Wednesday, March 13, 2013

Cengage Reports Second Quarter

Cengage reported their second quarter results two weeks ago (Feb 13) and their analyst meeting was also the first time new CEO Michael Hansen led the discussion.  As the chart on the left indicates the second quarter 2013 showed significant deterioration in performance relative to the same period last year.  This also follows a weak Q1.  While results are disappointing it is harder to discern if Cengage is truely in trouble as some analysts suggest when they confuse the company's operating performance with their considerable short and long term debt situation.  There is little doubt the company will be forced to refinance their debt but whether they will do this by taking advantage of bankruptcy law is still an open question.  There was no indication on the call that this was being considered.

The Q2 $48 mm variance was explained as a result of the following issues:
  • Texas - National Geographic sale was non-recurring revenue
  • Channel partner issue - Not identified but also mentioned last quarter
  • Enrollments - declining
  • Research segment - under pressure
Hansen took the audience through his update which included a state of the business - enrollment continues soft, exposure in the library market mainly affecting Gale, the impact of a non-recurring sale in the same quarter last year and generally 'performance pressure' in higher education, which he then followed with an update on his strategic initiatives.

During the last call, it was noted the company had received some materially bad news from one of their significant channel partners.  Revenues were impacted and Hansen undertook personally to get this relationship fixed which he says he has now done.  Ordering from this partner is now back on track (although he didn't indicate the financial terms needed to fix this issue nor whether the lost revenue would be recovered).

His 'to-do' list includes setting up his new executive team which he has completed and then executing on several key strategic initiatives. These are as follows:
  • Optimize existing solutions: Legacy print, increase digital homework solutions, align pricing and sales approach
  • Mind Tap: accelerate development and lead the market, establish a dedicated team: relaunch Fall 2013
  • Digital road map: delivery solutions that make learning fun, effective provide superior performance, invest in highly competitive, differentiated solutions
  • Establish a key performance measurement program
It is early days yet to show results but these are definitely the areas where Cengage needs to establish itself as educational publishing moves forward as education becomes based more on technological solutions rather than bound print.

There were several other bullets of note from the question and answer period:
  • Slowing enrollment down 1.8%
  • Library reference:
    • Public libraries: 57% say spending will be flat or lower
    • Three years in a row state support has declined
    • Gale exposed but continue to invest in the segment - negotiating partnerships to expand the segment
  • Shift to subscription models impacts the recognized revenue
  • "Research": 18% decline in print and 11% decline in revenue
  • Gale is flat - 70% of revenue is in electronic
With respect to their digital offerings he spoke about "attach rates" where a book is associated with a digital offering.  The 'attach' part of this being the percentage of students with the electronic component.  With their student home school helper for example they have seen significant increases in sell-thru versus the print only offer.  The re-invigoration of MindTap will be important for the future of the business and is currently offers over 600 solutions.  Their 2nd generation offering will be launched for the Fall semester and will be focused on two disciplines and Hansen suggested the company was looking for distribution/exposure rather than revenues in this cycle.

On a related call from the private equity company Apollo which has an investment in Cengage there was some discussion of their investment in Cengage.   It was noted that Apollo had reduced their position in the company: After refinancing during the last quarter, the CEO James Zelter noted: "They came out with numbers that definitely surprised us" and we "thought the exposure was too large given the new information" so we "monetized a chuck of the position which obviously realized a loss" and as "new information comes out we will reevaluate" our position accordingly

Cengage - Company
Apollo - SeekingAlpha

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