Houghton Mifflin Harcourt (HMHC) Linda Kay Zecher on Q2 2016 Results - Earnings Call Transcript

| About: HMH Holdings (HMHC)

Houghton Mifflin Harcourt Co. (NASDAQ:HMHC)

Q2 2016 Earnings Call

August 04, 2016 8:30 am ET

Executives

Rima Hyder - Vice President-Investor Relations

Linda Kay Zecher - President, Chief Executive Officer & Director

Joseph P. Abbott - Chief Financial Officer

Analysts

Jeffrey D. Goldstein - Morgan Stanley & Co. LLC

Peter P. Appert - Piper Jaffray & Co. (Broker)

Andre Benjamin - Goldman Sachs & Co.

Trace Adair Urdan - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Daniello Natoli - Oppenheimer & Co., Inc. (Broker)

Jeffrey Marc Silber - BMO Capital Markets (United States)

Jason Boisvert Bazinet - Citigroup Global Markets, Inc. (Broker)

William A. Warmington - Wells Fargo Securities LLC

Drew Crum - Stifel, Nicolaus & Co., Inc.

Operator

Good morning and welcome to Houghton Mifflin Harcourt's Second Quarter 2016 Earnings Call. I would like to inform you that this call is being recorded for broadcast and that all participants are in a listen-only mode.

I would now like to introduce Rima Hyder, Vice President, Investor Relations for Houghton Mifflin Harcourt. Ms. Hyder, you may begin.

Rima Hyder - Vice President-Investor Relations

Thank you, Candice, and good morning, everyone. Before we begin, I would like to point out that the slides we will reference during the course of this presentation can be accessed via the Investor Relations section of the Houghton Mifflin Harcourt website at www.hmhco.com. A replay of today's call will be available via phone until August 11, and the webcast will be available on our website for one year. We filed our financial statements and quarterly report on Form 10-Q with the U.S. Securities and Exchange Commission earlier this morning, along with our second quarter 2016 earnings release.

After our prepared remarks, we will open the call to questions from investors. To be fair to everyone, please limit your questions to one plus a follow-up. You may get back into the queue, if you have additional questions.

Before we discuss our results, I encourage all listeners to review the legal notice on slide 2, which explains the risks of forward-looking statements and the use of non-GAAP financial measures. Additionally, please refer to our Forms 10-K and 10-Q for a discussion of risk factors that could cause actual results to differ materially from these forward-looking statements.

Our slide presentation and discussions on this call will include certain non-GAAP financial measures. For such measures, reconciliation to the most directly comparable GAAP measures are in the appendix to the presentation. This non-GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similarly entitled measures reported by other companies.

This morning, Linda Zecher, Houghton Mifflin Harcourt's President and Chief Executive Officer, and Joe Abbott, HMHC Chief Financial Officer, will provide an overview of the company's second quarter 2016 results.

I will now turn the call over to Chief Executive Officer of Houghton Mifflin Harcourt, Linda Zecher.

Linda Kay Zecher - President, Chief Executive Officer & Director

Thank you, Rima, and thank you to everyone joining the call. Today, we are here to report our second quarter results where we continued to maintain our leadership position in the core domestic education market and also advanced several initiatives focused on deepening our core offerings and expanding into adjacent markets.

We are in the midst of our busy selling season and are seeing continued strength in the fundamentals of our business; however, in light of the current trends we see developing across our business, we believe it is prudent to update our full-year 2016 guidance for net sales and billings. We are confident in our ability to finish the year in our revised guidance range, and we believe we are well-positioned for success and to deliver above-market performance for the year.

There are two main factors driving our revised outlook. First, the 2016 new adoption market is smaller than we originally anticipated. Second, while we are seeing good traction with the EdTech business and expect it to be a significant growth driver going forward, we now expect a lower growth rate for our first full year of ownership. Joe will provide additional details on these drivers in a few minutes.

Our sales composition and the phasing of our selling season sets us up a little differently this year. This year, we ended the second quarter with greater visibility into our performance through the remainder of the year than we had in 2015, and we are confident in our revised outlook for 2016. Our reasons for this confidence are threefold.

First, we ended the second quarter with a higher-than-usual volume of open orders. The vast majority of these open orders represent our customers' intent to purchase and our ability to invoice and ship products in the second half 2016. As we are in the third quarter now, we have already started to convert some of these orders to billing. Second, we have a robust pipeline of sales opportunities for the remainder of the year across our business, and we continue to capture key education wins across the nation.

Third, based on reported wins in the new adoption market, which is our most visible market at this point of the year, through the second quarter, we believe we have captured market share in excess of 40% nationwide. We believe our solid performance is a testament to the strong fundamentals of our business, our top-performing core products, and our industry-leading sales force.

Now, I'd like to talk about some of our best-in-class core K-12 programs that continue to perform well. We continue to innovate and develop our core products. HMH is at the forefront of the digital evolution, and we are continuously enhancing and developing solutions that are interactive, adaptive, and are integrated to HMH's core curriculum.

We recently announced the launch of HMH Field Trips in collaboration with Google Expeditions, a virtual reality platform built for the classroom where teachers can guide students through a virtual field trip using smartphones and 3D cardboard viewer. As a built-in part of HMH's Science and Social Studies program, these virtual field trips are designed to seamlessly integrate with lesson plans, further enhancing the educational power of core curriculum.

Digital experiences are a major component of our new Science program which is being built from the ground up with the Next Generation Science Standard, or NGSS, adopted by 18 states so far. Within NGSS, there are three distinct and equally important dimensions to learning science. These factors call on educators and students to do more and engage in science and engineering practices. As a result, our program is rooted in the idea that content and practice are intertwined, and we are leveraging the power of technology to enable us to deliver one of the most innovative programs HMH has ever brought to market.

Social Studies is another area where HMH is enhancing its programs with more interactive digital experiences to engage students and advance to significant upcoming new adoption opportunities. Our new Social Studies program will feature an effective combination of print and digital instruction asset, including HMH Field Trips. We have also made the program more modular to accommodate a flexible purchase model.

Looking forward, as other core curriculum changes further down the pipeline, we are making exciting changes to our Reading program to reflect best-in-class fiction, non-fiction, poetry, and drama. We are also incorporating more interactive and digital delivery materials and introducing a highly flexible instruction program to fit a wide variety of future needs. These and other improvements are based on research findings and input from experts in literacy and reading education.

We also continue to be excited about our new Marketplace for supplemental educational resources and technology. Since the launch of HMH Marketplace last quarter, we have seen strong momentum within this online platform, and believe this is a result of our company's core focus on creating and delivering best-in-class content, technology, and services. That focus allows us to better understand the value and hard work that goes into making great content, and we believe this message is resonating with teachers and developers.

Since launch, the number of listings within the Marketplace has nearly doubled, and we've continued to onboard new sellers including Google, and we have launched additional ways to enhance the community experience in the Marketplace by providing a system for ideation and area for thought leadership and deeper integrations with social media. Our listing approval process also helps to ensure that our Marketplace serves as an extension of our core brand and a new distribution opportunity and provides a safe environment for our customers and the teacher community.

Moving on to our strategic growth areas. We are continuing to make progress in important adjacent markets which build on the strong foundations in the K-12 and Trade content spaces. In intervention, our READ 180, MATH 180, and System 44 programs continued to improve the learning experience of students around the country. After the successful pilot launch of READ 180 Universal earlier this year, we released the new programs to schools across the nation in June, completing an important milestone in furthering our intervention product strategy.

This next-generation intervention program builds upon READ 180's successful foundation and incorporates the latest research to create an innovative platform focused on brain cognitive functions. We are very excited about this new offering, particularly because of the critical link with HMH's core Reading curriculum. This makes us the only content provider with an end-to-end capacity for integrating struggling readers seamlessly into mainstream classrooms. We believe READ 180 Universal will be a meaningful growth driver for the intervention business.

In professional services, we've seen increasing demand for our expertise as schools choose HMH to help them address the challenges of a changing education landscape. Accordingly, our open orders in the business have grown meaningfully. As we continue to deepen our relationship with schools, we are further encouraged by recent findings at our second annual Educator Confidence Report, which examines educator sentiment on a range of issues including technology used in the classroom and professional learning opportunities. The findings in this Report give us a clear snapshot into the needs of K-12 teachers in the U.S.

Technology in the classroom is an area where teachers' appetites for digital tools are matched by their desire for professional learning and targeted solutions that can help ensure these tools truly improve learning outcomes. A stunning 84% of educators reported reaching into their own pockets each year to pursue their own professional development. This finding emphasizes the need for a complete integrated solution combining our best-in-class content with our capability for delivering high-quality and trusted professional development services. The complete report is available on our website at hmhco.com.

In our consumer business last quarter, we saw great strength in Curious World, our interactive early learning platform for kids two to seven years old, which has just reached the 1 million download mark. To increase awareness and benefit communities nationwide this summer, we have been taking the Curious World brand on the road in the form of experimental Curious World Tour. Serving as a playful learning experience in the nine markets coast-to-coast and focusing on key states such as Texas and California, the tour has reached nearly 20,000 kids and parents and delivered millions of impressions through out-of-home promotion and earned media.

Our Trade segment continues to perform well. We have many best sellers and pursue new strategies for growth in the business. Our best-selling titles this quarter were culinary titles such as Meathead, The Whole 30, Weber's New American Barbecue, and additionally, TED Talks, our first title in the business book line.

Last quarter, we told you about the important steps we are taking to upgrade and stabilize our platforms and technology infrastructure including HMH One and SAP. This investment in re-platforming is an important step in the evolution of HMH, enabling us to efficiently support new business models, reduce costs over time, and deliver a best-in-class experience to our customers. I'm pleased to tell you that we have completed our back-office integration of the EdTech business, and we expect to see the integration synergies from this acquisition in the second half of the year.

2016 is an investment year for HMH in many ways. In addition to investing in our infrastructure and the EdTech integration, we are also making important investments on our core product offering and in important strategic growth areas in order to help offset the variability of the domestic education market. We have a robust pipeline of innovation which we believe will help enable us to remain the market leader in the education space, while also investing in strategic growth markets to expand our customer base. As we continue to demonstrate our transformation into a prominent educational media company, we are excited about our current pursuit to exploit our rich intellectual property by producing original content that underscores the company's expansion into media production.

Before I turn the time over to Joe, I'd like to reiterate that our best-in-class products continue to be in demand in school districts across the country, and we remain confident in the power of our content. We are committed to drive a learning transformation and generating value for shareholders, both now and in the long-term. We remain confident in our growth strategy and our performance for the remainder of the year.

Now, I'll let Joe walk you through our quarterly results.

Joseph P. Abbott - Chief Financial Officer

Thank you, Linda, and good morning, everyone. Before I explain the drivers behind our revised guidance, let me quickly recap the quarter. We ended the second quarter with a 3% increase in net sales of $392 million; while billings, which we calculate as net sales taking into account the change in deferred revenue, were $413 million, or 5% lower year-over-year.

The improvement in net sales was largely attributed to the addition of the EdTech business, along with higher growth in international. This was partially offset by lower domestic revenue due to a smaller new adoption market and an increase in open orders. We also saw growth in Trade, primarily due to our best-selling culinary titles that Linda mentioned.

While we saw an increase in overall net sales, our billings were adversely impacted, primarily by the smaller domestic education market, as well as the previously mentioned increase in open orders. As Linda mentioned in her remarks, we saw higher year-over-year open orders through the end of the second quarter. These open orders were essentially backlog, which will become future billings as we ship the product to the customer. We expect most of these open orders to convert to billings in the second half of 2016. For example, the late June release of READ 180 Universal meant some schools will not receive their orders until Q3. In fact, through July, we're off to a good start in converting this backlog to billings.

Moving down to P&L, net loss in the second quarter of 2016 was $28 million, an unfavorable change of $20 million compared with a net loss of $8 million in the same quarter of 2015. The increase in net loss was largely due to higher costs, higher interest expense of $3 million mid-quarter resulting from our larger term loan, as well as a lower income tax benefit. These factors were partially offset by the increase in net sales.

Adjusted EBITDA for the quarter was $75 million; $5 million lower than prior year. This was primarily due to higher fixed costs attributed to the EdTech business, and increased cost of sales due to higher net sales. The third quarter will be our first full quarter in 2016 that would be directly comparable to 2015, and we expect our selling and administrative expenses can benefit from the EdTech integration savings.

Another key metric that we have disclosed in the past is post-plate adjusted cash EBITDA, which is adjusted EBITDA that takes into account the change in deferred revenue and our content development, or plate costs. This quarter, the change in deferred revenue was $21 million versus $56 million last year. The smaller change in deferred revenue was due to changes in our product mix as well as continued recognition of deferred revenue from the larger new adoption opportunities in 2014 and 2015.

Content development costs for the second quarter were $32 million, $5 million higher versus the same period last year. As we have stated before, content development spend is higher than last year, mainly due to the inclusion of the EdTech business and to support the upcoming new adoptions in 2017 and beyond.

As of June 30, 2016, we had cash and cash equivalents and short-term investments of $98 million compared to $432 million at year-end 2015. As a reminder, given the seasonality of our business, we typically use cash for operating activities in the first half of the year and generate cash in the second half. Partly explaining our increase cash usage relative to the last year is our ownership of the EdTech business through the first six months of this year versus just one month in 2015.

Back to our core business, the EdTech business generated negative free cash flow for the first half of the year. On a consolidated basis, free cash flow for the six months ended June 30, 2016, was a usage of $290 million compared with a usage of $212 million for the same period in 2015. The lower free cash flow was driven by the factors impacting operating cash and higher capital expenditures that I just spoke about. These factors amongst others also impact our expected full-year 2016 free cash flow.

Consistent with our guidance, we expect higher capital expenditures for content development this year for the reasons I've just stated. We are on track to meet our full-year guidance on this metric of $120 million to $140 million.

PP&E CapEx is expected to be higher due to our ongoing investments in infrastructure and platforms to support our continued growth and to improve profitability. These investments include systems and platforms like SAP and HMH One, new product builds and enhancements, and moving to new office space.

Additionally, while we expect to continue to drive efficiencies in working capital, we expect a more muted impact of free cash flow this year from changes in working capital this year relative to prior periods. Finally, interest is also expected to be higher due to our larger term loan.

Let me now provide you with some details behind our revised guidance. As you saw in our earnings release, our net sales are now expected to be between $1,485 million and $1,555 million; and billings are now expected to be between $1,525 million and $1,595 million. There's no change to our content development spend guidance of $120 million to $140 million for the year. The revised guidance reflects our reduced outlook for the 2016 new adoption market, as well as lower-than-expected sales from EdTech business in our first full year of ownership.

To provide you further detail in these drivers starting with the new adoption market. A major contributor to our revised outlook is in the State of California in both our core and EdTech businesses. As we have previewed with you on our first quarter call, many districts in California delayed purchasing English language arts materials in 2016, opting to conduct those purchases in 2017 and beyond. Many of the districts that have extended their purchases have historically been HMH customers, and a large proportion of those extended opportunities are in the K-5 portion of the market, an area of particular strength for HMH.

In total, we now expect that 2016 will represent approximately one-third of the total California reading adoption opportunity versus our initial estimate of 50%, leading what we believe to be a substantial selling opportunity for 2017 and beyond. Partially offsetting the reading delay is the third-year extension of the Math adoption that we discussed with you in the first quarter of 2016.

On the EdTech business, sales are being impacted by the California English language arts adoption delay where a majority of the purchasing decisions for intervention solutions have also shifted out to years two and three. Overall, our growth rate in this business has been lower than we expected this year. And while we still expect EdTech to be a strong contributor for 2016, we are expecting the full benefits of our integration in combined businesses to accrue in 2017 and beyond.

We have a strong portfolio of solutions and services including our new READ 180 Universal product, which was ready for general release in the third quarter, and we expect this product to be the undisputed leader in intensive reading intervention as with the case with its predecessor, READ 180.

Now, for an update on our share repurchase program. During the quarter, we've repurchased $20 million in shares, leaving approximately $486 million, or less than 50%, available for future repurchases under our $1 billion aggregate authorization. As I mentioned last quarter, we are examining and refining our capital strategy which incumbents as a framework to both capital structure as well as our capital allocation priorities. As this develops, we look forward to updating you in upcoming quarters.

In summary, we are on track to execute against our strategy. The trajectory of the business gives us further confidence that we have the right plan in place to create shareholder value. We entered the second half o the year with several key wins and encouraging level of open orders, and a strong pipeline of sales opportunities for both core education and growth markets. We are confident in our course for the remainder of 2016 and maintaining our market share, and we look forward to updating you at our next earnings call.

We also plan to hold an Investor Day in New York City on December 14, and we'll update you with details as we get closer to that date.

With that, Linda and I would be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. And our first question comes from Jeff Goldstein of Morgan Stanley. Your line is now open.

Linda Kay Zecher - President, Chief Executive Officer & Director

Good morning, Jeff.

Jeffrey D. Goldstein - Morgan Stanley & Co. LLC

Good morning. It seems like the adoption market was weak for the industry as a whole in the quarter, but are you able to give a sense of your growth there and how you think you're performing versus competitors?

Linda Kay Zecher - President, Chief Executive Officer & Director

Well...

Joseph P. Abbott - Chief Financial Officer

Hey, Jeff; it's Joe. Good morning. So, you're right. I mean, relative to last year, certainly, we've seen the adoption – the new adoption market lower. What we've said in our remarks here is that as we sit here today and look at our win rate in the new adoption market, really the new adoption market is the most visible market where we can start to gain and picture in terms of our competitive performance. We're seeing a win rate in excess of 40% across the nation today. So, hope that gives you a little bit of color there, overall. But, yeah, you're right; relative to last year, the new adoption market is a lower opportunity this year, we think for the full year.

Jeffrey D. Goldstein - Morgan Stanley & Co. LLC

Okay. That's helpful. And then, I just want to ask a bigger-picture question on free cash flow. Looks like in 2014, you saw a $300 million-plus number which was largely driven by the large Texas adoption, but then we saw a down number last year. And I just want to go back to your Investor Day where you indicated a 2019 goal of about $450 million or so in free cash flow. So, I just want to know if that type of figure is still attainable and what kind of path we could expect to get there.

Joseph P. Abbott - Chief Financial Officer

Yeah. Sure. Good question. Look, one of the things I think that I said in my first earnings call last quarter and then I'll say again here is that we see a tremendous amount of operating leverage in this business and a lot of free cash flow generation potential here. As I said in my remarks, we are expecting that due to some of the CapEx increases that we're seeing this year certainly given the mix of opportunity that we're seeing this year versus last year and prior years that free cash flow will be impacted for this year. But, overall, in the future, we see a lot of free cash flow generation potential in this business.

Jeffrey D. Goldstein - Morgan Stanley & Co. LLC

Thank you.

Operator

Thank you. And our next question comes from Peter Appert of Piper Jaffray. Your line is now open.

Linda Kay Zecher - President, Chief Executive Officer & Director

Good morning, Peter.

Peter P. Appert - Piper Jaffray & Co. (Broker)

Good morning. So, the weakness in EdTech, you mentioned California specifically, but anything else you'd call out? I'm a little bit surprised to see that softer here in the context of what's going on in the industry.

Linda Kay Zecher - President, Chief Executive Officer & Director

We really don't see weakness in EdTech. What we see is that in the California market, in particular this year, that most of the EdTech is really going into the second and third year adoption. And one of the reasons for that and we've been a lot surveys with schools and teachers, et cetera, is that because they have had such a long time between new materials, last year, they went to new math program. This year, they have a new reading program. And so intervention is really going to be the second and third year. So, this is really a timing related to California; it's not an asset performance issue at all.

Peter P. Appert - Piper Jaffray & Co. (Broker)

And then following up on that, then the markets apart from California, you're seeing year-to-year growth in EdTech sales?

Linda Kay Zecher - President, Chief Executive Officer & Director

Yes. As Joe said, we expect to have good growth in EdTech this year, and we expect it also to be very strong in 2017 and 2018. So, we're very confident in the business and it is going to contribute to the bottom line this year. Again, this is just a timing issue with California.

Peter P. Appert - Piper Jaffray & Co. (Broker)

Got it. Thank you.

Operator

Thank you. And our next question comes from Andre Benjamin of Goldman Sachs. Your line is now open.

Linda Kay Zecher - President, Chief Executive Officer & Director

Good morning, Andre.

Joseph P. Abbott - Chief Financial Officer

Hey, Andre.

Andre Benjamin - Goldman Sachs & Co.

Hi. Good morning. On the California topic, is the reason for the delay pretty uniform, why people are pushing out, or is there any kind of nuance as to – I guess, the main things that I would think about are budgets cuts, budget allocation being allocated to other things besides basal content or (25:43) I just want to get a better understanding of the nature (25:48)

Linda Kay Zecher - President, Chief Executive Officer & Director

Yeah, Andre, it's not budget related at all. The funding is there and, in fact, California actually put more funding into education than ever before. So, it's not a funding issue. It's a timing issue. And as you go out, you visit some of these schools and you see what they're dealing with, they've been so long without new materials that last year was a major Math adoption, especially in the K-8 area. It's a big deal for teachers to take on a new path program and get that going and then turn around and take a new reading program with all the professional development, et cetera, that's needed around that.

So, in an area that we are particularly strong, which is in the K-8 area, we're seeing a delay primarily because just year-over-year it's hard to get all of the teachers trained, it's hard to implement new programs at the same time. So, definitely not a funding issue and definitely a timing issue. And you would see, if you looked at – and I'm sure you've done some surveys in California, you'll see that a lot of major districts have moved their decisions out. And L.A. only did a portion of their adoption this year, and big portion of their adoption will be next year and the year after.

Andre Benjamin - Goldman Sachs & Co.

Thanks. And is there any change in the mix of what you're seeing in terms of how much schools purchased, that is digital versus print? I know that there's a mix, but any change in the percentage mix and any comments you can talk about as to how that tends to vary by subject? I would imagine the STEM subjects are higher?

Linda Kay Zecher - President, Chief Executive Officer & Director

Yeah. Last year, we did math as a major adoption and, of course, in Texas and in California, and Math is a much stronger digital sale than language arts. But again, we've moved all of our development into digital first. And so, we're developing everything digital, but reading programs generally carry more of a print mix, especially in the K-6.

Andre Benjamin - Goldman Sachs & Co.

Thanks.

Operator

Thank you. And our next question comes from Trace Urdan of Credit Suisse. Your line is now open.

Joseph P. Abbott - Chief Financial Officer

Good morning, Trace.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Thank you.

Linda Kay Zecher - President, Chief Executive Officer & Director

Hey.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

I wondered if you guys – if you might be able to help explain what your expectation was specifically for California and how that's changed, because by my reckoning, the math doesn't really add up. You're reducing your billings guidance by $100 million, which really can't, I think, be explained by California alone. So, I wonder if you could speak to that.

Joseph P. Abbott - Chief Financial Officer

No. Trace, we're not going to break out the specifics associated within an individual state as we go through the year. California is a driver – it's a major driver of the reduction in the outlook for the full year. But just the fact that this year, in particular, in EdTech we expect the higher growth still – we still expect a good growth this year. We're just expecting most of the fruits of the EdTech acquisition to really start bearing fruit in 2017 and beyond.

And California contributed – and the California adoption and (28:52) contributed to – as Linda said, contributed to our view on the EdTech business as a whole and its growth rate in this given year. So, those are your two major drivers. As we look at this, we're not going to break out the specifics or the parts of that, but those are the two large contributors there, Trace.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Okay. Just a follow-up then, can I ask if you – Simba sizes the California adoption opportunity at $300 million. Do you dispute that? Do you see that as something higher than what Simba says?

Joseph P. Abbott - Chief Financial Officer

Are you talking about in totality?

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Yeah. That's -

Joseph P. Abbott - Chief Financial Officer

(29:32)

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

The K-8 adoption, they have sized at $300 million.

Joseph P. Abbott - Chief Financial Officer

We're not – yeah, that's in the ballpark. That's right.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Okay.

Operator

Thank you. And our next question comes from Ian Zaffino of Oppenheimer. Your line is now open.

Daniello Natoli - Oppenheimer & Co., Inc. (Broker)

Yeah. Hi. This is Dan Natoli on for Ian. Just circling back on the EdTech business and in terms of the performance there, I mean, was that specific regionally again to California or are there also some other issues there related to integration or just the growth outlook? Maybe if you could just give us a better sense of the EdTech going forward and what that may mean, not necessarily as a point estimate but perhaps a range of outcomes? Thanks.

Linda Kay Zecher - President, Chief Executive Officer & Director

Well, actually, the EdTech business overall is pretty strong. I think we just had higher expectations, obviously, in the first year, California, and we're now finding that most of that is moving out. But the EdTech business overall is strong.

Now, our READ 180 Universal program, that has just been released and that's coming out in Q3. We've been piloting that. In Q2, we announced the pilot program. And now, general release is coming out now. And the pilots have been extremely successful. So, we feel very, very good about the business.

As far as the integration, as Joe mentioned, the integration has been completed and we will see some of the savings from that in the second half of the year, but we feel very good about the integration. We feel very good about the product. We feel very good about the acquisition of EdTech. So, this is a timing issue, again; it is not a product issue.

Daniello Natoli - Oppenheimer & Co., Inc. (Broker)

Okay. Great. Thanks.

Operator

Thank you. And our next question comes from Jeff Silber of BMO Capital Markets. Your line is now open.

Jeffrey Marc Silber - BMO Capital Markets (United States)

Thanks so much. Just want to go back to the beginning of the year. I believe you said you expected the core domestic addressable market in 2016 to be somewhat comparable to last year which was about $2.7 billion. Is that still the case? If not, how much lower you think it'll be this year?

Joseph P. Abbott - Chief Financial Officer

Well, you're going to have – Jeff, you're going to have the reduction in the new adoption portion in that market. Certainly, that contributes to this. As we said, California, which is a big contributor there, is going to push out. Open territory, we think, is actually – open territory we think is – we're seeing some encouraging signs there. I think, entirely, too early to call in terms of the overall performance in that market, but clearly, if trends continue, that can be countervailing effect. In total, no real update overall other than to say that, clearly, it's a smaller market now. If we look at the new adoption portion, certainly, contributing here and kind of stick with our estimates and what we're expecting in terms of the open territory portion of the market.

Jeffrey Marc Silber - BMO Capital Markets (United States)

All right. You also have talked a little bit in your prepared remarks about free cash flow; I think it was down about $80 million year-to-date. I know it's back-half loaded but on a year-over-year basis now that you'll have the anniversary of the EdTech acquisition, do you think free cash flow in the second half of the year will be up or down versus the second half of last year? Thanks.

Joseph P. Abbott - Chief Financial Officer

Yeah. We're not going to provide guidance at this stage on free cash flow, but we are planning to give you a lot more color and detail about how to think about free cash flow in this business and the free cash flow generation power of the business as we move to the back half of the year, in particular, in the Investor Day in December.

Jeffrey Marc Silber - BMO Capital Markets (United States)

Okay. Thank you.

Joseph P. Abbott - Chief Financial Officer

Sure.

Operator

Thank you. And our next question comes from Jason Bazinet of Citi. Your line is now open.

Linda Kay Zecher - President, Chief Executive Officer & Director

Hey, Jason.

Jason Boisvert Bazinet - Citigroup Global Markets, Inc. (Broker)

Hi. Thanks. Good morning. If I go back to your Analyst Day about a year ago, you talked about tripling market share in a couple of areas, consumer market, at services, and intervention. I think if I penciled out the numbers right, a year ago, that was about a $400 million sort of opportunity if you hit your goal. And my question is this, is there any of the efforts that you've made in the last year impacting revenue today? In other words, is any of the top line benefit of your efforts manifesting themselves in the income statement yet or is it still to come? Thanks.

Linda Kay Zecher - President, Chief Executive Officer & Director

We're going to talk – I mean, we've been talking about our adjacent markets. We're going to talk about more of that in end of Q3 and in the back half of the year. But we are seeing good growth in our services, and we're very excited about what we're doing in services. We are also continually excited about particularly in consumer and early childhood, and we think those are still very strong growth opportunities for us.

Jason Boisvert Bazinet - Citigroup Global Markets, Inc. (Broker)

Okay. But no comment on whether or not any of your efforts are actually impacting the top line today?

Joseph P. Abbott - Chief Financial Officer

Now, look...

Linda Kay Zecher - President, Chief Executive Officer & Director

They are.

Joseph P. Abbott - Chief Financial Officer

Yeah. We are seeing growth in adjacent portions of the business. We're not breaking out any of the specifics associated with that today, but that continues to be a key portion of our strategy, as well as driver of growth for us both this year as well as in the future.

Jason Boisvert Bazinet - Citigroup Global Markets, Inc. (Broker)

Okay. Thank you.

Operator

Thank you. And our next question comes from Bill Warmington of Wells Fargo. Your line is now open.

William A. Warmington - Wells Fargo Securities LLC

Good morning, everyone. So, a follow-up question on the EdTech business. If you strip out the California from the performance in the quarter, how much did the EdTech business grow?

Joseph P. Abbott - Chief Financial Officer

Yeah. We're not going to give specifics around individual growth rates within the businesses right now, Bill, but we've got the contributing factor of California moving out. We've also got, in general, just a lower growth rate than we expected in the first full year of ownership. But, again, as Linda said, we see a lot of growth in the future for this business as we move forward. But the comment really is about effectively the first full year of ownership. California is – and the move out, and the ELA adoption there on the intervention side is contributing to the growth rate this year. We still see EdTech being a strong contributor. And in total, we think that EdTech probably a double-digit grower for us on the top line.

William A. Warmington - Wells Fargo Securities LLC

And a follow-up question for you on free cash flow. I know that there are a lot of variables around free cash flow. It sounded like one of the more challenging ones on the working capital side was going to be less of a factor in the second half. But I was going to ask if you could maybe talk about a framework for how we can look at free cash flow as a percentage of billings for the year, not first half versus second half, but just kind of what would be a reasonable range that you're thinking about for free cash flow as a percentage of billings?

Joseph P. Abbott - Chief Financial Officer

Yeah. Same answer is that, yeah, we're not providing annual guidance on that nor we've provided on the back half. But I will tell you, we do want to provide you that framework in a way to think about free cash flow. We plan to do that as we move through into the back half of the year, certainly by December Investor Day.

William A. Warmington - Wells Fargo Securities LLC

Okay. All right. Thanks very much.

Joseph P. Abbott - Chief Financial Officer

Sure.

Operator

Thank you. And our next question comes from Drew Crum of Stifel. Your line is now open.

Drew Crum - Stifel, Nicolaus & Co., Inc.

Okay. Thanks. Good morning, everyone. So, I wonder if you could address your performance in the open territory states. According to the AP, that part of the market is up nearly 7%. And what are your updated expectations there? I think going into the year, you suggested that open territory is at a comparable rate to last year, which was about 2%. And then separately, I'm interested in your thoughts on your confidence level in the adoption schedule for 2017 amidst slow in tax receipts at the state level. Thanks.

Linda Kay Zecher - President, Chief Executive Officer & Director

On open territory, overall, it's kind of hard to measure until you're actually through the entire year. So, the numbers that you're seeing are really first half. And a lot of open territory happens in Q3. But we are very encouraged by the signs of the overall market growth and our own performance in open territory. But again, this is a market that's really difficult to measure, share, until we've really completed the year. But, overall, funding has been pretty strong in open territory, although there are some states that have been a little burdened by the impact of depressed energy. But, overall, we're feeling pretty good about open territory and there's a lot of demand.

I think you're second question was around what's happening with other adoption markets. The only thing that we are seeing so far and there has been some word about Texas and what's happening with Texas, and Texas is looking at potentially moving their reading adoption out for one year. It's not a funding issue; it's a timing issue with getting their TEKS completed. Funding will still be there, but overall, other than that, we're still seeing a very strong adoption market. And there are some benefits in that California next year will be moving more into 2017, with Texas potentially moving out to 2018 and 2019. And that does change the outlook on 2019 in a positive way.

Joseph P. Abbott - Chief Financial Officer

Yeah. To be clear on Texas, Texas wasn't going to be a large opportunity as part of the 2017 stat, which I think is your question.

Linda Kay Zecher - President, Chief Executive Officer & Director

Correct. Correct.

Drew Crum - Stifel, Nicolaus & Co., Inc.

Okay. Got it. Thanks, guys.

Operator

Thank you. And our last question comes from the line of Trace Urdan of Credit Suisse. Your line is now open.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Thanks. I wanted to ask a clarifying question about the product that you have in the marketplace in California right now. I understand that you're introducing the new READ 180 product in the third quarter. That's part of the California adoption, so presumably, that helps your addressable market opportunity or it helps your market share. But I'm wondering if you can comment on specifically where you feel like you're performing in market share in California. I mean, you talked about 40% nationwide, but I'm wondering if we can get a read on how well you're doing or expect to be doing in terms of basal adoption in California relative to expectations?

Linda Kay Zecher - President, Chief Executive Officer & Director

Well, yeah, again, Trace, as you know, California is a three-year adoption. And just like Math was a three-year adoption, it's very difficult to measure market share until you get to the exact finish of the adoption. Many of the areas where we are particularly strong in K-6, K-8 have actually been moved out to the second and to the third year and accounts where we are very strong.

So, we're going to measure our market share in California based on three years, but we are feeling good about our program. And our program is based on our very strong, award-winning Journeys program with a lot of technology changes and enhancements. And then with the new READ 180 program that is out now, READ 180 Universal, we feel very good about the offerings that we have in California.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

The reason I asked, Linda, was that, I remember when you all – when the California reading first came into your sights, you all kind of made an active decision that you were going to sort of go for it with new material. But we're hearing that basically what you guys have in the market is not technically new, it's really just sort of a refresh of the product that you've been selling for the last eight years, whereas some of your competitors have brand-new product, and I want to give you an opportunity to address that question specifically. Is that accurate? Is that inaccurate? Can you comment on that?

Linda Kay Zecher - President, Chief Executive Officer & Director

Yeah. That is just not true.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Okay.

Linda Kay Zecher - President, Chief Executive Officer & Director

It is just not true. We used our industry-leading Journeys program as a foundation and we developed a new program on top of that based on the California standards with new technology, new enhancements, et cetera. Because it's still called Journeys, I think there's a perception out there that it's an older product and not the same – or and the same product that was in the market before, and that is just not true.

But as we look going forward at how we're going to version programs and so forth and our ability to sell enhancements, I think we have to stop thinking in terms of naming conventions and start thinking in terms of technology and enhancements that are in the program and what the opportunities are to add new unique features based on technology. For example, one of the very strong components of our Reading program in California is the Player, and we are the only program in California that offers pure, real fidelity between offline and online experience.

And that is a big deal when you are in a classroom, especially in some of the classrooms where they've got 30 to 50 kids, and you've got a building that has six classrooms, two classes per grade – or six grades, two classes per grade. And all of those kids need to be on the system at the same time. That creates bandwidth issues and you will have teachers tell you that they lose entire learning windows because they do not have an online offering. With our fidelity between on and offline, our ability to be able to continue with that program at that time in the classroom with no loss of learning and teaching time based on what's happening with bandwidth is a really significant portion of what we offer.

Also, our ability to bring in other content through the player and enhance the offering through that is a key contributor to what we think is going to change learning outcomes. So, we feel really good about our program, and the – I think that there is a lot of noise in the marketplace that is just not accurate. So, I appreciate the opportunity to be able to clarify that, Trace.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Okay. And thank you. That's very helpful. Just one final follow-up then. In the press release, when you're talking about the new READ 180 product, you make some kind of broader references to other enhancements that you anticipate that being potentially beneficial for the future. And I'm wondering if that's anything that you think you might put in place ahead of the Texas reading adoption or whether that would be maybe too soon for some of those developments?

Linda Kay Zecher - President, Chief Executive Officer & Director

Well, the Texas adoption will have our next generation reading program which we based on our HMH One platform. And that's something that we've always talked about because we're moving to even more digital as we go forward, similarly to what we're doing with next generation science and next generation social studies that we've talked about. So, this is really just reinforcing our versioning strategy. But again, we are continually moving more and more to – with innovations toward a full digital offering and that's really what the new platform is going to provide for.

In addition, just like we've incorporated adaptive learning in our Math curriculum, we're incorporating to our new platform an adaptive learning environment with our new Reading program.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Okay. I'm sorry. I didn't quite understand the significance of the new platform. Can you just explain that in a little more detail? Is that something that's available right now in the California adoption as well?

Linda Kay Zecher - President, Chief Executive Officer & Director

No. The new platform is something that we're coming out with next year and it will be part of our next generation social studies and next generation science. And one of the reasons, Trace, that we did not roll out the new platform in California is that because we had took such significant share with Math in California, we wanted to maintain the same platform in California that we have with our Math program because teachers do not want to be in a situation where they're using multiple platforms.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Understood. But you are anticipating that – so, when would the new platform be available? Starting in 2017 with other states besides California?

Linda Kay Zecher - President, Chief Executive Officer & Director

It's available now. It's something that we're building out right now with back-to-school with our new next generation social studies and next generation science program.

Trace Adair Urdan - Credit Suisse Securities (USA) LLC (Broker)

Okay. All right. Thank you, Linda.

Linda Kay Zecher - President, Chief Executive Officer & Director

You're welcome. Thanks, Trace.

Operator

Thank you. And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Ms. Zecher for closing remarks.

Linda Kay Zecher - President, Chief Executive Officer & Director

Well, thank you, everyone, and we appreciate you taking the time to join us on the call today. If you need any additional information, please contact Rima and our Investor Relations department. And we will talk to the end of Q3 and see you at our Investor Day. So, operator, this ends the call. Thank you very much.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day, everyone.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!