Houghton Mifflin Harcourt's (HMHC) CEO John Lynch on Q3 2017 Results - Earnings Call Transcript

Houghton Mifflin Harcourt (NASDAQ:HMHC) Q3 2017 Results Earnings Conference Call November 2, 2017 8:30 AM ET

Executives

Brian Shipman - SVP, IR

John Lynch - President & CEO

Joe Abbott - CFO

Analysts

Drew Crum - Stifel

Jeff Silber - BMO Capital Markets

Peter Appert - Piper Jaffray

Bill Warmington - Wells Fargo

Operator

Good morning, and welcome to Houghton Mifflin Harcourt's Third Quarter 2017 Earnings Call. I would like to inform you that this call is being recorded. [Operator Instructions] I would now like to introduce Brian Shipman, Senior Vice President of Investor Relations for Houghton Mifflin Harcourt. Mr. Shipman, you may begin.

Brian Shipman

Thank you, Chelsea, and good morning, everyone. Before we begin, I would like to point out that the slides referred to on today's call can be accessed via the Investor Relations section of the Houghton Mifflin Harcourt website at hmhco.com. A replay of today's call will be available until November 10, 2017, and a webcast will be available on our website for one year. Our 10-Q was also filed earlier this morning, along with our third quarter 2017 earnings release.

Before we discuss our results, I encourage you to review the cautionary statement on Slide 2, which explains the risks and forward-looking statements and the use of non-GAAP financial measures in the slide presentation and on today's call. Please also refer to our most recent Forms 10-K and 10-Q for a discussion of factors that could cause actual results to differ materially from these forward-looking statements. In addition, please refer to the appendix of the slide presentation for reconciliations of these non-GAAP measures to the most directly comparable GAAP measures.

After our prepared remarks, we will open the call to questions from investors. During the Q&A, please limit yourself to one question plus one follow-up. You may get back into the queue if you have additional questions. This morning, Jack Lynch, HMH's President and Chief Executive Officer; and Joe Abbott, HMH's Chief Financial Officer, will provide a company update, as well as an overview of the company's third quarter 2017 results. I will now turn the time over to Jack Lynch, President and CEO of Houghton Mifflin Harcourt.

John Lynch

Thank you, Brian, and good morning everyone. Before we dive into the results for the quarter, titled I will begin the call with an overview of our long-term strategic approach for HMH.

As we shared at our Investor Day, we are employing a strategy that we believe will position us for continued market leadership and long-term value creation. There are three key elements of that strategy. Number one, enhance and extend the core; strengthening our core Basal business while investing in faster growing, higher-margin extensions of that business.

Number two, delivering integrated solutions to our customers. And number three, focus on operational excellence to enhance our results. Combined we believe these three key elements of our strategy will enable us to generate attractive free cash flow through this cycle over the long term. So let me go into each of the three elements of this strategy in more detail.

First we have a renewed focus on strengthening our core Basal curriculum business to expand on our market-leading position as the innovator in this space. Furthermore, we plan to leverage our core Basal strengths to strategically expand into faster growing extension of that business in order to enhance our value proposition.

Second, we believe that the strength of our core business and growth into extensions uniquely positions HMH to be the only player in the industry that can offer a fully integrated solution to our customers. We shared with you at investor day some examples of how partnering with school districts to deliver tailored, comprehensive offerings to meet the broad needs of our customers can result in improved student outcomes. Districts are looking for one trusted partner to provide the components of these solutions, and enable them to work together seamlessly, and we believe our deep established relationships coupled with the breath of our product line will enable HMH to be that partner.

Third, operational excellence will continue to be a core tenant of our strategy as we strive to become a leaner and more efficient organization. As we shared with you last quarter, we have already made significant progress on our operational efficiency initiate since the start of this year. This will be an ongoing focus for HMH as we instil a philosophy of continuous improvement throughout the culture of the organization.

We believe this long-term strategy will enable us to generate attractive free cash flows through this cycle, allow us to invest in developing highly competitive, best in class education solutions for our customers and create value for our shareholders. Recently we completed an important first step in executing this strategy by putting in place the new executive talent that will help drive this forward.

Now for the results. In the third quarter due to factors that Joe will discuss shortly, on a consolidated basis net sales were essentially flat year-over-year, while billings were down 6%. Year-to-date through Q3 net sales were up slightly compared to the first nine months of last year, and billings were down 3%. Our free cash flow was an $84 million improvement for the first nine months of the year compared to the same period in 2016.

Now let me share with you some high-level thoughts on our segment results in a broader market environment. Year-to-date within our Education segment, which includes international, net sales were up slightly while billings were down 5%. The increase in net sales was primarily due to higher sales of our Extension businesses, partially offset by lower Basal sales, inclusive of international.

The addressable portion of the AAP market declined 6.5% year-to-date through Q3 across both adoption states as well as in the open territory states. In the adoption states, we have seen the market decline roughly 7%, and the open territory portion of the market declined by about 6% through the first nine months of the year. Recall that we expected the open territory states to grow in the low to mid-single digits, which to some degree would have offset the decline in adoption states, and resulted in a comparable addressable market size in 2017.

Against that backdrop, our Basal net sales decreased 5% and billings decreased 10% on a year-to-date basis primarily driven by the smaller market opportunity in both adoption and open territory states. First the adoption states. As a reminder, this portion of the market is made up of two categories, new adoption opportunities and residual or other opportunities. We are not participating in the new elementary social studies adoptions taking place this year in North Carolina, Georgia and Florida, but we have seen an increase in the size of new adoption opportunities where we are competing relative to our expectations at the start of the year, and we believe this market segment will be approximately at the same size as it was in 2016.

Contributing to this larger than expected new adoption market, our Texas [world languages] in grades 6, 12 social studies in Florida. The remainder of adoption state spending on residuals and other opportunities has declined through the first nine months of 2017 contributing to a 7% decline in addressable adoption state spending this year. While we did see some softness in open territories in the second quarter as we have entered the back half of the year, which is the busy selling season, we gain more visibility into purchasing patterns and saw that softness continue through the third quarter, particularly in math and reading, the largest disciplines by addressable market size.

While open territory has its own purchasing cycle, we believe that many districts in open territory states intent to time their purchases of LA and math to take advantage of new programs. We believe this tendency, as well as budget pressures in some portions of the country contributed to the lower than expected demand in the open territories this year.

Given the software market conditions we saw through September, we believe that it is now likely that our addressable market will be smaller in 2017 rather than flat to slightly higher, which is what we had assumed at the beginning of the year. We are evaluating how these market conditions may also impact our market outlook for 2018.

Now onto extensions. Net sales increased almost 7% and billings increased 2% on a year-to-date basis, primarily driven by Heinemann and our Supplemental solutions. Heinemann continues to lead our growth in the extensions on a year-to-date basis, driven by the highly regarded Calkins Libraries, as well as the new release of Fountas and Pinnell Classroom.

The supplemental increase was led by higher sales of custom book bundles. Both of these lines of business are benefiting from increased usage of balanced literacy approaches to reading and K12 classrooms. However, strong performance from Heinemann, as well as supplemental custom book rooms was partially offset by lower assessment and intervention performance within the extension businesses. As we transition to selling our new READ 180 Universal intervention program, we have experienced a temporary short-term negative impact on billings due to challenges in converting existing READ 180 customers to our new solution. Longer-term, we continue to see strong opportunities in extensions as we leverage the strength and distribution advantage of our core K12 business.

Now for our trade segment. Trade continues to be a strong contributor this year with net sales up 12% on a year-to-date basis, while billings grew 11% year-to-date. This growth has been driven by strong sales of ebooks like Handmaid’s Tale, as well as backlist titles like Whole30 and The Things They Carried. Finally, trade segment adjusted EBITDA is up 6 million year-to-date versus last year as a result of sales growth and the restructuring activities we completed earlier this year.

Looking ahead to larger opportunities coming in the next couple of years, I would like to emphasize that we are diligently focused on strategic investments to build the strength of our core curriculum products ahead of these adoption opportunities. We continue to make progress on our next-generation reading and math programs in anticipation of the larger upcoming adoptions in California, Texas and Florida. We remain on track with next-generation products for the 2018 science, and 2019 math adoptions in the state of Florida. We also remain on track for the California science adoption in 2019, and importantly we remain on track for the Texas reading adoption in 2019.

Regarding the California 2018 social studies adoption process, while no final decisions have been made, at this point HMH's [K-8] programs have not been recommended for approval. We will be disappointed if our [K-8] programs are not ultimately approved by the California State Board of education. But at this time we cannot comment further on the process. If we are not able to compete in this adoption, we estimate the impact to HMH in 2018 would be approximately equivalent to 1% of our total billings.

Now turning to our outlook for the rest of 2017. We are reaffirming the billings and net sales guidance we set on our February earnings call, and Joe will provide some additional commentary in a few minutes. Given that later than expected ramp up of our content development spend this year, as well as efficiency gains realized through our next generation program design efforts we now believe that content development spending is likely to fall at the low end or possibly below the low end of our guidance range.

This will have a similar effect on our total Capex spending for the full year. In summary, we remain confident and committed to our strategy for long-term value creation. As we shared at our Investor Day, this is a transformational time at HMH and that transformation is still ongoing, but we believe that we have the right products, the right team and the right strategy in place. We look forward to the opportunities ahead.

Now I will turn the call over to Joe. Joe?

Joe Abbott

Thank you, Jack, and good morning, everyone. Thanks for joining us on the call. To reiterate what Jack shared, despite the smaller than expected addressable market through the first nine months of 2017, we remain on track to deliver full year billings and net sales consistent with the guidance we set for the year back in February.

I will share a quick recap of the results of the first nine months, and then turn to the detail for Q3. On a consolidated basis, billings, which we define as net sales plus the net change in deferred revenue, were down $37 million or 3% for the first nine months of the year compared to the same period in 2016. Compared to the first nine months of 2016, our year-to-date Trade segment billings were up $13 million or 11% and our Education segment billings were down [$15 million] or 5%. Within the trade segment, the strength in billings was driven by sales of the Whole30 series and Tools for Titans, stronger ebook sales such as the Handmaid’s Tale and 1984, and backlist print title sales such as The Giver and The Things They Carried.

In addition, trade billings for the third quarter benefited from a favorable product return experience. Importantly, trade segment adjusted EBITDA improved $6 million to $9 million for the first nine months of the year and is becoming a solid contributor to our free cash flow generation for the company. We categorize our net sales in billings for the education segment into Basal and Extensions. Our Basal billings, which include both domestic and international sales, were down $60 million compared to the first nine months of 2016.

This was primarily driven by a smaller addressable market size across both adoption and open territory states, as well as a decline in international due to a large one-time Department of Defense order in 2016 that was not repeated in 2017. Partially offsetting the decline in Basal billings was a $10 million increase in extensions billings year-over-year.

Our extensions businesses primarily consist of Heinemann, intervention, supplemental and assessment products as well as professional services. The growth was largely due to Heinemann’s classroom libraries and launch of our Fountas and Pinnell Classroom offering, along with strong sales of supplemental custom book bundles.

Partially offsetting the increase within our extensions were lower billings in intervention and professional services. We continued to see extensions, which are within faster growing market segments of our addressable market, as key drivers of growth for HMH long-term. Adjusted EBITDA was up $12 million or 6% in the first nine months of 2017 compared to the same period in 2016, and our free cash flow year-to-date through Q3 was a usage of $92 million, an $84 million improvement compared to a usage of $176 million for the same period in 2016.

The largest driver of the improvement in free cash flow was reduced property, plant and equipment capital expenditures of $49 million as 2016 included expenditures to upgrade technology infrastructure and to relocate to new office locations. Also contributing to free cash flow was increased profit from operations of $20 million, [favorable net] changes in operating assets and liabilities of $9 million due in part to improvements in collections.

Turning now to our financial performance for the third quarter on a consolidated basis. Net sales for the third quarter were $532 million, down modestly year-over-year. Education segment net sales were $481 million, a $6 million decrease partially offset by a $5 million increase to $51 million in our Trade Publishing segment. In our Education segment, which again includes our Basal business and our extension businesses, net sales were down primarily due to a $6 million decrease to $294 million in our Basal business, inclusive of international, year-over-year slightly offset by modestly higher net sales in our extensions.

As Jack discussed earlier, the primary drivers of the decrease in our Basal business were lower net sales of Basal math and English language arts due to a smaller addressable market in both adoption and open territory states.

Our extensions business’s net sales of $186 million were flat year-over-year. Strong performances in the Heinemann business and supplemental were partially offset by lower than expected performance in intervention. Since we launched the new READ 180 Universal program last year, we have seen a good uptake by new customers, which drove strong billings growth in the first half of this year. However, we experienced lower-than-expected conversion rates by existing READ 180 customers to the new program, which did not include certain features that our existing customers valued in the previous version.

We have updated READ 180 Universal and subsequent releases to add these valuable features, and believe that these steps, along with the important new features introduced at launch, will improve our ability to convert existing customers and allow us to resume growth in this product line.

Within Heinemann, performance was largely driven by our Calkins Libraries, as well as release of our Fountas and Pinnell Classroom solution, which we expect to remain strong for the balance of the year. The primary drivers of the increase in our supplemental solutions were sales of custom book bundles. Within our trade business, net sales were $51 million, up $5 million, or 12% compared to the third quarter of last year. The increase in net sales for the third quarter was due to strong sales of ebooks such as Handmaid’s Tale and 1984, as well as backlist titles, including the Polar Express and Little Blue Truck.

Our consolidated billings were $584 million in the third quarter of 2017, a 6% decrease compared to the third quarter of 2016 primarily due to the same drivers affecting net sales. Our overall cost of sales decreased slightly to $254 million in the third quarter of 2017 from $255 million in the same period of 2016. Our cost of sales, excluding publishing rights and prepublication amortization, increased $4 million due to a product mix carrying higher costs.

Selling and administrative costs in the third quarter were $178 million, down $7 million compared to the third quarter of last year. This decrease was primarily due to operational efficiency initiatives undertaken as part of our 2017 restructuring plan. As you know, HMH is highly focused on operational excellence. As part of the operational efficiency initiatives related to our 2017 restructuring plan we saw a reduction in labor related costs of $5 million, and a $4 million decrease in discretionary expenses such as promotions, advertising, and travel and entertainment all due to actions taken under the 2017 restructuring plan.

Restructuring charges in the third quarter were $1.8 million, also related to our previously announced 2017 restructuring plan primarily driven by severance and termination benefits of $0.6 million, office space consolidation of $1.1 million and minor implementation and impairment charges. Overall, we now expect the total charges under the plan to be between $45 million to $49 million, of which $35 million to $39 million will be cash charges.

As we stated on our last quarterly earnings call, we have substantially completed all of our organizational design changes, which have helped us to streamline the organization and make HMH leaner and more efficient. Our other initiatives are expected to be complete by the end of 2018. For the third quarter, operating income grew $7 million from $83 million in 2016 to $90 million in the third quarter of 2017. This was largely due to decreased selling and administrative costs.

Our net income was $91 million, up modestly from the $90 million of net income we reported in the third quarter of 2016. Adjusted EBITDA for the third quarter of 2017 was $165 million, a decrease of $3 million from the $168 million in the same quarter of 2016 , primarily due to lower net sales and increased cost of sales.

Prepublication or content development costs were $31 million compared with $29 million for the third quarter of 2016 primarily due to investments in our next generation products. Property, Plant and Equipment or PP&E spending was $15 million during the third quarter, a 57% decrease compared to the third quarter of 2016 bringing total CapEx to $46 million for the quarter. I’ll discuss CapEx further in a few minutes.

During the first nine months of the year, our free cash flow was a usage of $92 million substantially improved from the usage of $176 million in the same period of 2016. As we’ve mentioned previously our core business is subject to seasonality and it is typical for us to use cash in the first half of the year and generate cash in the second half of the year. As of September 30, 2017, HMH had $210 million of cash and cash equivalents in short-term investments compared to $307 million at year end 2016.

Net cash provided by operating activities for the nine months ending September 30, was $38 million compared to $9 million in the same period of 2016. This was largely driven by more profitable operations, net of non-cash items of $20 million and by favorable net changes in operating assets and liabilities of $9 million.

As Jack mentioned we believe that our strategic investments in our core and extension businesses in offering an integrated solution for our customers couple with our commitment to operational excellence would drive value creation and in the long term improve our ability to generate free cash flow at all points through the cycle. As a reminder we expect the initiatives we’ve identified under our 2017 restructuring program for this year and next year will result in approximately $70 million to $80 million in annualized cost savings by the end of 2018.

Now turning to our outlook for the rest of 2017. As we shared with you earlier we believe that our addressable portion of the AAP market declined year-over-year through the first nine months of 2017. Given the relatively small contribution of the fourth quarter to the market size for the year, we expect that the full addressable AAP market in 2017 will be lower than 2016 compared to our original expectations were flat that’s how we are.

However, we remain confident that HMH is on track to deliver 2017 billings in net sales within the guidance range that we shared with you in February. Directionally given our results to-date and our outlook for the remainder of the year we believe that billings is likely to be towards the lower end and net sales is likely to be the upper end of our previously issued guidance ranges on these metrics. Additionally, because we began to ramp up content development later in the year then we had originally expected as well as efficiency gains through our next generation program design efforts we now believe that content development spend for 2017 is likely to fall at the low end or possibly below the low end of our guidance range.

We’re continuing to develop our next generation reading and math solutions and expect year-over-year content development spend increases in the coming quarters as we near the launch for these important new programs. But due to the lower content development spend expectation we also expect total CapEx to finish at or below the low end of our guidance. We do not expect any material change to the quality of commentary on adjusted EBITDA margin or free cash flow we shared with you in February.

Now Jack and I will take your questions. Chelsea will you please open the line for Q&A.

Question-and-Answer Session

Operator

Certainly. [Operator Instructions] And our first question comes from the line of Toni Kaplan with Morgan Stanley.

Unidentified Analyst

Hi, this is Jeff Goldstein for Toni. I want to ask just for some more color on why you think your addressable market declined in the quarter and with now and expected to the third year with declining addressable market. Is there any change of some type of structural shift, did you see more of a timing issue where maybe not you expect 2018 and 2019 just looking for, just more overall thoughts on the market environment?

Joe Abbott

Yes Jeff, its Joe. Thanks for the question. Couple of things really drive what we think happened, it was predominantly in the open territories that’s where we saw the decline in the addressable market and as we said in the remarks we think that there was some pressure from budget in certain pockets of the country. But also what we’re seeing is reading or English Language Arts I should say and math purchases that have started to slow. Now we think that that has a lot to do with where those open territory districts are in the replacement cycle for materials in the subject areas, if you think back four, five, six years ago with the real adoption of common core materials you’re really not quite to the full end of the useful life of the reading and EOI materials that are out there in the open territory. So we do think that as we the next couple of years come forward and new materials from us and others next generation materials are released, we’re expecting that the open territory spend in those categories will pick up again in the open territory.

Unidentified Analyst

And then just with free cash flowing improving each quarter so far this year I think you’re $84 million better for the year as a whole, how should we think in that your full year free cash flow guidance, I think you just mentioned that you expect free cash flow to be negative, still to be negative at the midpoint of your billings guidance. So just what are the big factors there that could try that number to be positive? Thanks.

Joe Abbott

So Jeff, what we said was no real change to the qualitative commentary on free cash flow relative to what we said at the beginning of the year and as you recall, what we had said was that we expected that we would have negative free cash flow this year with the potential to breakeven at the top end of our billings guidance range we just shared with you, we think now that will be towards the lower end of that billings guidance range and so we still expect that there is going to be negative free cash flow for the full year. However, we’ve seen lot of improvements year-over-year due to our operational efficiency initiatives as well as some great working capital management.

If you think about the drivers then going into the remainder of the year, one of the biggest of those is the ramp up on our content development spend as we look out and continue to get ready for those big program adoptions next year in Texas and Florida.

Unidentified Analyst

Okay, thanks guys.

Operator

Thank you. Our next question comes from the line of Drew Crum with Stifel.

Drew Crum

Okay, thanks, good morning everyone. Just I wanted to get your thoughts on your development and social studies programs going forward given your absence in Florida this year and I guess the lack of approval in California, does that in any way influence your content development decision making going forward, you got a couple of social study adoption opportunities into 2018 and 2019. And then, sticking the market outlook any update on Texas in terms of their plans to split elementary grades from secondary grades across multiple years with the reading adoption? Thanks.

Joe Abbott

Sure. Well, as it relates to California social studies just a quick point of clarification, the decision hasn’t been made there at this point in time, but that is something that we will be watching very, very closely here in the next coming weeks which is just that we want recommended by one of the preceding steps to core adoption. So just as a point of clarification, we want to make sure that that clear.

But Drew I think your question is, will we continue to develop our next generation social studies programs going forward for some of the opportunities and the answer is yes, we will I mean, we think that in the rest of the country we have a lot of opportunity both in the adoption states as well as the open territories with a very strong program and so we will continue to develop those programs for those other opportunities.

Your next question is any update on Texas and our plans, what that out, their plan has been to predominately focus on the adoption for K through 8 so that's K through 6 reading and then 6 through 8 literature for spending in 2019 and then the remainder of high school adoption will then push into the next year, so that's little consistent with the Texas plan.

Drew Crum

Got it, okay. Thanks guys.

Operator

Thank you. Our next question comes from the line of Jeff Silber with BMO Capital Markets.

Jeff Silber

Thanks so much. Appreciate the update on where you think the addressable market will be for this year, your addressable market. I am just curious from a market share perspective what you know now, how do you think you have done this year, what you think will be for the reminder of the year? Thanks.

Joe Abbott

Sure. Well, we think we have seen some modest degradation in share for the first nine months, I will tell you that the fourth quarter as you can see is implied by billings guidance that we are anticipating some growth there and we do expect that we will recover some of that share degradation but again it was modest and not a major driver of results in the education segment. It was more of the market size point, but we do think that there has been a small amount of share degradation through the first nine months of the year.

Jeff Silber

And would that be both from the adoption state and open territories?

Joe Abbott

Yes. Yes. It's broad-based across both segments of the market.

Jeff Silber

Okay, great. And then, I haven't had a chance to check your updated new state adoption schedule. Besides what you mentioned on social studies, anything else sometimes there is puts and takes there anything else you want to call out?

Joe Abbott

Yes. Nothing of major impact, I guess the only thing that we highlighted in the remarks was that Florida social studies is 6 to 12 portion a lot of those purchases went this year, occurred this year so as opposed to earlier expectations where we thought there might be more of a spread across 17 and 18, we are seeing a lot of those purchases have occurred in 17.

Jeff Silber

Great. And I think forgive me I didn't get all the commentary, but I think you said, you mentioned that what will happen if you could have an impact on the addressable market for next year? Can you give a little bit color on that?

Joe Abbott

Yes, sure. We are happy too. We are right now in the middle of our forecasting and budgeting process for 2018. We are continuing to monitor the situation in open territory very closely and it's what the impact that we have, we are not really to the stage where we can make a market share call, excuse me, a market size call, but that is something that we are watching very closely right now.

Jeff Silber

Okay, fantastic. And appreciate the details you gave us on net sales and billings between Basal and extension that's helpful.

Operator

Thank you and our next question comes from the line of Peter Appert with Piper Jaffray.

Peter Appert

Thank you, good morning. Jack, I am interested in your perspective on how the changed Pearson might impact the industry environment, the competitive environment whether it creates opportunities for you, just your sort of big picture view of it?

John Lynch

Peter just let me repeat the question and make sure I understand it. The question was how does, what Pearson is doing with your K12 business impact to market. Is that the question?

Peter Appert

That's the question and then specific opportunities, implications I mean obviously what I really want to know is, one of their pieces to that business it will be relevant for you?

John Lynch

Yes. I would say that for our part we see Pearson as a very strong competitor. We haven't seen a change in their competitive stance since the announcement of their strategic evaluation of their K12 segment and so they continue to compete very strongly in the market. And in terms of strategic value of the asset, we just don't comment on those kinds of potential opportunities.

Peter Appert

Okay, fair enough. And then Joe for you the – you were talking about the ramp in content development costs being slower. That's not a function of some efficiencies request being less. This is just the time issue I assume correct. And then does that then imply that the content development costs we should assume will be higher in 18 than otherwise might have been the case?

Joe Abbott

Well, timing to a degree but only in the sense Peter that what we have done is we have worked a lot of our program design process and in the – as we were doing that really through the last couple of quarters we slowed down the pace of actual capitalized work against the program. But we think what ultimately results is a much stronger and more competitive set of offerings for what we are launching next year. So I agree with at least part of your premise which is yes, it is timing. It causes us don’t start later but it's because of some of the efficiency improvements that we have introduced here. But we don't expect any massive amount of shift up in the 2018 and that is because we have reworked the process and we have actually, we think gained some efficiencies there. So it's not as though we are pushing a lot of that spend later in the process. It's just that we have started that later.

Peter Appert

Understood, okay. So does that you haven't given specific 18 guidance, can you give us any thought in terms of how we should be thinking about play cost on the go-forward basis then?

Joe Abbott

No. No specific forward-looking guidance. I think what we have said to you is part of the Investor Day comments is that relative to this year, which we had anticipated being a very large content development spend here that we were expecting as spend that slowed in science and social studies that we are anticipating 18 and 19 to be lower content development spend that's what we would expect in terms of the actual projects that we are working on. But we are not giving any specific role of guidance at this point other than to say, hey we know we are going to be lower this year than we originally anticipated. But now the relative size of that change is something that we don't yet have a full handle on but we will update you when we provide guidance in the fourth quarter call.

Peter Appert

Okay, great. Thank you and Shipman can beat me up later, but I am going to violate the rules here with another question and that is the trade business and the strength and earnings pretty noteworthy, historically business very hit driven. So some thoughtful changes to the driving profitability improvement and really how sustainable it is?

Joe Abbott

Yes, we are really proud of the trade business and the operational efficiency gains that we have been able to achieve this year. It was part of, at least in part the restructuring and operational efficiencies initiatives that we commenced earlier this year. So they saw some good progress there but also because they are having good billings throughout the year this year and you’re seeing some of that flow through.

Peter Appert

Okay, thank you.

Operator

Thank you. [Operator Instruction] And our next question comes from the line of Bill Warmington with Wells Fargo.

Bill Warmington

Good morning everyone. Just had a question for you on the cash flow 2016 versus 2017 if you could say little more, I want to understand what specifically is driving the improvement. You mentioned a lower CapEx levels but then it's also been some increase levels of investment there. And there has also been some cost takeout. So maybe if you could do a bridge 2016 to 2017 and then in that context if you want to throw any color on 2018?

Joe Abbott

Yes Bill, so on really kind of three major drivers as I think about it 2016 versus 2017 improvement there or something I should say. Post property plant and equipment, CapEx improvement is a big one or reduction I should say. Remember last year we had large IT infrastructure projects underway that we slowed down in 2017 and we also in 2016 had some onetime office moves that occurred in 2016 that obviously won't recur going forward now we have made those moves. But to-date you have seen about $49 million reduction in the PP&E CapEx line. So that's your biggest driver. There has been about $20 million of profitable operations you can see that. So if you can see that statement of cash flows. And then about $9 million of call it working capital changes and what that is largely is improved operational efficiency in our collections efforts so we have seen some real and very impressive gains this year on our ability to collect cash and speed our cash collection this year.

So in general that is a bit of operational efficiencies also a bit of non-recurring spend that you saw on the non-plate area on our CapEx line.

John Lynch

Going forward, for the rest of your question, we will provide guidance on what we expect free cash flow look like on our fourth quarter earnings call.

Bill Warmington

Got it. And then follow-up question on which state specifically are driving the softness in the open territory?

Joe Abbott

Well, the specific states are not things that we are getting into I can tell you that really it is more than just the state by state analysis that you have to do because there are large districts within certain states they can have very big impact even if the rest of the state were doing very well for particular state or district within the state isn't doing well that can have an impact. So that's not really the way we characterize the overall view of the open territory. But I think it's just kind of referring back to the earlier comments, you are seeing spots within the country where there are some budget pressures and then you are also seeing more macro trends around reading and math in the replacement cycle for those common core materials.

Bill Warmington

Got it, all right. Thank you very much.

Joe Abbott

Thank you.

Operator

Thank you. And I am showing no further questions at this time. I would now like to turn the call back to Joe Abbott for any closing remarks.

Joe Abbott

Okay. Thank you Chelsea and thanks to everyone for joining us on the call today. If you have any additional questions please reach out to Brian Shipman in our Investor Relations department. Chelsea you may end the call.

Operator

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