Houghton Mifflin Harcourt Announces Third Quarter 2015 Results

BOSTON – Global learning company Houghton Mifflin Harcourt (“HMH” or the “Company”) (NASDAQ: HMHC) today announced its financial results for the third quarter ended September 30, 2015.

Third Quarter 2015 Highlights:

• HMH captured approximately 40% market share in its addressable domestic education market for K-12 instructional materials, including 45% of the new adoption market for the first nine months of the year.
• Net sales increased 4% to $576 million compared with $551 million in the third quarter of 2014. On an organic basis, which excludes the contribution from the acquired Educational Technology and Services (EdTech) business, net sales would have been $493 million.
• The EdTech business contributed net sales of $82 million for the quarter.
• Billings declined approximately 1% to $682 million compared with $692 million in the third quarter of 2014.
• Net income increased over 22% or $24 million to $131 million compared with net income of $107 million in the third quarter of 2014.
• Adjusted EBITDA of $192 million was 4% or $8 million lower compared with $200 million in the third quarter of 2014. Adjusted cash EBITDA was $298 million, 13% or $43 million lower compared with $341 million in the third quarter of 2014.

Full Year 2015 Outlook and Recent Highlights:

• In light of a softer open territory market and smaller supplemental and residual market, the Company is revising its full year 2015 guidance for billings, net sales and content development spend. Our addressable open territory market is expected to grow by 1 percent for the full year. While this is a rebound from the first half of the year, it is 5 percentage points below our initial expectations. Billings are now expected to be in the range of 1% to 4% lower than full year billings in 2014 and net sales are expected to be in the range of 3% to 6% higher than net sales in 2014. Content development spend is expected to be in the range of $110 to $120 million.
• On November 3, 2015, the Company’s Board of Directors authorized the repurchase of an additional $500 million of shares of HMH’s common stock bringing the program total to $1 billion. On a pro forma basis, as of the end of the third quarter, approximately $760 million would have been available for share repurchases under this aggregate program which may be executed through the end of 2018.
• The Company is planning to increase its debt by an additional $250 million, subject to market and other conditions.

“In spite of market challenges and revisions to our 2015 guidance, our underlying business remains healthy. We continue to lead our core domestic education market, and have been encouraged by the strides made in key strategic growth areas,” commented Linda K. Zecher, President and Chief Executive Officer of HMH, “In 2015, we set out to accelerate the growth of our professional development and services lineup, build on our consumer and early childhood offerings, and further enhance our industry-leading digital capabilities. We have taken clear and meaningful action on all of these fronts, which we believe will be key contributors to our future success. We have expanded our share repurchase program to an aggregate $1 billion given our confidence in the long term prospects of the business.”

Eric Shuman, Chief Financial Officer of HMH, stated, “To date in 2015 we have continued to generate free cash flow, invest in our growth, execute on key strategic initiatives and maintained a leading 40% market share despite the overall anticipated contraction in the domestic education market this year. We believe that this is a testament to the ongoing strength of our business and further underscores our long-term growth potential.”

Third Quarter 2015 Business Highlights:

Education Segment: HMH continued to see encouraging demand for its education products in the third quarter of 2015 despite the anticipated contraction in the overall domestic education market this year relative to 2014. The Company captured 45% of the new adoption market year-to-date, bringing total market share in the domestic education market through the first three quarters to approximately 40%. Within this, HMH captured more than 50% share in the California math adoption and an approximate 30% market share in the Texas social studies/world geography adoption. Demand within open territories picked up for the third quarter, but growth for the year remains below initial expectations. Key open territory wins include New York, Michigan, and Wisconsin.

The Company grew net sales in its professional development business in the third quarter 2015 by 40% compared with the same quarter in 2014. In addition, the recent integration of HMH’s education services organization and the EdTech services business brings together valuable offerings, experiences and employees to create a best in class organization.

Trade Publishing Segment: In the third quarter, revenues of HMH’s Trade Publishing segment slightly decreased, but we continue to build our offering and pipeline of new books that we believe will drive year over year growth in this segment. HMH recently released the critically acclaimed Girl Waits With Gun and Rosemary, the Hidden Kennedy Daughter. Randall Munroe, best-selling author of What If? will release a new title, The Thing Explainer, this month. Additionally, HGTV reality stars The Property Brothers’ debut title Dream Home: The Property Brothers’ Ultimate Guide to Finding & Fixing Your Perfect House, and the memoir of U.S. women’s national soccer team captain, Carli Lloyd are both slated to be released next year.

Key Growth Areas:

Consumer: To support its consumer growth strategy, in October 2015, HMH officially launched Curious World, a subscription-based interactive content service that offers children aged three to seven an ever-expanding collection of games, videos, and eBooks mapped to key learning areas. Additionally, the Company recently acquired select eBook and technology assets of MeeGenius, an eBook subscription service for children up to eight years old.

Digital capabilities: The Company announced the HMH Marketplace – an online destination for educators to discover, share, and sell resources that enhance the teaching and learning experience. Launching in early 2016 in beta, the marketplace will combine applications by edtech developers and start-ups with original content made by teachers for teachers, in a one-stop shop for supplementary education applications that integrate with and support core curriculum.

Additionally, HMH solidified a new partnership with Osmo, the creators of a platform that is revolutionizing the way children learn on the iPad®. This strategic collaboration reinforces the connection between home and school learning and underscores our digital leadership.

International: HMH partnered with Trunity Holdings, Inc. to add new HMH digital curricula to Trunity’s eLearning Platform, enabling on and offline access to HMH programs for K-12 educators and students around the world. HMH programs Holt McDougal Physics, Holt McDougal Chemistry, and Science Fusion became available in international markets starting September 2015. The launch of these new programs follows a successful full-year pilot with the Institute of Applied Technology in the United Arab Emirates during the 2014-2015 school year.

Third Quarter 2015 Financial Results

Net Sales: Net sales for the three months ended September 30, 2015 increased $25 million to $576 million, up 4% year-over-year, from $551 million. Net sales were driven by the $82 million contribution from the EdTech business. Excluding the contribution from EdTech, net sales would have been $493 million. Net sales for HMH’s Education segment increased 5% or $28 million year-over-year from $504 million to $532 million, driven by the contribution from EdTech, partially offset by a $55 million decrease in the domestic education business. The decline in the domestic education business is largely attributable to the overall smaller adoption market in 2015 relative to 2014 which included large adoptions in Texas, California, and Florida. Partially offsetting this were strong results in markets such as West Virginia and Tennessee. HMH’s Trade Publishing segment recorded $43 million in net sales in the third quarter, a 7% or $3 million decrease, from $46 million in the same period in 2014. The decline was driven by strong prior year net sales of titles such as The Giver and the bestselling What If? partially offset by strong net sales of front-list culinary titles such as The Whole 30, The Real Paleo Diet Cookbook and Cake My Day.

Cost of Sales: Cost of sales in the third quarter increased by 3% or $8 million to $272 million compared to $264 million in the same quarter of 2014. During this period, cost of sales, excluding pre-publication and publishing rights amortization, grew by 7% or $15 million year-over-year from $205 million to $220 million, primarily attributable to higher volume, product mix, higher royalty costs, and technology costs to support HMH’s digital products. This resulted in cost of sales, excluding pre-publication and publishing rights amortization, increasing from 37% to 38% as a percent of net sales.

Selling and Administrative Expenses: Selling and administrative expenses in the third quarter of 2015 increased 14% or $24 million to $192 million from $168 million in the prior year. This was primarily due to a $29 million increase related to the addition of the EdTech business along with higher labor and technology costs to support HMH’s growth initiatives, and partially offset by an $11 million decrease in sales commissions. Excluding the EdTech business, selling and administrative expenses would have been lower by 3%, primarily due to lower sales commissions.

Operating Income: Operating income for the three months ended September 30, 2015 decreased $13 million, or 12%, from $116 million for the same period in 2014 to $103 million, primarily due to the aforementioned changes in cost of sales, and selling and administrative costs partially offset by the increase in net sales.

Net Income: HMH recorded net income of $131 million in the third quarter of 2015 compared to a $107 million net income in the same quarter of 2014, an over 22% year-over-year increase, primarily due to a $40 million income tax benefit in the third quarter 2015, compared to a $3 million income tax expense in the same period last year, partially offset by a $6 million increase in interest expense along with the same factors impacting operating income.

Adjusted EBITDA and Adjusted Cash EBITDA: Adjusted EBITDA for the third quarter of 2015 was $192 million compared to $200 million in the same quarter for 2014, down $8 million or 4% year-over-year. Adjusted EBITDA in HMH’s Education segment was $198 million compared to $206 million in the same quarter for 2014, a decrease of 4% or $8 million. Adjusted EBITDA for the Company’s Trade Publishing segment decreased $3 million year-over-year from $7 million to $4 million, a 48% decline. Corporate and Other costs, which represent certain general overhead costs not fully allocated to the business segments, such as legal, accounting, treasury, human resources, technology, and executive functions, were a loss of $11 million for the quarter compared with a loss of $13 million in the year-ago period. Adjusted cash EBITDA, defined as adjusted EBITDA plus the change in deferred revenue, was $298 million in the third quarter of 2015 compared with $341 million in the third quarter of 2014.

Cash Flow: Net cash generated from operating activities for the nine months ended September 30, 2015 was $163 million as compared to $301 million in the first three quarters of 2014. The $138 million decrease was primarily driven by lower billings stemming from a smaller domestic education market, and higher interest from the increase in the Company’s term loan. HMH’s free cash flow, defined as net cash from operating activities minus capital expenditures, for the nine months ended September 30, 2015 was $35 million compared with $161 million for the same period in 2014. As of September 30, 2015, HMH had $524 million of cash and cash equivalents and short-term investments compared to $743 million at December 31, 2014.

Capital Allocation

On November 3, 2015, the HMH Board of Directors authorized an increase in the size of its existing share repurchase program by an additional $500 million for an aggregate total of $1 billion.  The aggregate $1 billion share repurchase program may be executed through the end of 2018. Repurchases under the program may be made from time to time in open market, including under trading plans, or privately negotiated transactions.  The extent and timing of any such repurchases would be at the Company’s discretion and subject to market conditions, applicable legal requirements and other considerations.

During the third quarter, HMH repurchased 2 million shares for approximately $48 million on the open market and through privately negotiated transactions bringing the year to date total to approximately $240 million of shares repurchased. On a pro forma basis, as of the end of the third quarter, approximately $760 million would have been available for share repurchases under the aggregate $1 billion share repurchase program.

The share repurchases align with HMH’s broader capital allocation strategy, which focuses on driving organic growth, pursuing strategic acquisition opportunities and returning capital to stockholders, when appropriate.

Additionally, subject to market and other conditions, the Company plans to increase its debt by an additional $250 million and use some or all of the net proceeds from the financing to fund a portion of its share repurchases under the share repurchase program among other general corporate purposes.

2015 Outlook

The Company is revising its guidance for full year 2015. HMH expects its billings to be in the range of $1,530 to $1,580 million, which is approximately 1% to 4% below 2014 billings and net sales to be in the range of $1,415 to $1,450 million, which is 3% to 6% up from 2014 net sales. The revision is primarily due to softness in the open territory market along with lower than expected net sales in the supplemental and residual market.

HMH’s addressable domestic education market, the market where it primarily sells its instructional resources for grades K through 12, is expected to remain at $2.7 billion in 2015 compared with $3 billion in 2014.

Additionally, pre-publication or content development costs for 2015 are now expected to be approximately $110 to $120 million, a change from the mid-year guidance of $120 to $140 million.

About Houghton Mifflin Harcourt

Houghton Mifflin Harcourt (NASDAQ:HMHC) is a global learning company dedicated to changing people’s lives by fostering passionate, curious learners. As a leading provider of pre-K-12 education content, services, and cutting-edge technology solutions across a variety of media, HMH enables learning in a changing landscape. HMH is uniquely positioned to create engaging and effective educational content and experiences from early childhood to beyond the classroom. HMH serves more than 50 million students in over 150 countries worldwide, while its award-winning children’s books, novels, non-fiction, and reference titles are enjoyed by readers throughout the world. For more information, visit http://www.hmhco.com.