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

Greetings. Welcome to the Cengage Group's Fourth Quarter and Full Year 2026 Year-End Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Ed Ditmire, SVP, Investor Relations. You may begin.

Thank you, operator. Good morning to everyone connected today, and welcome to Cengage's Fiscal 2026 Fourth Quarter and Fiscal Full Year 2026 Investor Update. Joining me on the call are Michael Hansen, Chief Executive Officer; and Dean Tilsley, 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 and the earnings materials contain forward-looking statements about the company, forward-looking statements relate to the future and are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. These statements are based on our current expectations and are subject to the cautionary statement in our accompanying investor presentation and our financial reports. The company disclaims any obligation to update any forward-looking statements, except as required by law. On today's call and in our investor presentation, we will refer to certain non-GAAP financial measures. Definitions and the rationale for using these measures and reconciliations to their most directly comparable GAAP financial measures are provided in the legal disclaimer in the appendix to the investor presentation. Michael will first share a high-level overview of company performance and a review of our progress on key strategic priorities, followed by Dean, who will take you through the financial perform in the detail. We will then open the call for questions. Michael?

Thank you, Ed. Let me start off with the performance for the year, then highlight our strong progress in key strategic areas and how I see the market demand for the year ahead. Dean will then follow with detailed Q4 results. Fiscal year 2026 ending March 31, 2026, delivered solid overall results. with adjusted cash revenue of $1.55 billion, up 1% year-over-year and adjusted cash EBITDA of $545 million, up 1% as well, with a 35% adjusted cash EBITDA margin. . Our performance was in line with expectations despite timing driven declines in K-12 and impact in international due to the strategic shift away from print to digital. Additionally, we have made significant strides in fiscal year 2016 to implement our new global operating model and execute on our strategic priorities beyond the top line results. Elaborating further, it is important to recognize that we deliver stronger mid-single-digit adjusted cash revenue growth in each of our 2 largest and most strategic segments, higher education and work. These segments are a clear long-term secular growth engines as well as the areas most aligned with the power of our education for employment mission. Second, it was very encouraging to see our momentum build as fiscal '26 progressed with second half adjusted cash revenues up 6% and adjusted cash EBITDA up 21%. Our higher education and work growth engines played a big part in that second half improvement, with top line growth in the key U.S. Higher Ed business, up 8% and had to go up 21% year-over-year for the last 6 months. The second half also benefited from annualized cost savings of $40 million driven by efficiencies derived from our new global operating model. H2 adjusted EBITDA margin rose over 360 basis points year-over-year. So stronger performance in the less cyclical strategic growth segments and better growth and momentum as the year progressed. I've spoken earlier in the year about the company's strategy to deliver strong, sustainable growth. To reiterate, it is built on a belief that trusted content is considered table stakes, and value is shifting profoundly to impact and outcomes. When we consider our largest opportunities for that sustainable growth, we believe our Work segment is right at the front in terms of long-term growth rates while also being capable of driving higher margins due to our very efficient operating model. Interest in rewarding career path outside of 4-year degree programs is growing strongly and accelerating with workplace changes due to AI creating a huge opportunity for Cengage, a market leader in this space. For full fiscal 2026, we continue to see sustained growth within the largest area of the Work segment at to go with 24% year-on-year growth on an adjusted cash revenue basis. While ed2go well-established higher ad distribution channel continues to perform well, we are also realizing large growth in our new corporate distribution channel. The corporate channels revenue more than doubled over the past 12 months, with new partnership with organizations such as HCA, Amazon and Novant Health. Additionally, this March, we released the third edition of the Cengage Work Learner Outcomes report. This report offers a transparent and very final view of how our workforce education and upskilling programs translate into real-world employment results. Based on payroll record data validated by a global credit bureau, our report provides more reliable insights than traditional surveys. And because of that, it is especially satisfying to see people who complete our courses attain 9% to 14% average year 1 compensation increases, an 18% average compensation increases within 2 years of certification completion. ROI is critical. So we are excited to leverage these exceptional outcomes to differentiate ourselves and win in this fast-growing market. As we begin fiscal 2027, we continue to increase our investment to extend our reach. For example, we've recently began offering our advanced career certifications in the Canadian market, partnering with Canadian institutions and expanding a To Go's catalog with the first localized Canadian option in Q1. We are also working to reach more learners by offering Spanish language courses. Now let's turn to our strategic technology priorities. There are 3 central pillars to how we are leveraging powerful technology to transform our business and how we serve our customers. First is the ongoing digitization of the business. moving from a legacy of print textbooks to increasingly interactive digital content and courseware delivered over a highly scaled platforms. We now have over 16 million digital users and digital revenue reached $1.2 billion on a GAAP basis for fiscal '26. This digital revenue represents an increase of 10% year-over-year and now representing 81% of the company's total GAAP revenue for the period. Second, with the digitization of our business, significantly complete in key markets, we have set the foundation to add AI-enabled tools for our customers, products that accelerate learner outcomes and enhance effectiveness for instructors. Fiscal 2026 was the year Cengage launched solutions for each of its business segments. User engagement is building nicely, and we are seeing encouraging evidence on impacts. For example, an internal study of students in early release testing, who began using student assistant who described themselves as struggling in a course with 90% more likely to continue submitting assignments through the end of the term. We are focused on continuing to drive higher adoption of these new tools. Third, we are investing in AI capabilities to improve enterprise performance. However, we are taking a disciplined and cost-effective approach to enterprise AI adoption, prioritizing use cases with clear business impact, measurable productivity benefits and the ability to scale responsibly. This work is led by our AI enablement center, a dedicated team responsible for helping us deploy AI safely and effectively. We are already seeing tangible benefits in our work segment. AI is helping us accelerate the development and release of new products in high demand areas. In the higher education and school, we are using AI to streamline content development, including media production, translation and assessment creation while maintaining high standards for quality, accuracy and efficacy. We also see meaningful opportunity beyond content creation. For example, AI is helping us improve the performance of our digital products and support faster, more effective customer service. Overall, we view AI as an enabler of our strategy, helping us move faster, operate more efficiently, improve the customer experience and strengthen our ability to deliver innovative learning solutions at scale. We expect to mature our capabilities significantly over the coming years. I'm proud of the progress the organization has made in enabling these opportunities, and I'm grateful for the culture of innovation that has taken root in the company's talented team. Because of this, it was especially appreciated when March of this year, Fast Company named Cengage to its prestigious list of the world's most innovative companies in 2026, a list which shines a spotlight on businesses that are shaping industry and culture through their innovations. Cengage's recognition reflects its leadership in building a responsible AI-powered learning ecosystem that spans K-12, higher education and workforce training. Pedagogy-first innovation with AI tools that enhance rather than shortcut the learning process. I'll congratulate the team again and thank our customers for their trust as we work together to innovate. Now let me speak briefly on the demand dynamics that our larger businesses are facing as we begin executing in fiscal 2027. In our work segment, we expect continued increased demand for credential training. National Student Clearinghouse preliminary data release business showed undergraduate certificate enrollment up 10.2% in spring 2026, underscoring the shift towards shorter career-focused education pathways. In higher ed, we expect to see continued strong demand for digital courseware and solutions. And in K-12, where certain state support and coordinate buying by district and schools on approximately 6-year cycles, we are shifting to a multiyear phase beginning in fiscal 2027 that will be characterized by anticipated cyclical increases in those large state adoptions. I will now hand the call over to Dean who will provide a more detailed review of our fiscal Q4 and full year 2026 financial performance. Dean?

Thank you, Michael. For the financial review, unless otherwise noted, I will be citing financial figures on an adjusted cash basis and comparisons will be to the prior year period. Consistent with prior presentations, the appendix includes explanations of any adjustments made as well as the GAAP financial results. . Okay. Let's review the high-level Group Financial first. For fiscal Q4, the company delivered solid performance with revenue growth of 4%, driven by increases in our 2 largest segments, higher ed and workforce skills. School, where Q4 traditionally the smallest sales quarter declined year-over-year due to a lack of large deals and the early renewal of key gale contracts that were recognized in Q3. Their Q4 top line growth of 4% was compounded at the EBITDA level with a 9% increase at the company implemented its new operating model, delivering mid-single-digit reduction in operating expense and unlocked almost 200 basis points of margin expansion. Looking at full year 2026 results, as Michael mentioned earlier, we achieved a modest increase of 1% in both adjusted cash revenues and EBITDA. Supported by our strong second half momentum with H2 2026 EBITDA up 21% on 6% higher revenue. We continue to improve the strength of our balance sheet with net debt at 2.3x on adjusted trailing 12-month cash EBITDA, a 300 bps reduction over the last 12 months. And total liquidity of $561 million, up 109 million or 24% year-over-year. This improvement is driven by a significant expansion of levered free cash flow, which was up $133 million year-over-year. Turning now to Q4 highlights by segment, starting with higher education. Higher Education segment revenues rose 6% in Q4, with the key U.S. higher ed business up 6%, driven by increased sales of digital products, price and growth in the institutional sales channel. Institutional sales rose 18% to over $330 million and now make up 57% of U.S. higher ed revenues. The other smaller higher ed businesses, International and Gale, combined for an 8% year-over-year increase led by Gale, which continue to see a strong H2 with both U.S. and international sales recovering following government actions earlier in the fiscal year. Canada enrollment continues to be impacted by government policy that sets limits on the number of foreign students. Q4 Higher Ed profitability built on that 6% top line increase with an 8% increase in EBITDA due to the higher profitability of digital products as well as benefits from our implementation of the new operating model. Next, Cengage Work segment, Q4 revenue rose 4%, with our biggest work area it to go, delivering 20% growth year-on-year. As Michael highlighted, ed2go continues to see fantastic growth with increasing demand with our traditional 2- and 4-year college and university partners, augmented with rapid growth in our emerging employer-focused channel, which has now more than doubled in the past year. Ed2go growth was supported by Continuing Technical Education, or CTE, the second largest business within the Work segment, which was up 2% year-over-year. Looking at the other areas of Cengage work, which include Median Infosec, I'd like to take a moment to zoom in on Infosec. Here, there was a significant $4 million year-over-year headwind, which was driven in main by the partial U.S. government shutdown, which negatively impacted enrollment. The shutdown has now been resolved, and we expect some bounce back benefit in the early part of fiscal 2027. Looking at Q4 work EBITDA, the 4% decrease year-over-year was heavily impacted by the Infosec business headwinds as well as investments to scale the ed2go and CTE businesses. Turning now to our school segment. As already mentioned, Q4 is the smallest quarter for sales with only 5% of annual U.S. K-12 revenues occurring in Q4. Q4 revenues were down 11% year-over-year, but this was impacted by the early renewal of key contracts recognized in Q3. Removing the timing impact and looking at H2 performance, adjusted cash revenue for the segment were up 3% year-over-year, which is a better reflection of the business performance versus the prior year, again, during a traditionally low sales period. The full year performance of a 7% revenue decline reflects what we have highlighted all year that 2026 was a low adoption year. At the EBITDA level, we saw an $8 million decline in Q4 due to both the lower revenue as well as the net effect of a revised partner agreement in the prior year period. School is less than 20% of our total revenues. But as Michael mentioned, in fiscal 2027, we entered a multiyear period of large state adoption opportunities in California, Florida and Texas. This will move the demand backdrop from a 2026 headwind to a multiyear tailwind. And we entered that period of greater opportunity with products benefiting from recent investments in both core content and innovative AI tools. Finally, our smallest segment, English Language Learning, Q4 revenue rose $2 million or 4% and driven by higher sales in both the international and U.S. K-12 areas with a $1 million increase in EBITDA. When considering full year results in ELL, I want to highlight that 2025 benefited from a single large $6 million nonrecurring deal in the Caribbean. Normalizing for the single deal, full year revenue would have been down 2.5% year-over-year, driven by the lower U.S. K-12 adoption year. Full year EBITDA fell more moderate $4 million or 7% as cost actions offset more than half the revenue decline. Let's turn to the group cash flow dynamics. Levered free cash flow saw a fantastic improvement of $133 million in fiscal 2026 due to 3 key drivers. First, change in working capital improved by $55 million, reflecting stronger collections in the later portion of the year after H1 invoicing delays were resolved as well as benefits from the ongoing shift to institutional sales. Full year results also benefited from the timing of royalty payments that were accelerated to Q4 2025 due to the new ERP system going live in Q1 of 26. Second, restructuring costs and other nonoperating expenses were significantly lower in 2026, plus we had lower M&A activity with the fiscal 2025, including the acquisition of Visible Body. Together, these items drove almost $50 million in improvement. And lastly, interest payments were lower by $25 million due to a successful refinancing of our term loan debt in January 2026. So in 2026, we stepped up to deliver $181 million in leveraged free cash flow, almost 4x the prior year, representing a large improvement in our cash conversion rate. Total liquidity, comprising cash on the balance sheet and available capacity on our revolving credit facility rose $109 million over the last 12 months to $561 million as at March 31, 2026, driven by improved cash balances. Net debt declined by $121 million to $1.26 billion, with net leverage at 2.3x trailing 12-month adjusted cash EBITDA, a 300 basis point reduction year-over-year. Our strong balance sheet and liquidity positions us well to continue our strategic execution. So we have presented our financial results on an adjusted cash basis. For those who want to compare us with some of their public company peers, I would like to highlight that our fiscal 2016 results on a GAAP basis, group adjusted EBITDA was up 9% year-on-year on 4% higher revenue. With our key Higher Ed and Work segments, adjusted EBITDA up 11% and 16%, respectively. With that, I'd like to pass back to the moderator for any questions.

Certainly, at this time, we will be conducting a question-and-answer session. [Operator Instructions] Your first question for today is from David Salpeter with Jain Global.

I know it's 1 of your smaller segments, but I want to talk briefly about K-12 and the coming adoption cycle. I think 1 of your competitors on their most recent earnings call talked a little bit about decision making in California being perhaps delayed longer than they had originally expected. And some of the challenges around Texas is sort of pushing open-estate belt up and educational resources in terms of adoption of math curriculum there. I just was hoping if you could talk about basically the size and timing of the opportunity and whether that has changed relative to what you once might have thought given that kind of commentary?

Yes, David, it's Michael. Happy to take that question. first, I want to reiterate, it is a -- K-12 in general is a smaller segment, a much smaller segment for us, sub-20% of total revenue. more importantly, even the K5 segment, where many of the adoptions that you currently cited in Texas and California are focused on is an even smaller segment for us, it's around 3% of our total revenue. So clearly not a major area of focus for us. That said, the comments made by our competitors, I think we can confirm what happened in California is there was a lot more experimentation with different types of approaches and different kinds of pedagogy. And as a result, a lot of districts pushed their decision-making out to next year. which will benefit everybody and us as well next year. And in the Texas -- the Texas initiative to use OER with blue bullet is also a fact in this market. There has been implementation with open educational resources for many decades. But that said, again, it is not a major area for us and not a major area of concern at all in terms of our overall performance.

[Operator Instructions] We have reached the end of the question-and-answer session. And I will now turn the call over to Michael for closing remarks.

Thank you, Holly, and thank you to everyone joining the call and for the time and focus you have put into reviewing the Cengage story. I just want to close with a brief summary of our messages today regarding our fiscal 2026 results and, in particular, the second half, where we saw a building of momentum that we are working to continue with where we're investing in the business and in the technology in ways that are completely aligned with our strategic direction. And we've begun our fiscal '27 with the demand context that when paired with strong execution is healthy overall and conducive to continued progress. So thank you all for joining us, and we're looking forward to update you in 3 months. Thank you.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.