief Financial Officer

Bill Warmington -- Wells Fargo Securities -- Analyst

David Pang -- Stifel Financial Corp. -- Analyst

George Tong -- Goldman Sachs -- Analyst

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