Cengage Learning Holdings II, Inc. (CNGO) Earnings Call Transcript & Summary

Greetings, and welcome to the Cengage Group's Fiscal 2022 First Quarter ended June 30, 2021 Investor Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Richard Veith, Senior Vice President and Treasurer. Thank you. You may begin.

Good morning, and welcome to Cengage's fiscal 2022 first 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 cengage.com/investor. The following discussion may contain forward-looking statements within the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Such forward-looking statements are neither historical facts nor assurances of future performance and relate to future results and events, and they are based on Cengage'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 Risk Factors section of our Fiscal 2021 Annual Report for the year ended March 31, 2021. 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. 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 first quarter details, before we open the call for questions. Michael?

Thank you, Richard. In June, we updated you on our resilient performance through the pandemic and the growing momentum across our portfolio coming into fiscal year 2022. Our first quarter results demonstrate continued consistent growth in our U.S. Higher Ed and Workforce Skills businesses, and as we expected, rebounding in our other businesses. As you know, given the seasonality of our business, quarter-over-quarter observations provide limited insight. This year, the uneven COVID recovery further exacerbates this fact. That said, Q1 adjusted cash revenue exceeded pre-pandemic fiscal year '20 levels, demonstrating the strength of our digital transformation as we remain on track to deliver on our guidance of mid-single-digit growth and improved margins. Our confidence in the sustainability and predictability of our results is based on the proven track record of our longer-term strategies and clear understanding of our core business drivers. Specifically, digital usage, gaining momentum for many years accelerated during the COVID pandemic, driving further monetization of each classroom, recurring revenue and margin expansion. Print, on the other hand, is an ever smaller part of our business, creating less drag each year. We continue to gain market share through our differentiated digital products, innovative commercial strategies and award-winning service level. Enrollment, historically viewed as a core business driver, has much less of an impact on our business as we have proven that we can deliver growth despite enrollment fluctuations. We remain committed to our 3 strategic priorities and are confident in the strong trajectory of the business. First, we will continue to grow digital users in our Higher Ed businesses. Our U.S. Higher Ed business continued to grow steadily in Q1, both in revenue as well as in digital users. All leading indicators validate our confidence in the sustainability of the growth we achieved in fiscal '21, driven by adoption wins, customer migration and sell-through gain, continuing the steady progress that we have made for more than 5 years now. Second, we will rapidly grow our Workforce Skills. We remain focused on building our offerings and serving more owners in the growing market for alternative career upskilling pathway. Our Workforce Skills enrollment growth remains strong as learners continue to seek more flexible and targeted path to career growth, a user need that we call Education for Employment. We are cementing our position in this market by expanding our catalog in high demand industry verticals, growing our partnerships with institutions, and enhancing our lead conversion capability. Beyond our current offerings, we are actively pursuing opportunities to expand our presence in Education for Employment and support the millions of adult learners who seek a skills-based education to improve their life. Third, our other synergistic portfolio businesses will continue to leverage our technology, content and distribution platform. First quarter indicators of post-COVID recovery were positive across the entire portfolio. Growth across our International Higher Ed, English Language Teaching and Research businesses demonstrate that buyer confidence is returning to pre-COVID levels and, in many cases, faster than anticipated. As these businesses recover from COVID, we are also seeing a step change in digital product usage, providing Cengage with monetization, pricing and margin benefits. Our leverage model across the portfolio is a key differentiator for our businesses, driving strong contribution margins, and we will continue to invest in the technology and content platforms that underpin it. In July, we closed on a highly successful refinancing of our $1.65 billion term loan. The offering was more than 2x oversubscribed and pushed the term loan maturity to 2026. This refinancing strengthens our financial foundation, reflecting the great progress we've made and positions us to execute our ambitious growth agenda. Based on our strategy, our portfolio of synergistic businesses and our efforts over many years to build brick by brick towards growth, we have now decided it is time to rebrand Cengage into Cengage Group. This brand refinement clearly indicates that we are a sum of many important parts, all of which play a critical role in our go-forward strategy, focused on growth and our digital first approach. As of today, we will use Cengage Group when referring to our corporate level ambition and plan. Each of our businesses will continue to go-to-market as they have been unchanged. To recap, our first quarter results continue our strong momentum from prior quarters. We are on track for healthy mid-single-digit growth this year. Our robust results and confidence in our outlook reflect the continuation of the performance trajectory we have been building for over 5 years. We remain fully committed to our 3 strategic priorities: continue to grow digital users in our Higher Ed businesses, rapidly growing our Workforce Skills business and leveraging our content and technology platforms across our synergistic portfolio. I remain very grateful to the over 4,000 Cengage employees who have put in the hard work over many years to build an amazing culture with me and the executive team and have put Cengage into this position of strong revenue momentum and true market leadership. With that, I will hand it over to Bob to provide the detailed financial update. Bob, over to you.

Thanks, Michael, and good morning, everyone. Turning to Slide 8, Financial Highlights. We have had a strong start to our fiscal '22. Adjusted cash revenue for the first quarter increased 27% to $243 million. Our first quarter results were driven by sustained momentum in U.S. Higher Education, where net sales grew 21% and continuing recovery in businesses that were most heavily impacted by the COVID pandemic. Recognizing that the prior year first quarter was sharply impacted by the onset of the pandemic, it is notable that our fiscal '22 Q1 revenue performance is slightly ahead of pre-pandemic revenues of $241 million in the first quarter of fiscal '20, albeit with some phasing benefits. Adjusted cash ELPP for the quarter improved significantly to $15 million, representing a favorable $35 million swing from last year's first quarter loss of $20 million. This reflects the strong top line growth and the cumulative benefits of our operating model transformation, which has improved our cost structure. The Q1 profit performance also compares favorably to pre-pandemic results in fiscal '20, where first quarter adjusted cash ELPP was a loss of $23 million. Our first quarter typically represents only 15% to 20% of our annual revenue. Given the seasonality of our business and shifting channel and demand dynamics, which were amplified by COVID, we remain focused on performance through the annual cycle as a key yardstick of the success of our strategy. On that note, our trailing 12-month adjusted cash revenue for the period ending June 30, 2021 was $1.34 billion, representing a 1% year-over-year increase. This reflects a continuation of the positive momentum across the portfolio coming out of fiscal '21, underpinned by the success of our digital strategy. Digital net sales for Cengage as a whole grew 11% on a trailing 12-month basis, reaching $957 million or 72% of total net sales. The trailing 12-month adjusted cash ELPP grew 8% year-over-year to $335 million. As Michael mentioned, a recent key milestone was the successful refinancing of our senior secured term loan, which was completed in July. The offering was well received by new and existing lenders and extended our most proximate maturity to 2026. We've made solid progress on our commitment to delever the balance sheet as our net leverage ratio now stands at 5.5x. Slide 9 sets out first quarter adjusted cash revenue and adjusted cash EBITDA less prepub for each of the 6 segments we report. All businesses in our portfolio delivered double-digit adjusted cash revenue growth, underlining the strength, posted the continued trajectory in U.S. Higher Ed and Workforce Skills, and recovering demand across other segments of our business. In addition, all business segments contributed meaningfully to first quarter profits. The turnaround to first quarter profitability from losses in the comparable quarter in the prior 2 fiscal years was further supported by the scale and synergy benefits of our operating model. This enabled us to maintain the cost of corporate functions broadly flat while driving strong top line growth. In Workforce Skills, where we see a compelling growth opportunity, the adjusted cash ELPP reflects the investments we are making to scale the business and expand our product offering and go-to-market capabilities. Looking across the annual cycle, Slide 10 shows segment performance on a trailing 12-month basis. The improvements in trailing 12-month adjusted cash revenue growth from minus 6% at the end of fiscal '21 to plus 1% in the 12 months to the end of June is underpinned by 4% growth in U.S. Higher Ed and 40% growth in Workforce Skills. With all other segments improving their revenue performance, we are on track to meet our guidance for fiscal '22, which I will come back to at the end of the presentation. Turning to the performance by business segments and U.S. Higher Ed on Slide 11. First quarter net sales in U.S. Higher Ed grew 21% to $95 million compared to the prior period, with the business maintaining good underlying momentum going into the key fall season. Year-to-date growth benefits from the earlier renewal of our largest Cengage Unlimited Institutional contract, which included a significant uplift in both annual seat and revenue. The first quarter also reflects normalization of channel partner stocking orders, which was significantly depressed last year as bookstores and institutions were closed due to the onset of the pandemic. With respect to the early renewal, we continue to see good underlying digital sales momentum through the first quarter and very strong underlying double-digit growth in institutional sales, consistent with growth trends in fiscal '21. Courseware activations in the first quarter were modestly down after record growth in the prior period. This reflects lower summer enrollments, which we do not believe to be representative of the coming fall season. Looking across the annual cycle, the sustained momentum in U.S. Higher Ed is evident. On a trailing 12-month basis, net sales were $695 million, representing underlying growth of around 5%. Digital sales were $571 million, up 11%, with courseware activations up 10% on a trailing 12-month basis. We have also continued to gain market share and outperform competitors, with our share increasing to 26.3% as measured by MPI. Our U.S. Higher Ed business is well positioned going into the fall season, underpinned by unique digital strategy. Enrollment remains uncertain at this stage and a factor outside our control. Whilst we continue to expect overall enrollment to be no worse than last year, the recent resurgence of the pandemic and Delta variant leaves a question over when we will see growth and recovery in enrollment between this year and next year, when we also expect federal funding initiatives to have a positive impact. Turning to our businesses, which were more significantly impacted by COVID on Slide 12. Across these segments, improving sales trends, increasing demand and digital momentum, it was clearly evident in the latter half of fiscal '21 has continued into fiscal '22. In International Higher Ed, Q1 net sales were up 58% to $29 million. Canada, our largest market, contributed approximately $4 million to growth following our acquisition of the business in July 2020. The strong increase was otherwise led by the EMEA and Asian markets, where continued digital growth supplemented a strong recovery in distributor demand. In contrast, recovery in the Australian market has not kept pace, reflecting its high dependency on international enrollment. First quarter net sales in Secondary Education grew by 9% to $31 million. Secondary Ed has been repositioned to focus on the high school and career and college readiness segments, which underpins the year-to-date net sales growth. As we covered in our last update, we anticipate this to be a transitional year for this business as certain K-8 product lines continue to run down. The English Language Teaching business has recovered strongly, with net sales up 78% to $22 million from last year's trough. The bounce-back from schools reopening and distributor restocking has been supplemented by new business wins in Asia and strong growth in digital. Looking at Slide 13. At Gale, our research business, first quarter performance exceeded our expectations with net sales of 41% to $48 million. This includes around $3 million phasing benefit from early subscription renewals. With subscription renewals successfully maintained at well over 90%, growth was otherwise driven by recovery in demand for digital archives and eBook collections in the U.S. academic and K-12 library segments and for international archive generally, as budget concerns eased and institutions reopened. Workforce Skills continues to grow at an exceptional rate with adjusted cash revenues up 26% to $14 million. The moderation in the growth rate to what we believe to be a sustainable level of 20%-plus reflects the expected stabilization of demand for shorter fundamentals courses. Demand for the longer advanced career training courses, which provide pathways to certification in sectors with high structural skills gaps, such as allied health, remains very strong. We are more effectively capturing this demand through investments in lead generation and conversion capabilities and expansion of our product catalog and distribution channels fueling this growth. Slide 14 summarizes the Q1 cash performance. Levered free cash flow for Q1 was an outflow of $81 million compared to an outflow of $41 million in the prior period. This $40 million change reflects the strong trading performance of the business, outweighed by the normalization of temporary actions taken in the prior period to mitigate the impact of COVID. The most significant is the deferral of annual incentive and sales commission payments from June to October last year. These payments, together $60 million, were made in June of this year as normal, and this shift accounts for the majority of the swing in working capital. Similarly, Q1 in the prior year benefited from actions which shifted the timing of interest payments, which also normalized in this fiscal year's first quarter. The overall cash performance and outflow in Q1 reflects the normal annual cash cycle with the business reaching a low point in June, July each year, ahead of the back-to-school season. Over the full year, the business will generate significant positive levered free cash flow. As we signaled on our fiscal year 2021 call, we anticipate lower conversion than our historical average in fiscal '22 due to the normalization of temporary benefits from our COVID mitigation program. Slide 15 addresses our total liquidity at the end of the June quarter, which remains strong at $449 million, built on a cash position of $373 million. The combination of increased profitability and strong cash generation over the last 12-month period reduced our leverage ratio to 5.5x at the end of June. We are heading in the right direction and remain committed to reducing our net leverage ratio to 4x over the medium term. In closing, our strong performance in the quarter reinforces our confidence in our full year fiscal '22 outlook, which is summarized on Slide 16. In maintaining our guidance, we are assuming that the Delta variant and future course of the pandemic does not have any further material adverse impact on our market. We expect mid-single-digit top line growth in fiscal '22. This is underpinned by sustained digital momentum in U.S. Higher Ed, continued strong growth in Workforce Skills and the demand recovery we are seeing in our other businesses. Within this revenue growth range, we expect the business to deliver solid ELPP growth with modest ELPP margin expansion, a short-term COVID cost benefit in fiscal '21 normalized. We expect the combination of our operating costs, prepublication spend and CapEx to increase by $40 million to $50 million in fiscal '22. This is driven by the normalization of prior year temporary COVID cost benefit, the full year effect of the Canada acquisition and investments in Workforce Skills, partly offset by incremental structural savings from ongoing simplification of our operating model. In summary, we're on track and encouraged by both the strong start to the year and the continued progress we are making with respect to our longer-term growth objectives. I will now hand back to the operator to take your questions. Thank you.

[Operator Instructions] Our first questions come from the line of Todd Morgan with Jefferies.

I guess a couple of quick things, if I could. Print revenues were up precipitously or very sharply in the quarter. Is that simply a function of the revenue requisition model? In other words, as you sell more product as well as digital product, just the print revenue gets recognized more quickly? And I guess, Michael, I guess, in the past, on the Cengage Unlimited front, you've talked about the number of courses per student, in other words, the students subscribed to Cengage Unlimited, how many courses they actually used that for and that ratio, that number being something like 1.1 courses per student? I don't know if you've seen any sort of material change in that through last year and even into this period. I'll stop there.

Yes, Todd, thanks for your question. Let me take the second one first. The answer to that is yes. We have seen an increase from the starting point where we were with 1.1, which you correctly remembered, we are now somewhere close to 1.8, which, obviously, for the student is really good news in the sense that, on average, they're getting a lot more value for the product. And that's obviously something we're taking into consideration as we're thinking about the evolution of the model, the pricing and all of this going forward. So I think that's the first -- the second question. The first question, you're absolutely right. I think this is more, and Bob can chime in on this, much more a question of phasing. As you will appreciate, what happens is with physical print product, the majority of that print product is still going through traditional bookstores. Those bookstores typically stock up in the first quarter and get ready -- in our first quarter to get ready for the fall season. And that's why we're seeing an increase in that category, but that is then normalized as we are then going into the second quarter, where we see a much, much greater preponderance of digital, particularly the direct exit. Bob, anything to add on that?

I would just add, Michael, that the growth you're seeing quarter-to-quarter is really exacerbated by the situation last year. And that, of course, was the onset of COVID where institutions almost universally closed down and bookstores similarly closed down. So there was very, very low ordering in this period last year. And so that's what you're seeing quarter-to-quarter. I think, as Michael said, as we roll through the academic cycle, our expectations for print are unchanged, and we expect print to continue to decline as it has done in previous periods as we continue to drive our successful digital strategy.

Maybe if I could, one quick follow-up on the enrollment. You made a comment that this year, it's very uncertain as to what the domestic Higher Ed enrollment is going to look like. I don't know if you have any sort of more real-time thoughts on that, at least anecdotally, from where I sit, I hear many more stories about colleges having obviously seen huge jumps in applications and also having many more acceptances than they anticipated. So there's many more freshman showing up than anticipated and probably a lot of kids who deferred who show up this year. And perhaps maybe not quite so strongly in the second 2-year college world, but in the 4-year private institution and the larger institutions, it sounds like it's a pretty healthy enrollment. I don't know if you have any kind of more current thoughts about that.

Yes, Todd. Very, very much spot on what you're saying. It's really it's a tale of 2 cities. It's the 4-year institutions that are seeing the phenomena that you are describing, basically a release of the pent-up demand, people that have deferred coming back now, wanting to enroll and acceptances rate is going up as well, as you said. The community college situation is much more dire than what we are seeing, again, from anecdotal evidence, nobody knows yet. But typically, those are students that are deciding much closer to the beginning of classes, so there is not really that application process during the summer, the spring and the summer. They are deciding closer to class. They are typically lower income students. They are often working at the same time. And for them, the consideration, do I enroll or don't I enroll has become a lot more complex. There are clearly -- there are financial pressures for them. But there is also a very healthy demand in the job market, the increase in wages that might draw them away and say, like, I'd rather work more than study. So I think the community college situation, the 2-year college situation is highly uncertain. The full year situation is much more stable as you are describing it.