管理層發言
Hello, and welcome to the McGraw Hill Fiscal Third Quarter 2026 Earnings Conference Call for the quarter ended December 31, 2025. As a reminder, today's call is being recorded, and a written transcript will be made available in the Events and Presentations section of the company's Investor Relations website. A webcast replay of today's call will also be made available on the company's Investor Relations website. I would now like to turn the call over to your host, Danielle Kloeblen, Treasurer and Senior Vice President, Investor Relations. Please go ahead, Danielle.
Good evening, and welcome to McGraw Hill's Fiscal third quarter 2026 earnings call. Joining me today are Simon Allen, Chair of the Board of Directors; Philip Moyer, President and Chief Executive Officer; and Bob Sallmann, Executive Vice President and Chief Financial Officer. As announced on January 6, 2026, Simon retired as President and CEO on February 9 and remains Chair of the Board. During today's call, we'll be making forward-looking statements about the company. These statements are based on our current expectations and the current economic environment. Forward-looking statements, estimates and projections are inherently subject to significant economic, competitive, regulatory and other uncertainties and contingencies, many of which are beyond the control of management. These forward-looking statements are also subject to the cautionary statement that is included in our fiscal third quarter 2026 earnings release, the accompanying investor presentation and our Form 10-Q for the fiscal third quarter 2026 and other filings with the SEC.
Important assumptions and factors that could cause actual results to differ materially from those in the forward-looking statements are specified in our earnings release issued today, as well as in our SEC filings. We will also refer to certain non-GAAP measures today. We believe that these measures provide useful supplemental data that, while not a substitute for GAAP measures, allow for greater transparency in the review of our financial and operational performance. In the earnings press release, the appendix of the accompanying investor presentation and as a supplemental file on our Investor Relations website, you can find a definition of these non-GAAP measures and reconciliations to their most directly comparable GAAP measures. For those who listen to the recording of this call, we remind you that the remarks made herein are as of today, February 11, 2026, and have not been subsequently updated. With that, I'll turn the call over to the Chair of the Board of Directors, Simon Allen.
Thank you, Danielle, and good morning, everyone. It's an exciting time for McGraw Hill as we continue to build momentum, deliver strong quarterly results and position ourselves for a return to growth in fiscal year 2027. Revenue for the third quarter increased 4.2% year-over-year, driven by our higher education business, which continues to outperform the market. Recurring revenue grew 14.8% over prior year, representing 82% of total revenue, while digital revenue expanded 11%, representing 84% of total revenue. Adjusted EBITDA increased 7.7% versus prior year, yielding a margin of 31.3%. These fiscal Q3 results reflect strong execution and ongoing momentum, giving us the confidence to raise fiscal year 2026 guidance, which Bob will discuss shortly. Education is fundamental to society, and our mission serves as our foundation fueling our resilient high-margin, cash-generative business model.
Our trusted content and innovative technology don't just deliver information; it empowers educators to engage learners with personalized experiences that enrich understanding and growth. Our multilayered moat built on intellectual property, first-party data fueled by billions of learning interactions each year and domain expertise across the learning life cycle creates what we believe is a distinct competitive advantage at scale. Unlike generic AI, McGraw applies AI thoughtfully to improve learning outcomes, leveraging our multilayered moat to deliver evidence-based impact while saving educators valuable time. This approach is resonating. A recent study conducted by Morning Consult ranked us as the top education company for effectively utilizing AI, recognized by both students and instructors. Before moving forward, I want to acknowledge my decision to retire as CEO and President. Leading this team of over 4,000 mission-driven employees to transform a legacy publisher into a market-leading digital education solutions provider powered by trust, innovation, and a strong financial profile that you'll hear more about today has been the greatest honor of my career.
I will continue as Chair of the Board and will remain deeply engaged to ensure a smooth transition to Philip Moyer, who will lead the next chapter of McGraw Hill's proud history. When the Board and I began our search for my successor, we were looking for a seasoned CEO and technology leader who could not only appreciate our strong foundation, financial profile, and trusted brand but also harness these strengths to fully capitalize on the enormous opportunities ahead for McGraw Hill. We led a comprehensive search, and I can say with absolute confidence that we found the right leader in Philip. Philip brings a wealth of experience from senior technology-focused roles at Google, Amazon, Microsoft, and most recently, the CEO of Vimeo. One of the many attributes that set him apart is his early career passion for using technology to envision the future of education. From his creation of the digital software solution to modernize the management of individualized education plans to the growth he led in the education sector while at Vimeo, we believe that Philip brings the perfect blend of operational excellence, strategic vision, and customer-centric technology expertise to honor the commitments we have made to grow profitably, to expand margins, and to achieve our 2 to 2.5x net leverage target. Philip, I'm extremely excited about our partnership. Welcome to McGraw Hill.
Thank you, Simon. I have to thank you and acknowledge the incredible foundation that you and the team have built. It's a privilege to take the baton at a time that McGraw Hill is expanding market share, executing on its financial commitments, and positioning itself for long-term growth. What attracted me to this role wasn't just McGraw Hill's strong financial profile; it's the mission of the company, and it's the trusted position in the industry. Throughout my career, I've seen how technology can transform industries, but education is where technology can transform lives. We're at an important juncture in the education industry. Technology can be both a distraction or an accelerant to learning. It is essential to support teachers and school administrators in engaging this generation of students with new and more effective technologies. The experience I have in building enterprise-grade AI platforms and global video distribution technologies provides a unique vantage point into the opportunity ahead.
While AI adoption grows, it's not a one-size-fits-all model that will be solved by large AI model companies. Instead, personalized learning and personalized AI is essential for the student and the educator. McGraw Hill is well positioned to lead in this next generation of learning. We're harnessing one of the most trusted curriculum libraries in the world. We're building new learning technologies, leveraging billions of proprietary data points about what does and does not make learning effective. Importantly, we have one of the most respected global distribution and customer service teams in the world that connects directly with educators and students to make sure that they are successful in using our tools. My focus will be on accelerating growth, scaling our business, and maintaining our brand trust and academic integrity while we build some of the most engaging and exciting learning tools in the world.
I admire the financial rigor that Bob and Simon have instilled, and I look forward to progressing further on our goals as we reinvest in growth opportunities and expand margins, reducing our debt and leveraging McGraw Hill's strong brand and seasoned talent. I'm eager to partner with Simon, Bob, and the rest of the leadership team and our Board to drive shareholder value. I look forward to meeting many of you in the coming months ahead and to speaking with you again in June when we report fiscal year-end 2026 results.
Thank you, Philip. Let's dive into some more details underpinning our exceptional third quarter performance. In higher education, we continued to significantly outperform the market with 24% year-over-year revenue growth supported by our record high 30% market share according to MPI, our go-to-market execution, first mover advantage in product innovation, and portfolio expansion. Building on this momentum, our Evergreen platform now boasts a growing library of over 700 titles. Evergreen streamlines workflow management for educators and enhances sales rep productivity, allowing an increased focus on takeaways. Additionally, our new ALEKS for calculus solution supports a more comprehensive STEM offering that unlocks approximately $100 million in market opportunity globally. AI-powered solutions are driving deeper engagement, improving efficiency and fostering academic success, all while boosting platform utilization and reinforcing our position as a leader in education innovation.
For example, AI Reader reached over 1 million higher education students in Q3, generating 16 million learning interactions, up from 11 million in Q2, for a total of 27 million since inception. We recently expanded AI Reader into our First Aid Forward and Access Medicine offerings within our global professional segment, enhancing the learning experience with alternative explanations, summaries, and personalized quizzes. Building on this AI innovation, clinical reasoning is also gaining recognition from medical professionals for its ability to foster critical thinking and real-world application. We are experiencing promising momentum in institutional pilots and are advancing its impact by introducing new modules and virtual cases in the months ahead. As we scale, we are pursuing a greater institutional focus and deeper integration among our offerings. Sharpen Advantage, a new AI-powered enterprise solution, exemplifies this through an attractive TAM extension that leverages our existing content and capability to offer unique content.
Redefining our traditional professor-focused high registration approach, Sharpen Advantage deepens penetration by selling institution-wide with solutions for administrators, professors, and students alike which all work together to improve student outcomes. Integrating Sharpen with ALEKS this fall should drive incremental upsell. In K-12, we've gained market share in a smaller year, building on strong prior year performance. We are ranked first or second in 10 of the top 11 adoption opportunities with success in science as well as ELA. As we've said before, we've not experienced any material impact from proposed federal education policy changes. Fiscal year 2027 marks a larger market opportunity driven by purchasing cycles in California Math, Florida ELA, and Texas Math. Active pilots in the California math market are progressing, and we have secured some early wins. In Florida ELA, we secured a leadership position this year, which we believe should position us well moving forward.
And we are optimistic for Texas math where our offering will integrate with McGraw Hill Plus, a platform that has seen district access up 86% year-over-year and a 40% increase in average time spent on the platform since the start of the school year. We believe that our investments in innovation and portfolio breadth provide more integrated end-to-end solutions moving forward. Supplemental and intervention solutions like ALEKS Adventure, with 4 times more monthly student users than last year, McGraw Hill Plus, and AI capabilities like teacher assistant and writing assistance enhance our capabilities to fuel growth beyond the core. To this end, we have secured an early win with our K-5 literacy curriculum emerge and launched Summit and Saw for grades 6 to 12. These programs deliver cohesive personalized literacy solutions integrated with tools like teacher assistant and writing assistant, which integrate Essaypop, which we acquired in March of 2025.
We're strengthening our competitive edge by delivering more integrated end-to-end solutions positioning ourselves to drive growth beyond our core offerings. Now I'll turn the call over to Bob to discuss the financials.
Thank you, Simon. I'll review the fiscal third quarter results shortly, but first, I want to express my deepest gratitude for your mentorship and friendship during my tenure at McGraw Hill. You have been a transformative leader who has driven an exceptional financial turnaround that positions McGraw Hill as the global leader in education solutions. Under your guidance, the company has developed a unique culture that combines passion, excellence, and innovation, empowering teams to achieve exceptional results and laying the foundation for continued success in the years to come. You've left an indelible mark on this organization, and we are all better for it. I've already spent significant time with Philip, and I'm energized by our partnership as we focus on scaling the business, expanding margins, reinvesting in growth, and achieving our net leverage target. Now on to the results, which demonstrate our strong earnings quality, our resilient business model, and unwavering dedication to meet our commitments even in a seasonally small quarter for the business.
In the quarter, total revenue reached $434 million, growth of 4.2% year-over-year, while fiscal year-to-date revenue increased 0.7% versus prior year. Recurring revenue grew 14.8% year-over-year to $357 million, representing 82% of total revenue, showcasing a robust digital mix. Digital revenue grew 11% versus last year to $364 million. Growth in higher-margin digital subscriptions continues to strengthen our financial profile, adding a layer of predictability that is reflected in our remaining performance obligation, which stood at $1.7 billion at the end of the quarter and will move higher as we begin to capture the first wave of larger K-12 opportunities. Gross profit margin expanded nearly 100 basis points year-over-year to 85.3% due to efficient operations and a favorable digital mix with no impact from tariffs on our business. Adjusted EBITDA rose to $136 million in the quarter, achieving a 31.3% margin, up nearly 100 basis points year-over-year, reflecting strong operating leverage amid ongoing reinvestment.
Internally, we continue to infuse technology to streamline processes and enhance operations. In Q3, we launched an offer management system to strengthen our go-to-market by simplifying the sales process, compressing time to close deals, and improving pricing visibility. We also expanded AI use cases across product development and operations to enhance efficiencies and unlock incremental margin opportunities over time. Now moving on to the segments. Higher education revenue grew an impressive 24% year-over-year to $225 million in the quarter, with recurring revenue growing 33.5% and digital revenue expanding 24.8%. This strong performance was fueled by market share gains, increased demand for our innovative portfolio offerings, enrollment growth, and strategic value-based pricing. Inclusive Access now represents 60% of higher education revenue, with nearly 2/3 of fall 2025 growth driven by new course adoptions from existing customers, highlighting strong cross-selling efforts.
Onboarding approximately 100 new campuses annually further supports multiyear growth visibility as accounts typically scale within 2 to 3 years. We expect the activations for accounts landed in fiscal year 2026 to increase by 15 to 20 times in the next few years. 70% of Higher Education revenue now comes through Evergreen, exceeding our initial expectations. Professors are increasingly adopting the latest releases without sales rep intervention, allowing our sales team to focus on new opportunities, which positions us well for retention and market share takeaways heading into fiscal year 2027. Our exposure to resilient enrollment pockets also remains favorable. One-third of our higher education business is tied to 2-year colleges, and our portfolio overindexes to disciplines like business management, which continues to demonstrate relative strength. K-12 revenue was $128 million, a decline of 14.6%, in line with our expectations, given the impact of the smaller market this year and the lapping of exceptional capture rates in the prior year.
In Q3, recurring revenue only declined 1.6%, benefiting from strong prior year sales. As Simon mentioned, this year, we continued to gain market share, and we took a lead in Florida ELA. We also continue to show momentum in science adoptions in Alabama and Tennessee. We are actively preparing for the fiscal year 2027 adoption cycle. California math pilots continue as we enter the key selling season. In addition, we have seen initial success in ELA with an early K-5 emerge win in open territory ahead of the California ELA adoption in fiscal year 2028. We bring forward a competitive value proposition leveraging integrated solutions like McGraw Hill Plus and a broader portfolio to drive growth beyond the core. Global Professional revenue increased by 2%, and its recurring revenue grew by 3.5% in the quarter. Growth in digital medical and engineering solutions has successfully offset the impact of our noncore print exit.
Additionally, early momentum from our AI-powered clinical reasoning solution further strengthens our confidence in future opportunities. International revenue declined, narrowing sequentially to 1.8% year-over-year in the quarter. While higher education headwinds persist, we are gaining market share and remain optimistic about growth opportunities driven by new innovative solutions like ALEKS Calculus. We ended the quarter with $514 million in cash and $964 million in liquidity with our revolving credit facility remaining undrawn. Net leverage was 2.9x as of December 31. We generated $309 million in cash flow from operating activities in the quarter, an increase of 12% year-over-year. Our attractive cash flow profile enabled us to prepay an additional $50 million in term loan principal in December, for a total of $200 million in the quarter. Year-to-date, we prepaid $596 million in term loan debt, generating over $41 million in annualized cash interest savings.
Our disciplined capital allocation strategy continues to prioritize reinvestment and debt reduction while maintaining flexibility to optimize our capital structure. We remain committed to a net leverage target of 2 to 2.5x and pursuing strategic tuck-in M&A. Looking ahead, based on our strong performance, RPO visibility, sustained share gains, and favorable enrollment trends, we are raising our full year fiscal 2026 financial guidance. We now anticipate total revenue for fiscal year 2026 in a range of $2.067 billion to $2.087 billion, recurring revenue ranging from $1.516 billion to $1.526 billion, and adjusted EBITDA between $729 million to $739 million. We continue to expect unlevered free cash flow to slightly exceed the low end of the 50% to 100% adjusted EBITDA conversion range, while CapEx and product development as a percentage of revenue remains unchanged at 8% to 9% of total revenue.
Finally, a couple of modeling items for Q4. Stock-based compensation is expected to be in the range of $1 million to $2 million, and tax expense is expected to breakeven in the quarter. We will share our fiscal year 2027 financial guidance during the fiscal year-end earnings call in June. We remain confident in fiscal year 2026 and the foundation for fiscal year 2027, with a return to revenue growth and continued margin expansion. Now we will open the call up for your questions.
分析師問答
Your first question comes from the line of George Tong with Goldman Sachs.
Can you help unpack the growth drivers that you're seeing in higher ed and how you're thinking about fiscal 4Q perhaps talk a bit about Evergreen as a differentiator?
George, it's Simon. Thank you. It's a great question. I feel like I'm a broken record when I talk about our higher education business because every quarter I explain to you all that we are so proud of the growth we've had, our continuing ability to take market share, significant market share really. And you look at the growth rates, and we're just extremely pleased with where we've landed this quarter. And there's a lot of reasons why we've had this growth, but primarily, I think you mentioned Evergreen, that's a wonderful innovation that we have that is unique to McGraw Hill in providing continual updates to faculty, making sure that they no longer need to think about new additions and ensuring that they have the most up-to-date information, meeting our reps' need to spend really far less time working with the faculty and paying much more attention to growing market share by working on new adoptions.
That's been very successful for us. And our faculty tell us our customers how much they really enjoy Evergreen because it just gives them the immediacy and the knowledge that they've got the most current and engaging information for their students, and that's really very important. I think our go-to-market teams have done incredibly well; our customer success groups, our representatives, our learning specialists, you name it. ALEKS specialists have done so well across all of our go-to-market. It really is very, very pleasing for us. And I think the last thing I'd say—and there is a lot, George, I could say about higher ed and the growth that we've had—but when I think about the Morning Consult survey that we referenced in our script a little earlier, we're very proud that they cited us McGraw Hill as the company that uses AI most effectively, and that, of course, is told to us by our educator customers and our student customers.
And that gives us great pride. And I think you put all those together, the value proposition that we've explained so carefully, the ability to innovate with so many different tools now with AI Reader really coming on stream, making a big difference to higher education students in pretty much every discipline. Evergreen now 70% of our revenue, even more than we expected. It's just a very pleasing picture, George.
And Simon, maybe let me quantify some of that for you and lean into a little bit of Q4 how we're thinking about it. On the 24% growth, 17% year-to-date, 3% to 4% of that is coming from enrollment. You may have seen enrollments quoted at a lower number from the National Student Clearinghouse. Obviously, as we over-index into 2-year colleges as well as business management, that allowed us to have a little bit stronger growth there. In addition, and I mentioned in the past, we continue to realize price. And so we go out with inflationary pricing; it sticks. But you have to offset that with some of the mix as it's associated with inclusive access. So on a net basis, we're getting over 1% of price in higher education. We also benefited in the quarter related to a sales return release. And that's really a result of a couple of factors. But the first being lower levels of returns coming in in the quarter.
And this is a mechanical exercise we do every quarter. You could read about it more in our disclosures. But the other part I do want to highlight is we continue to move to more concentration of inclusive access; that higher quality revenue tends to show a lower level of return. So again, it positions us well as we think about the future. And then when we think about the fourth quarter, we think about sort of how to think about the full year, I would just get you to think about double-digit growth in billings and on a revenue basis. So when you do that math, you're still seeing that 4% to 5% growth from share gains. And you can tie that back to some of the MPI data that Simon had referenced before. So those are the areas. And you're probably coming on to the fourth quarter question around what that change or why are we seeing the growth rates slightly decline. As we highlighted before, we come to a difficult comp in the fourth quarter. And again, as we think about the full year, we're going to still experience that double-digit growth, but we are facing a more difficult comp in the fourth quarter.
Your next question comes from the line of Ryan MacDonald with Needham & Company.
Congrats on a great quarter, and welcome to Philip. Maybe just to start, first question for me is around the K-12 business. Obviously, continuing to benefit from the strong market share gains from last quarter. But as we look ahead to fiscal '27, can you just unpack a little bit more about what gives you that confidence in sort of the return to growth and magnitude of growth for that business? And as you look across the three sort of large state opportunities, with California, Florida, and Texas. I'm curious to get your thoughts on sort of the trajectory for the Texas opportunity we've been hearing more and more about how, as they've changed their adoption cycle and some of the mechanics there. There's just a lot more material instructional materials that they have to review ahead of the sort of purchasing cycle. Any concerns that that could delay decisions at all ahead of fiscal '27?
Ryan, that's a lot of questions in that one. And let me take them piece by piece, if I may. And you're quite right. We're very pleased with our K-12 performance as well. And you know that FY '26 was a smaller market size, and yet we've continued to grow market share. And that's what's important to us. We've got to keep outperforming our competitors at every level. And we're very pleased that we've ranked #1 or #2 in 10 of the top 11 adoption opportunities this year. And that's driven a lot by our ongoing success in science and ELA, as Bob indicated in our earlier comments. And in states like Alabama and Tennessee, we're very, very pleased with our performance there. I would—and also looking ahead, I mean, to your question, Florida ELA, we've got a good start there in year 0. We're feeling very good about what that could mean for us going forward. We will make sure that we recognize the market growth opportunity and what that means for us in FY '27.
I think we've mentioned before, Ryan, that we're looking at about a $300 million increase in the term for next year. So we're obviously optimistic about what that means for us. It's very early in the adoption process. As you know, the selling season really begins January and doesn't conclude until Memorial Day or even slightly after. So we're in the stages right now in the battle, which we love. And we'll know a lot more about how things are when we get to the end of May, early June, and we can update you at that stage then. But we're very pleased with the pilots we're offering. We've had some good wins with Emerge our K-6 literacy program. As you know, we've launched also our 6 to 9, 9 to 12 Summit products, which are very exciting. We had a wonderful sales meeting in New Orleans. I won't give you all the details, but I will say that we had a great launch with that product. About 600 reps are very excited about what they're seeing, which is marvelous.
So we feel very good about that. Very briefly on Texas. Your point is a good one. I mean, they're changing the style in a way, but we've got great relationships, a really great market, and a fine knowledge of how that state operates. We welcome new competitors. It may change. You mentioned the delay. We're not sure about that. The way decisions are made are extremely effective. They're very strong as they always have been. And really, we feel that the end-to-end offerings that we have through all of our content, technology, you name it, that's something that other companies cannot provide. They usually lack in the technology development that really integrates with a lot of the content. That's the key strength of McGraw Hill, as you know, which is why we feel good about how that's going to develop for us.
Really appreciate all the color there, Simon. And maybe as a follow-up, I would love to propose one to Philip. Obviously, early on in your tenure, but just curious as you evaluate the opportunity coming in, would love to get your view, particularly as a technologist, sort of McGraw's AI strategy and how you think you can continue to evolve that in the role moving forward?
Ryan, thank you very much for the question. I would have to start by saying AI is only good as the data and the quality of the training. And coming in, it's one of the things that attracted me most to McGraw Hill. As you think about building a next-generation company, just any company, you're going to need data. You're going to need experience with workflows. You're going to need integrations, you're going to need a whole variety of things. Ultimately, you're going to build a system that has experience in answering questions or taking action. We're coming into this next generation with simply unmatched assets in the education industry. We've got one of the largest vetted localized content platforms in the world, with literally tens of thousands of specific AI images and assessments specific to learning pathways. We also have mapped out these learning pathways that developed tens of thousands of discrete skills along the way at every single age.
We have billions of data points and algorithms that understand when somebody is on the pathway and someone is off the pathway. And we can serve the teacher and also the student in really unique ways with that knowledge. We have go-to-market and service teams that have deep enterprise relationships, and they understand the regulatory environment down to a ZIP code level. Over the past 5 years, I have to say, coming in, what was so evident to me is in the past 5 years, there's been a really significant investment in technology and AI, and you're seeing that. I don't think what's been talked about and what you're not seeing underneath the iceberg is all the tools that have been released over the past 12 to 24 months, ALEKS Calculus, an AI Reader, Teacher, and Writing Assistant. Sharpen, as an example, we just released within 9 months, and we already have 1 million active users on that platform.
So I'm excited about the pace at which we're innovating. I'm excited about the assets and I'm really, really excited about all the opportunities ahead. So I feel very good as someone that's lived in tech my whole life about what we're going to do.
Your next question comes from the line of Stephen Sheldon with William Blair.
Maybe I wanted to start with Philip as well. I guess you started the new role this week. I guess if you think about the coming months, what are some of your early priorities where do you envision spending your time across the organization as you think about the coming months?
Sure. First, obviously, I'm learning the organization, I'm learning the products, but most importantly for me is getting out with the customers. Already, the customers that I've been spending a little bit of time with, I hear very firsthand from customers already. Many are really concerned about AI. Many are confused around technology. Many are unsure whether or not their students are engaged and whether or not they're comprehending when they're using AI. Most importantly for me is getting out with our higher ed customers, our K-12 customers, our global professional customers, and our international customers. A lot of them want to know that there's going to be a trusted partner as they go into this next generation. For me, it's going to be listening, and it's also going to be assuring them that we're going to be a partner every step of the way. The second thing I would tell you that's very important to me as well is just what I—a little bit of what I was just talking about.
We've got a great pace of innovation, and I really want to spend time to make sure that we've got a solid vision for the customer, for the student, for the teacher, and for the administrator of where we're going in McGraw Hill with our technology and do we execute as quickly as we can. I'm really looking forward as well to spending time with our go-to-market teams. They're world-class. They’re world-renowned. They have incredible relationships. I also want to hear from them how we can empower them more to serve that customer base.
That's great. I appreciate that. And then maybe one for Bob as a follow-up. It sounds like the team is confident about the return to growth in K-12 for next year, and you gave some hopeful commentary on the factors driving growth in the higher ed segment. So just curious, if you look at higher ed and thinking about fiscal 2027, how much visibility do you have at this point on the potential growth heading into next year? It seems like some of the factors that are supporting growth like broader adoption of inclusive access. Some of those things should have some legs. So just at the high level, I know you're not giving guidance or anything at this point, but just how are you thinking about growth heading into next year? And how much visibility do you have into it at this point?
Yes, sure. And as you're aware, we'll provide guidance in our June call. At that point, I'll be leaning into some of those early indicators which we watch would be fast applications, high school graduation rates, information like that. But some of the things that give us confidence, we look at the RPO, we see activations in January in the spring. Some of that will carry into next year. So all of those things—and I'd say the thing that we are most confident about is our ability to continue to take share. We've demonstrated that. We're seeing takeaways as we walk into next year already. So all of those things bode really well for us.
Your next question comes from the line of Steven Koenig with Macquarie Group.
It's Steven Koenig with Macquarie. Nice to be on the call. Congratulations is due to Simon; I want to echo previous comments by others on your contribution financially, operationally, and certainly culturally to McGraw Hill. So you leave a really good position here for Philip to build on, and welcome to Philip.
Let me just say thank you.
I wanted to ask a two-part question that's related. So one part of the question maybe for you, Simon, is you mentioned that Sharpen Advantage expands your TAM by providing the institution-wide solutions not only for professors but for administrators and students. Can you expand on that? And then I'm going to put the related question out there as well. And Philip, feel free to give us your thoughts on this as well. I think something that a lot of investors miss certainly about my software coverage is like the competitive moat isn't just from the IP. It's from the customer lock-in that happens when you integrate the solutions, you deploy them, and you integrate them with the data, processes, workflows, et cetera. And you're clearly doing that at McGraw Hill, and I'm not talking about just the technology solutions, but also your go-to-market and what you're doing to make yourself irreplaceable in the institutions. I'd love to hear your thoughts on how your technology, your go-to-market, and your content all influence that.
Thank you very much, Steve. Again, thank you very much for your very kind comments. I'll kick off a little on Sharpen, and thank you for asking. We're very proud of the type of product that we have there, as you may remember, it is very much focused on how students learn today. That lovely quote that it's like my textbook and TikTok had a baby. That's how so many students learn in their first and second year, particularly at University and college. What we've done with Sharpen—and we've got a proven model with students. We know that it works well. We know that they really appreciate the type of video-based learning and quiz-focused activity, really a lot of gamification tools in there. What we discovered is that the market increasingly asked us to look at this in a broader sense on what can we provide for the institution. We make sure that we can focus on a broader coverage, allowing the educator to include their own content, for example, making the institution at that level use Sharpened materials across the entire network, every single class, every single sector and department where we operate, which is pretty much everywhere.
The breadth of coverage at the institutional level really opens up a significant market for us, a new market, if you like, beyond just that student and the faculty relationships that are so near and dear to our company. I think with Sharpen, we're just really excited about how quickly, as Philip said earlier, we've really developed some serious revenue and customer base, and now we're looking forward very much to seeing that expand exponentially at the institutional level. I'll pass it over to Philip now for the additional questions that you had on AI.
Sure. I get asked a lot about LLMs in the context of education. I'd like to say that every generation of technology, whether or not it was a PC, the Internet, the cloud, every one of those needs deep domain expertise to bridge the last mile for the big tech platforms. I lived in that for a long time. I know that it was a very vibrant ecosystem of software companies and services companies. It's become a massive industry to bridge that last mile. This era is no different in artificial intelligence. I think that our moat is going to be really clear. A couple of things, as I mentioned, we understand local education requirements down to the ZIP code level, and today, more than ever, educational requirements are becoming down to the ZIP code level. We have these specific age-appropriate learning pathways. I'd like to say that LLM may know what you're asking, but we know why you're asking it. We can build security and trust and psychological safety into what we're building.
We have the ability to build personalization for every student, for every teacher. We can enter new curriculum markets in a way that we've never been able to before, with fine-grained supplemental work. We're able to create really engaging learning experiences that just a standard LLM is not going to do. We also have the ability to understand whether or not someone's comprehending what the answers are that they're giving to the teacher and then also for the teacher to understand their students. We think there are all these fantastic opportunities to build great moats with artificial intelligence and LLM technology.
Your next question comes from the line of Marvin Fong with BTIG.
Congratulations on the great results as well as Philip for the new role and Simon, I didn't have that long a time to work with you but certainly hope to continue the relationship there and best of luck. Just a couple of questions. Again, on AI, maybe a different angle for either Simon or Philip to answer. But from the outside as investors, how would you suggest we measure the impact of AI on your business? I know you also provided some internal metrics on time to development and costs that AI has benefited you from. Maybe on both sides of that coin, how can we measure AI and how it's impacting your business?
Thank you very much, Marvin. I'll kick off and then pass it over to our new CEO, Philip. I think what I would say, first of all, is that with everything that we do with AI, we've done a ton. We've released some tremendous products. All that we focus on is ensuring that we use a human-in-the-loop approach to make sure that everything that is delivered, we know has efficacious value to the teacher. The focus of a lot of our AI tools, if I think of writing assistance or teaching assistant, is providing the educator more time to spend face-to-face with the student. That's got to be really emphasized all the time. You will have read a lot recently about the need for that human interaction for the teacher and student to really bond and spend significant time together. So a lot of the AI tools that we've innovated in the last few months allow that. Think about AI Reader in higher education; we're allowing the students to really understand more complicated materials in repetitive ways, in fact, really helps them grasp difficult concepts and enables them to then have more meaningful conversations with their professor.
I think at the K-12 level, again, writing instruction tools enhance how the students begin to think about creating sentences, paragraph structure, you name it, again, allowing for that formative discussion with the teacher at every stage. As I look at our medical business, clinical reasoning is another great new innovation that we've provided for medical students looking at how they can diagnose what they can think about utilizing as they look at the patient interactive evaluation tool that we provided, so they can start to immediately relate to a patient's situation that may need help with. All of our tools that we've created and tested are valuable. We test them incessantly before we release anything to make sure that we're adding value to what we provide. It's a very thoughtful process, Marvin, and will continue to be, but it's wonderful to have the opportunity to do this with the technology now that the advancements in AI. We've been operating with machine learning, as you know, for over 20 years with ALEKS. Now we really can stretch ahead with AI. I'll pass it over to Philip. He may have other comments as well.
Coming at this as a technologist, I always look at user engagement. I want to know how many users are using it, how many are using it daily, and how long are they spending on the tool. So internally, we'll be tracking that. We're also going to be tracking outcomes, and we're seeing some pretty extraordinary outcomes already on our tools in terms of grade-level improvements and overall comprehension. That's the second one—so really the learning outcome. But then a few other areas that you should really— that you're going to be able to watch us focus on. I heard a statistic, I think it was just today, that the average district has as many as 1,000 learning tools that are inside of their organization. That's going to become even more complex. Imagine AI tools sitting inside of a local district or a local university. Enterprise adoption is going to be a really good focus. We will try and simplify for the institution the use of AI, whether or not it's from a cost perspective, whether it's from a content perspective, whether it's not from a safety or security perspective.
Enterprise adoption is important. The last thing, the way that we use AI is accelerating our own development and entry into new markets. I also expect that our ability to be able to do more supplemental work to be able to do hyper-localization. The education industry on a worldwide basis is about $7.3 trillion, and it's growing to about $10 trillion by 2030. How big can we think, and how many markets can we be in, how many educators and students can we serve? I think it's going to be driven by harnessing AI.
Your next question comes from the line of Jeff Silber with BMO Capital Markets.
I know it's late. I'll just ask one. I know you don't give specific guidance for the quarter, but obviously, results were better than expected. Were there any timing issues either in terms of revenue recognition or maybe deferring some expenses into the fourth quarter that we should be aware of?
No, I'd just come back to as we think about the comp that we have in Q4. I just want to reiterate that we do have a difficult comp as we think about the fourth quarter. But we're doing this while taking share, and we've seen share gains in all of our businesses. As I think about the fourth quarter, really leaning into the RPO, also looking at the early activations that we saw on higher ed positions us to increase our guidance, and that's sort of the drivers for us.
So there was nothing specific in the third quarter to call out one time?
Let me come back to that reserve. I mentioned it in higher ed. I didn't mention it was about 400 basis points of benefit to us in the quarter. I just want to come back; that is not one-time, if that's what you're alluding to. I mean, we have a mechanical process that we do every quarter, and we disclosed that in the Q. But it was slightly larger than we've experienced in the past. That's why I wanted to call that out. The reason for it being higher is just because of the smaller reserves that we—returns we experienced in the quarter. That's why it was notable for us this quarter, and I wanted to call it out.
Your next question comes from the line of Henry Hayden with Rothschild & Co Redburn.
I'd like to add to the congratulations, Simon, on your retirement. I guess to start off, it's great to see leverage continuing to come down towards the target range. Could you please give us an update on capital allocation and how you're thinking about leverage progression from here? Since you commented on it, how are you thinking about M&A in that context? What sort of assets would be of most interest?
Sure. Thanks, Henry, and thanks for staying up late. Our first priority is always the organic opportunities, right? As we look at where we deploy capital, we see organic opportunities to generate the greatest ROI. We'll continue to do those. Those have always been fully funded both in our budget, which is our guidance for next year, as well as our strategic plans. So we'll continue to put our dollars there first. Secondly, it comes back to our commitment to deleveraging. You saw we were at 2.9x leverage at the end of the quarter, and we have a seasonal cash flow which will result, and that's slightly picking up as we think about both the fourth quarter and into Q1. Ultimately, as we enter the fall, you'll see that cash continues to build. We're really excited about where we sit in cash, our cash position as well. We anticipate paying down another $50 million in the fourth quarter. In addition to the $200 million we paid down in the third quarter, we will be paying down another $50 million in the fourth quarter, given just the strength of our cash position.
Lastly, around M&A, we're looking at some bolt-on tuck-ins. We have a very active funnel. They sit in all of our business units. We're looking at things internationally in the global professional space, higher ed in K-12, both as technology advancements as well as other small tuck-ins. Nothing transformative in the funnel today, but we’ll continue to look at things, and opportunistically, we’ll execute when it makes sense, utilizing cash on the balance sheet. Again, we're excited about where we sit, the investments that we're making, continuing to pay down and delever. Just as a reminder for modeling purposes, Q4 and Q1 represent our cash trough, and then it will continue to cycle back up as we build the RPO in Q2.
That's very helpful. And then just as a quick follow-up. What sort of appetite are you seeing in the market for Teacher Assistant from the customer side? How should we think about the relative growth uplift from that product as it gets a broader rollout kind of in the next year?
That's a good one, and it's an encouraging answer. I think, Henry. Teacher Assistant is designed for exactly what is described—and it really has been well received to just enable the K-12 teaching community that they're feeling pretty beaten up in many situations. It's been a pretty tumultuous time for a lot of the teachers, particularly since COVID; they're looking for tools that can allow them to do classroom preparation activities in a straightforward way and provide some enthusiasm for their students. It's an important tool for us. No one else has anything like this. We're very proud of how it integrates with our materials, our content. We're very pleased with how it's been launched. Only recently launched, but the early signals are extremely encouraging for us.
Your next question comes from the line of Jeff Meuler with Baird.
Simon. Welcome, Philip. This question is for Philip. I hear you on being well positioned with a lot of assets to leverage for the AI opportunity and hear you refer to continued margin expansion for the enterprise. I just want to gauge what gives you confidence that you're spending at the appropriate level to fully harness the AI opportunities?
Well, I've been here for 3 days. This is my third day. So I got the confidence of 3 days. I officially started on Monday. What I would say to you is that already my exposure to efficiency and effectiveness of the development teams. I mentioned before, we've been able to release a record number of AI tools over the past 12 to 24 months. These are good tools that tackle really difficult problems. I'm excited, first and foremost, around the talent inside the organization. We're not just talking about building AI; we're also using AI ourselves, and we're also using cutting-edge tools. We're educating ourselves and we have a culture of learning internally around the use of these tools. I could not be more happy to be following Simon and Bob and the work that's been done over these past 5 years to really get the cost structure in line with where it should be. When you really look at our gross margins and our overall margins, we are set up to be a next-generation company, probably better than most of our peers in the industry based on the costs we've taken out and the innovations in the development teams and improvements in development processes that we've already built. It's evident to me that we have a technology and digital-first culture here.
Appreciate the perspective 3 days in. There was a comment about no material impact from proposed federal education policy changes. There have also been some government shutdowns and headlines around federal student disbursement around those things. Just, I guess, what are you still watching for potential impact? Or I guess, similar question, the level of confidence that the risks related to that and risk related to changes around the Department of Education are not going to impact you?
Yes, it's a good one. Without being naive, it really is true that we've seen no damage to our business. We obviously look with great interest at what's happening; the formative changes are a good example. Honestly, it has made no difference to our business whatsoever because how we operate is very much directly with the school districts or with the states in the case of K-12 and directly with instructors and institutions in higher education; this is true around the world. There is no desire for any government or any federal or governmental institution to want to remove the focus on education—they would never get reelected again. We don't see the effect on our business whatsoever. We describe ourselves as a very defensible company because of the resiliency that we have. The defense that we have is simply that our products are needed by schools, by students, by universities and colleges globally, and medical schools while that happens. There is no government intervention that will damage our business because the core of what we offer is so important to every aspect of society.
As a reminder, Jeff, there's a very small amount of strict budgets that come from the federal government as well.
Your next question comes from the line of Josh Chan with UBS.
Congrats Simon and welcome Philip. I'll just ask one to Simon. I guess, historically, in your experience as you gain share in higher ed, does it become easier or harder to keep gaining share? I guess I'm just asking kind of a momentum question. And what does it take to kind of keep up the momentum?
That's a good question. What I would say is—and I've done this for 40 years in August actually, Josh, 40 years in August 16, if you want to be precise. I can tell you that since I've been in higher education and the momentum that you get is a joyful situation because it really does—success breeds success. The reason is that you have, for example, the growth we've seen in inclusive access. You heard Bob earlier talk about continued growth well beyond 20% yet again this quarter. You look at what that does as you realize that the land-and-expand strategy with inclusive access gives you a far greater number in the second and third year of the institution's use of inclusive access. That momentum just continues and continues in a wonderful way. When you provide products like Evergreen or solutions like Evergreen that allow our professors to continue with our product, it frees up time for our reps to go after new business.
That, again, creates momentum, and we're seeing that already when we look at the pipeline very early in the selling season. We see that already as we think about the year ahead. With higher education, when you start to get a greater presence on the college campus in any discipline in any department, it grows. You find that you almost flower as you go through the selling season, and you get to a level of maturity that's quite joyful to see. Success breeds success. It's why we've had continued market share growth every quarter I've spoken to you and why that will continue. We're very proud of our higher ed business, and we're taking substantial market share as you've seen.
Congrats on your accomplishments, Simon.
Your next question comes from the line of Toni Kaplan with Morgan Stanley.
Congrats on the quarter and also on Simon, on your retirement. It's been great working with you. You mentioned the strong stats on McGraw Hill Plus with the 86% increase in district access and 40% increase in average time spent. Just to get maybe a little bit of additional context. Hoping to understand what the penetration rate is across the business from the school districts for that and how the forward pipeline looks for the platform? I know in the past, when you guys are signing new K-12 districts and trying to retain old ones, I think largely, the retention hasn't necessarily been a big thing, but could this change that dynamic where you do start to see more retention of old districts because they like that personalization.
That's a very thoughtful question, Toni. The latter statement, I think, is what you've hit on is so crucial for us. When you think about why we created McGraw Hill Plus initially in mathematics, as you know, and now extending into ELA and other disciplines quickly and going from just a handful of states to getting on for a dozen, I think going forward. The reason that we're so excited about this product and you touched on it is that once you get integrated with McGraw Hill Plus and utilize the data, you can see just how your students in the classroom are performing. You can look at that knowledge graph and recognize every component of the education system that the students have succeeded with and where there may be gaps in that data becomes very—positively, very addictive. The only way that you continue to—you can continue to understand how your class is performing is by continuing to use our products, particularly with McGraw Hill Plus.
The integration with that data-driven tool alongside our core product—in mathematics, you've got Reveal Math or Everyday Math, and ALEKS as a supplementary product. And then you've got all the data provided with those tools on McGraw Hill Plus. So when you start utilizing that year-on-year, it's very difficult to leave because you rely on the data, you rely on what it tells you about your students performing. As you move a student from second grade to third grade to fourth grade, you can track their progress in a wonderful way. This longitudinal student record is very attractive to the schools themselves. You hit the nail on the head. It is that ability for us to truly integrate the products that will increase retention because the products and solutions we provided will really be very difficult to live without once you've integrated them in.
Great. And then just as my follow-up, I think in past quarters, we've sort of talked a lot about the ability to use AI across the business through Scribe. I sort of noticed that Scribe hasn't really been mentioned. I know you've talked about margin expansion, so not trying to imply that you're not seeing margin expansion. But I guess, trying to understand if Scribe is going to be a big driver? Is it still—like any update on it? Should we not be thinking about Scribe as sort of one of the biggest levers for margin expansion? Or maybe we're just talking about it in a different way. So just want to understand that.
Yes. Toni, yes, so we didn't specifically call it out. We continue to lean into Scribe. We continue to find new use cases every day. We see it as a meaningful opportunity for us to continue to reduce cost and accelerate time to market. It will be something you'll continue to hear us talk about as we move forward. We're still in the early days of the use cases and actually seeing the cost savings. But we are very excited about that opportunity, and we'll continue to talk about it going forward because it is a meaningful opportunity for the business.
Your next question comes from the line of David Karnovsky with JPM.
Maybe just following up on supplemental within K-12. Can you just update on the ongoing crossing opportunity there? What the uptake has looked like recently for products like ALEKS?
Yes. It's a good one. ALEKS is a very good example for the supplemental intervention sector. For us, ALEKS has been around since 2000, which is a tremendous tool that provides students in math and now chemistry the ability to either with their teacher or really self-directed understand how they're progressing as they learn math; having directive question-and-answer processes to really enhance their learning and focus. It's very personal; it can tell you exactly where you've made a mistake as you go through the workings of any answer. ALEKS for us—not just K-12 but very much in higher education—provides the placement tool for the placement program that we use; it allows instructors to understand the level of performance they can expect out of their students. It's the backbone, frankly, for our supplemental business for that. Let's not forget what we've accomplished with Achieve3000 for literacy.
The reason we made that acquisition five years ago was to augment our position in the supplemental there and give us strength in math in literacy. With Achieve3000 and actively loan, we've done exactly that, and we're very pleased with the growth that we've seen in our ability to serve all of our customers. It's not just about being the leading core provider in K-12, as you know, McGraw Hill already is. It's also about providing supplemental material to help students beyond the core, and that's something we have focused a lot of attention on. We see a lot of growth coming from that sector, and I think it's exciting for us. Core is still the majority of our K-12 business, but we see serious growth opportunities ahead in supplemental and intervention.