Cengage Learning Holdings II, Inc. (CNGO) Q2 2024 Earnings Call Transcript

Cengage Learning Holdings II, Inc. (OTC:CNGO) Q2 2024 Earnings Conference Call November 9, 2023 8:30 AM ET

Company Participants

Richard Veith – IR

Michael Hansen – CEO

Bob Munro – CFO

Operator

Good day, and welcome to the Cengage Group Fiscal 2024 Second Quarter Investor Call. [Operator Instructions]

It is now my pleasure to turn the floor over to your host, Richard Veith. The floor is yours.

Richard Veith

Good morning, and welcome to Cengage Group’s Fiscal 2024 Second Quarter Investor Update. Joining me on the call are Michael Hansen, Chief Executive Officer; and Bob Munro, Chief Financial Officer. A copy of the slide presentation for today’s call has been posted to the company’s website at cengagegroup.com/investors.

The following discussion contains forward-looking statements within the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Such forward-looking statements can be identified by words such as believe, expect, may, will, estimate, likely and similar words, and are neither historical facts nor assurances of future performance and relate to future results and events, and they are based on Cengage Group’s current expectations and assumptions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Many factors could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements. You should consider such factors, many of which are subject to the risks and uncertainties discussed in the slide presentation which accompanies this call and in the Risk Factors section of our fiscal 2023 annual report for the year ended March 31, 2023, as may be updated by our quarterly reports for fiscal year 2024. Any forward-looking statement made in this presentation is based on currently available information. The company disclaims any obligation to publicly update or revise any forward-looking statements, except as required by law.

On today’s call and in our slide presentation, we will refer to certain non-GAAP financial measures. Definitions and the rationale for using these measures and reconciliations of each to its most directly comparable GAAP financial measure are provided in the appendix to the slide presentation.

I’ll now turn the call over to Michael for an update on the business, followed by Bob, who will take you through the second quarter details before we open the call for questions. Michael?

Michael Hansen

Thank you, Richard. Good morning, everybody, and thank you for joining us for our Fiscal Year 2024 Second Quarter and First Half Results Update.

First and foremost, I want to highlight that we are on track to deliver a third consecutive year of mid-single-digit revenue growth with profit growth expected to outpace revenue growth as we continue to drive efficiencies through our operating model and expand margins. Our entire portfolio of businesses continues to demonstrate our strong position as we strive for sustainable revenue growth and margin expansion across all 3 business units.

September year-to-date, revenue is up 9% versus prior year. September year-to-date ELPP of $262 million is $31 million or 14% ahead of prior year. This year-over-year strong performance is impacted by meaningful favorable sales times effects, with earlier customer ordering benefiting this year and as a result of the supply chain issues that we faced last year. As these effects normalize, we expect the pace of growth to moderate during the second half of our fiscal year.

The overall first half revenue growth was driven by our secondary, Work and ELT businesses, all of which delivered growth of 20% or more, with strong underlying growth in secondary and ELT being boosted by the sales timing effects.

Our secondary business reported revenue growth of 26%. Stripping away the timing effects, we expect solid underlying growth in secondary this year, in stark contrast to the downward trends seen by a number of competitors and reflecting our differentiating strategies focused on the middle and high school and college and career readiness segments of this market.

Staying within academic. U.S. Higher Ed delivered a successful fall season, driven by increasing adoption of digital and institutional solutions. U.S. Higher Ed remains on a trajectory to return to growth in the near term with revenues on a trailing 12-month basis through September now flat against the prior period.

In Select, English Language Teaching September year-to-date adjusted cash revenue was up 35% versus prior year due to strong global and U.S. K-12 demand.

Lastly, the Research business maintained its solid growth momentum with adjusted cash revenue up 4%, driven by higher subscription billings.

Cengage Work adjusted cash revenue is up 20% versus prior year, with a key driver of growth being our advanced career training programs. These courses are focused on providing students with the skills they need to obtain necessary certification for employment, most notably in health care, IT, and trades, where there is high structural demand.

A highlight of the past quarter was the release of our inaugural Cengage Work Outcomes report. We are committed to providing learners with tangible outcomes of their education investment. We call this our Education for Employment strategy. Cengage Work programs help learners develop relevant skills and earn industry-recognized certifications that are applicable to local jobs and relevant nationally. Each year, more than 250,000 learners gain employability skills with our Cengage Work products.

Our outcomes report provides timely credibility to the skills programs we offer. Based on our research, we know that 83% of Cengage Work learners complete courses, and 90% of those learners who set for certification exams passed and earned an industry-recognized credential. Driven by changes in income, Cengage Work learners on average experienced a positive ROI within 2 years of completing their course.

In the last quarter, we have continued to refine our approach to leveraging generative AI to improve the learning experience of students and the teaching experience of instructors. In August, we published research that provides insight into U.S. Higher Ed instructor views on generative AI in the classroom. A majority of instructors agree that generative AI will play an increasingly important role in Higher Ed. While instructors may feel some trepidation, they do plan to use generative AI to automate certain administrative tasks to free up time for teaching and connecting with students.

Our research and ongoing conversations with students, instructors and administrators has informed our generative AI product strategy. We have tested various product enhancements and will have more to share in future quarters. Beyond product enhancement, we are committed to vigorously protect our valuable intellectual property and will take the necessary steps to do so.

On behalf of the entire Cengage Group organization, I am extremely proud of our Q2 and first half results. Our Q2 results in particular are very strong, and we have plans in place to raise the bar to continue to drive our growth, both in revenue as well as profitability.

Thank you for your continued support. Bob, over to you.

Bob Munro

Thank you, Michael, and good morning. Turning to the Cengage Group financial highlights. Our business continued to perform well in the second quarter and onwards through October to close out a successful fall season. Q2 adjusted cash revenues were up 10% to $570 million, resulting in first half revenues of $840 million, 9% ahead of the prior period.

Digital remains a key engine of growth with digital net sales up 13% to $624 million in the first half and representing over $1 billion of annual net sales on a trailing 12-month basis or around 73% of the total. First half adjusted cash ELPP was $262 million, up 14%, reflecting the strong flow-through of revenue growth.

The first half performance benefits from significant sales timing effects, notably in our secondary and English language teaching businesses. In fiscal ’23, our first half performance was held back by supply chain issues which resulted in almost $20 million of confirmed orders that would have ordinarily been fulfilled in the first half being deferred to the second half. In addition to successful mitigation of supply chain risks and normalization of back orders in this fiscal year, we have experienced early ordering and favorable returns timing in secondary and ELT. These also boost first half growth relative to our full year expectations.

Taking account of these sales timing effects across our businesses, the underlying first half performance is in line with our overall Cengage Group expectations for this year, underlining the strength of our portfolio.

We have also added adjusted cash EBITDA to the financial highlights. We believe this is an increasingly important metric in our business and relevant in the comparative assessments of performance. This reflects the continued evolution of our operating model as we have become a predominantly digital business with prepublication highly integrated with digital product development. Consistent with this, we expect that, between prepublication costs and CapEx, we have reached a reasonably stable level of annual spend which together amounts to less than 10% of annual revenues. Adjusted cash EBITDA for the first half was $299 million, representing a margin of 36%.

Our business unit performance illustrates the good progress across the portfolio. In Cengage Academic, adjusted cash revenue was $523 million in the first half, up 6%. Overall growth was driven by significant sales order timing benefits in secondary, which are expected to reverse in the second half and moderate full year growth. Stripping out the timing effects, the underlying performance of Academic reflects solid growth in secondary, improving performance in U.S. Higher Ed, consistent with our expectation of the business returning to growth, and softness in international driven by our strategy to stem dilutive reimportation into the U.S. market.

In Cengage Work, adjusted cash revenues were $62 million, up 20%, with growth accelerating coming out of fiscal ’23 and the business moving into profitability as expected.

In Cengage Select, adjusted cash revenues were $239 million, up 13%. Beyond the sustained solid growth in Research, this is driven by ELT, which also benefits from significant timing effects in sales orders and returns.

In Cengage Academic, adjusted cash revenue for U.S. higher ed for the second quarter reached $226 million, 1% ahead, with sales benefiting from channel orders deferred from the first quarter. First half adjusted revenues reached $299 million, marginally behind the prior period with net sales flat.

The performance of the U.S. Higher Ed business through the first half and the underlying drivers of that performance give us increasing confidence in our expectation of the business progressively returning to growth. On a trailing 12-month basis, U.S. Higher Ed adjusted cash revenues were flat year-over-year at $594 million, driven by continuing momentum in institutional revenues and high digital penetration.

Trailing 12-month institutional revenues were $194 million, representing 34% year-over-year growth. This positive trend was broadly sustained as we closed out the fall selling season in October, which is the key month in our fall cycle for institutional billing. In addition, our performance is benefiting from improved enrollment this fall. We estimate that the headline figure of 2% growth in undergraduate enrollment recently released by the National Student Clearinghouse translates into around 1% benefit to our business.

In International Higher Ed, first half adjusted cash revenue was $56 million, 7% behind the prior period. This decline partly reflects order and returns timing but is otherwise driven by sales weakness in the Europe, Middle East and Africa region. This is a result of pricing and channel actions to address reimportation into the U.S., a consequence of which we believe has been some sales uplift in the U.S. For the full year, we expect the decline in international to moderate as the timing effects reverse with overall revenue down year-over-year driven by EMEA.

The secondary business closed first half with adjusted cash revenues up 29% to $169 million. The first half performance includes significant order timing effects through the combination of earlier ordering this year and the first half performance in fiscal ’23 being impacted by order fulfillment delays as a result of supply chain issues which were mitigated this year.

The secondary business is now well over 80% through its selling cycle. After a strong back-to-school season, we expect the business to deliver full year revenue growth in the mid-single-digit range. This reflects our strategic focus, which is driving good underlying momentum in core middle and high school programs, where we have seen notable wins this year in social studies in Nevada and Florida, and also in AP and CTE which together are compensating for the large fiscal ’23 Florida math adoption.

Cengage Work sustained strong growth momentum through the second quarter, driving first half adjusted cash revenues to $62 million, 20% ahead of the prior year. Ed2Go net sales of $41 million are 26% ahead of the prior period, driven by the advanced career training products. Here, we are capturing strong growth in enrollment underpinned by B2B channel expansion, new commercial models, deeper integration with educational partners, whilst also improving yield per course through pricing strategies.

As Infosec, net sales grew by 9% in the first half to $21 million. Performance reflects the combination of double-digit growth in security awareness software business, which has been moderated by lower growth in the upskilling and reskilling business, where timing effects held back year-to-date boot camps performance.

Infosec growth is expected to accelerate through the remainder of this year as timing effects reverse and initiatives focused on increasing the capacity and effectiveness of our marketing and sales capabilities gather momentum.

The ready-to-hire business is continuing to progress well with pilots meeting key milestones and with the expectation that it will contribute marginally to revenue in fiscal ’24 while we continue to invest in and grow this offering.

Cengage Work has moved firmly and sustainably into profitability in fiscal ’24, with first half adjusted cash ELPP of $3 million. This reflects the effective scaling of the business and its inherent strong unit economics with low customer acquisition costs, which differentiates our business from many others in the sector. For the full year, we expect Cengage Work to largely sustain its first half revenue growth with its profit contribution and margin expected to improve further.

In Cengage Select, English Language Teaching has maintained its strong sales growth momentum through the second quarter. First half adjusted cash revenues were $78 million, 35% ahead of the prior year. This reflects a strong underlying performance in the U.S. driven by wins in large K-12 school districts and the regional businesses covering Latin America and Europe, Middle East and Africa.

First half performance benefits from meaningful favorable sales timing and returning benefits. We expect these timing effects to reverse in the second half, moderating our full year growth, with the ELT business expected to deliver another year of strong double-digit growth. ELT first half adjusted cash ELPP was $27 million, up over 46% with margin improvement driven by a combination of continued underlying expansion as the business scales and favorable sales mix and timing effects.

Research also delivered a solid second quarter with the renewal timing effects that moderated Q1 performance reversing this quarter. First half adjusted cash revenue was $122 million, up 4%, maintaining the solid growth momentum in fiscal ’23. Year-to-date growth is underpinned by strong subscription renewal rates, which are running at 94%, and sustained demand in U.S. academic and K-12 markets. With good momentum and healthy sales pipelines going into the second half, the business remains on track to deliver another year of expected solid revenue growth.

In the Other segment, an improved Q2 drove first half adjusted cash revenues to $39 million, up 6% on the prior year. Growth is driven by Milady, which is 9% ahead year-to-date, reflecting digital growth and a rebound in print sales added to pricing effects, all underpinned by solid underlying demand across its markets. The Australia K-12 business continues to face headwinds in with first half revenues broadly flat.

Turning to cash flow. First half unlevered free cash flow or operating cash flow, a key measure for our business, was $59 million, $6 million better than the $53 million in the prior period. The first half cash performance primarily follows the normal seasonality of the business with a net cash outflow in the first quarter and the business progressively building cash over the second to fourth quarters as the academic year progresses.

The working capital movement principally reflects this seasonality, together with temporary year-over-year timing effects which we expect to reverse in the balance of the year. As a result, for the full year, we expect working capital to be broadly neutral with net sustainable cash benefits driven by working capital initiatives and the normalization of the fiscal ’23 supply chain issues, offsetting the impact of the investments we are making in our multiyear new SaaS-based global infrastructure systems: CRM, e-commerce and ERP. As a result, we expect our operating cash conversion to be approaching 90% for the full year, reflecting the highly cash-generative nature of our business.

Our tax payments are expected to remain modest for this year and for the medium term, being driven by international operations. In the U.S., we expect to generate taxable income in fiscal ’24 and future years with payments sheltered as we draw down on the approximately $1 billion of NOLs available to the business coming into fiscal ’24.

Our cash interest costs this year are expected to be around $190 million, reflecting higher rates on our term loan, which is unhedged; moderated by savings from the redemption of our senior notes, with the final tranche of $31 million being repaid in October.

With other non-operating cost run rate expected to be broadly sustained in the second half as we continue to drive strategic initiatives to structurally improve our operating leverage and drive top and bottom line growth, we expect to further strengthen our cash and liquidity position over fiscal ’24.

Turning to our capital structure. With the proceeds of the preferred equity issue which was used to redeem $500 million of our senior notes and the continuing growth in profitability, we have delivered a step change in capital structure and the net leverage of the business, which stood at 3.8x at the end of September. This is 2.5x better than a year ago. Gross leverage has been reduced to 4.3x or 3.6x on an adjusted EBITDA basis. That is before prepublication costs.

Further, following the redemption of the final $31 million tranche of the senior notes earlier in October, we have deployed around $150 million of excess cash over the past 2 years to redeem senior notes and meet amortization payments on the term loan whilst maintaining a strong liquidity position throughout.

We ended the first half with total cash of $184 million and total liquidity of $354 million. Our cash and liquidity positions are expected to progressively build over the second half driven by the inherent strong cash-generation dynamics of the business, consistent with patterns in previous years. As a result, we expect to end the year in a stronger cash and liquidity position than a year ago, having funded the debt repayments.

Under the terms of the preferred equity issue, the company can elect to fulfill dividends payable at 10% quarterly in arrears in cash or payments in kind. We elected to pick the $13 million September quarterly dividend, having paid the $6 million June partial period dividend in cash. We will continue to assess future dividend payments in the context of our strategy and related liquidity requirements.

Closing with our full year guidance. With a successful fall season behind us, we are reconfirming and refining our revenue guidance for full fiscal year ’24. We expect Cengage Group to deliver a third year of solid growth in adjusted cash revenue which we expect to land in the 4% to 5% range. Underpinning the full year group revenue performance, we expect Academic to be broadly flat, Cengage Work to largely sustain its first half growth and Cengage Select to deliver strong single-digit growth.

With our continuing focus on driving scale, operating leverage and productivity, we expect solid ELPP growth to outpace revenue growth in the full year, continuing our track record of progressive margin expansion. Finally, we expect improved operating cash performance driven by working capital initiatives and the normalization of supply chain issues which impacted the prior year.

In summary, the combination of the strong performance of the business in the first half and the strategic operational and financial momentum we take into the second half underpins our growth expectations both for the full year ’24 and beyond.

I will now pass back to the operator for questions.

Question-and-Answer Session

Operator

Operator

There are no questions in queue at this time. I would now like to turn the floor back over to Michael Hansen for closing remarks.

Michael Hansen

Thank you, operator, and thank you all for listening today. We are looking forward to updating you on our progress in about 3 months’ time. Good morning, everybody.

Operator

Thank you. This does conclude today’s conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.