HOUGHTON MIFFLIN HARCOURT COMPANY The following discussion and analysis is intended to facilitate an understanding of our results of operations and financial condition and should be read in conjunction with the interim unaudited consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 , which was filed with theSecurities Exchange Commission (the "SEC") onFebruary 27, 2020 . This "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. See "Special Note Regarding Forward-Looking Statements" included elsewhere in this Quarterly Report on Form 10-Q.
Overview
We are a learning company committed to delivering connected solutions that engage learners, empower educators and improve student outcomes. As a leading provider of K-12 core curriculum, supplemental and intervention solutions, and professional learning services, we partner with educators and school districts to uncover solutions that unlock students' potential and extend teachers' capabilities. We estimate that we serve more than 50 million students and three million educators in 150 countries, while our award-winning children's books, novels, non-fiction, and reference titles are enjoyed by readers throughout the world. For nearly two centuries, ourHMH Books & Media segment has brought renowned and awarded children's, fiction, non-fiction, culinary and reference titles to readers throughout the world. Our distinguished author list includes tenNobel Prize winners, forty-nine Pulitzer Prize winners, and twenty-six National Book Award winners. We are home to popular characters and titles such as Curious George,Carmen Sandiego , The Lord of the Rings, The Whole 30, The Best American Series, the Peterson Field Guides, CliffsNotes, and The Polar Express, and published distinguished authors such asTim O'Brien ,Temple Grandin ,Tim Ferriss ,Kwame Alexander ,Lois Lowry , andChris Van Allsburg .
Recent Developments
COVID-19
Prior to the spread of COVID-19 inthe United States , we experienced net sales results consistent with our historical first quarters. As we proceeded through the first quarter of 2020 and the impact of the COVID-19 pandemic progressed, schools began to close in response to federal, state and local social distancing directives resulting in a decline in net sales and sales orders in the second half ofMarch 2020 . OnMarch 27, 2020 , we announced steps to address COVID-19 and provided a business update related to the pandemic. We implemented a number of measures intended to help protect its shareholders, employees, and customers amid the COVID-19 outbreak. We took actions to help mitigate some of the adverse impact of COVID-19 to our profitability and cash flow in 2020, while working proactively with schools to support them through this period of disruption with virtual learning resources. Actions taken to date to address COVID-19 and in addition to the Strategic Transformation initiatives announced in the fourth quarter of 2019 include: (1) director, executive and senior leadership salary reductions, and for the majority of employees, a four-day work week with associated labor cost reductions; (2) a freeze on spending not directly tied to near-term billings, including a reduction in all discretionary spending such as marketing, advertising, travel, and office supplies; (3) reduced inventory purchasing; (4) temporary closures of warehousing and distribution centers, (5) deferral of long-term capital projects not directly contributing to billings in 2020 and (6) borrowing$150 million from our asset-backed credit facility as a pre-emptive measure to mitigate against capital market disruptions. Further, we have elected to defer the payment of our employer payroll taxes allowed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Given the COVID-19-related school closings mandated by states and districts nationwide, our Education business will be impacted, and significant uncertainty is likely to persist in the marketplace. Additionally, ourHMH Books & Media business will be impacted as many states enforce temporary shut downs of non-essential businesses as well as changes in consumer spending habits are likely to occur. As a result, we withdrew our 2020 full-year financial guidance and 3-year outlook, issued in conjunction with our fourth quarter 2019 earnings onFebruary 27, 2020 . 26
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Strategic Transformation Plan
OnOctober 15, 2019 , our Board of Directors approved changes connected with our ongoing strategic transformation to simplify our business model and accelerate growth. This includes new product development and go-to-market capabilities, as well as the streamlining of operations company-wide for greater efficiency. These actions, which we refer to as our 2019 Restructuring Plan, resulted in the net elimination of approximately 10% of our workforce, after taking into account new strategy-aligned positions that are expected to be added, and additional operating and capitalized cost reductions, including an approximately 20% reduction in previously planned content development expenditures over the next three years. These steps are intended to further simplify our business model while delivering increased value to customers, teachers and students. The workforce reductions were completed during the first quarter of 2020. After considering additional headcount actions, implementation of the planned actions resulted in total charges of$15.8 million which was recorded in the fourth quarter of 2019. With respect to each major type of cost associated with such activities, substantially all costs were severance and other termination benefit costs and will result in cash expenditures.
Further, as part of such strategic transformation plan, we recorded an
incremental
Key Aspects and Trends of Our Operations
Business Segments
We are organized along two business segments: Education andHMH Books & Media (formerly referred to asTrade Publishing ). Our Education segment is our largest segment and represented approximately 85%, 86% and 87% of our total net sales for the years endedDecember 31, 2019 , 2018 and 2017, respectively. OurHMH Books & Media segment represented approximately 13%, 15% and 14% of our total net sales for the years endedDecember 31, 2019 , 2018 and 2017, respectively. The Corporate and Other category represents certain general overhead costs not fully allocated to the business segments, such as legal, accounting, treasury, human resources and executive functions.
We derive revenue primarily from the sale of print and digital content and instructional materials, trade books, multimedia instructional programs, license fees for book rights, content, software and services, consulting and training. We primarily sell to customers inthe United States . Our net sales are driven primarily as a function of volume and, to a certain extent, changes in price. Our net sales consist of our billings for products and services, less revenue that will be deferred until future recognition along with the transaction price allocation adjusted to reflect the estimated returns for the arrangement. Deferred revenues primarily derive from online interactive digital content, digital and online learning components along with undelivered work-texts, workbooks and services. The work-texts, workbooks and services are deferred until control is transferred to the customer, which often extends over the life of the contract, and our hosted online and digital content is typically recognized ratably over the life of the contract. The digitalization of education content and delivery is driving a shift in the education market. As the K-12 educational market transitions to purchasing more digital, personalized education solutions, we believe our ability now or in the future to offer embedded assessments, adaptive learning, real-time interaction and student specific personalization of educational content in a platform- and device-agnostic manner will provide new opportunities for growth. An increasing number of schools are utilizing digital content in their classrooms and implementing online or blended learning environments, which is altering the historical mix of print and digital educational materials in the classroom. As a result, our business model includes integrated solutions comprised of both print and digital offerings/products to address the needs of the education marketplace. The level of revenues being deferred can fluctuate depending upon the mix of product offering between digital and non-digital products, the length of programs and the mix of product delivered immediately or over time. Core curriculum programs, which historically represent the most significant portion of our Education segment net sales, cover curriculum standards in a particular K-12 academic subject and include a comprehensive offering of teacher and student materials required to conduct the class throughout the school year. Products and services in these programs include print and digital offerings for students and a variety of supporting materials such as teacher's editions, formative assessments, supplemental materials, whole group instruction materials, practice aids, educational games and professional services. The process through which materials and curricula are selected and procured for classroom use varies throughoutthe United States . Currently, 19 states, known as adoption states, review and approve new programs usually every six to eight years on a state-wide basis. School districts in those states typically select and purchase materials from the state-approved list. The remaining states are known as open states or open territory states. In those states, materials are not reviewed at the state level, and each individual school or school district is free to procure materials at any time, although most follow a five-to-ten year replacement cycle. The student population in adoption states represents approximately 51% of theU.S. elementary and secondary school-age population. Some adoption states provide "categorical funding" for instructional materials, which means that those state funds cannot be used for any other purpose. Our core curriculum programs typically have higher deferred sales than other parts of the business. The higher deferred sales are primarily due to the length of time that our programs are being delivered, along with greater component and digital product offerings. A significant portion of our 27 -------------------------------------------------------------------------------- Education segment net sales is dependent upon our ability to maintain residual sales, which are subsequent sales after the year of the original adoption, and our ability to continue to generate new business by developing new programs that meet our customers' evolving needs. In addition, our market is affected by changes in state curriculum standards, which drive instruction, assessment and accountability in each state. Changes in state curriculum standards require that instructional materials be revised or replaced to align to the new standards, which historically has driven demand for core curriculum programs. We also derive our Education segment net sales from supplemental and intervention products that target struggling learners through comprehensive intervention solutions aimed at raising student achievement by providing solutions that combine technology, content and other educational products, as well as consulting and professional development services. We also offer products targeted at assisting English language learners. In international markets, we predominantly export and sell K-12 books to premium private schools that utilize theU.S. curriculum, which are located primarily inAsia , the Pacific, theMiddle East ,Latin America , theCaribbean andAfrica . Our international sales team utilizes a global network of distributors in local markets around the world. OurHMH Books & Media segment sells works of fiction and non-fiction in the General Interest and Young Reader's categories, dictionaries and other reference works. While print remains the primary format in which trade books are produced and distributed, the market for trade titles in digital format, primarily ebooks, generally represents approximately 8% to 10% of our annualHMH Books & Media net sales. Further,HMH Books & Media licenses content to other publishers along with media companies.
Factors affecting our net sales include:
Education
• general economic conditions at the federal or state level; • state or district per student funding levels; • federal funding levels; • the cyclicality of the purchasing schedule for adoption states; • student enrollments; • adoption of new education standards;
• state acceptance of submitted programs and participation rates for
accepted programs;
• technological advancement and the introduction of new content and products
that meet the needs of students, teachers and consumers, including through
strategic agreements pertaining to content development and distribution;
and
• the amount of net sales subject to deferrals which is impacted by the mix
of product offering between digital and non-digital products, the length
of programs and the mix of product delivered immediately or over time.
HMH Books & Media
• consumer spending levels as influenced by various factors, including the
• the publishing of bestsellers along with obtaining recognized authors;
• film and series tie-ins to our titles that spur sales of current and
backlist titles, which are titles that have been on sale for more than a
year; and
• market growth or contraction.
State or district per-student funding levels, which closely correlate with state
and local receipts from income, sales and property taxes, impact our sales as
institutional customers are affected by funding cycles. Most public school
districts, the primary customers for K-12 products and services, are largely
dependent on state and local funding to purchase materials.
We monitor the purchasing cycles for specific disciplines in the adoption states
in order to manage our product development and to plan sales campaigns. Our
sales may be materially impacted during the years that major adoption states,
such as Florida , California and Texas , are or are not scheduled to make
significant purchases. For example, Texas adopted Reading/English Language Arts
materials in 2018 for purchase in 2019. California adopted history and social
science materials in 2017 for purchase in 2018 and continuing through 2020 and
adopted Science materials in 2018 for purchase in 2019 and continuing through
2021. Both Florida and Texas , along with several other adoption states, provide
dedicated state funding for instructional materials and classroom technology,
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with funding typically appropriated by the legislature in the first half of the
year in which materials are to be purchased. Texas has a two-year budget cycle,
and in the 2018 legislative session appropriated funds for purchases in 2018 and
2019. California funds instructional materials in part with a dedicated portion
of state lottery proceeds and in part out of general formula funds, with the
minimum overall level of school funding determined according to the Proposition
98 funding guarantee. We do not currently have contracts with these states for
future instructional materials adoptions and there is no guarantee that our
programs will be accepted by the state.
Long-term growth in the U.S. K-12 market is positively correlated with student
enrollments, which is a driver of growth in the educational publishing industry.
Although economic cycles may affect short-term buying patterns, school
enrollments are highly predictable and are expected to trend upward over the
longer term. From 2018 to 2028, total public school enrollment, a major
long-term driver of growth in the K-12 Education market, is projected to
increase by 1.4% to 57.4 million students, according to the National Center for
Education Statistics .
As the K-12 educational market purchases more digital solutions, we believe our
ability to offer embedded assessments, adaptive learning, real-time interaction
and student specific personalized learning and educational content in a
platform- and device-agnostic manner will provide new opportunities for growth.
Our
While print remains the primary format in which trade books are produced and distributed, the market for trade titles in digital format, primarily ebooks, has developed in the recent decade, as the industry evolved to embrace new technologies for developing, producing, marketing and distributing trade works. We continue to focus on the development of innovative new digital products which capitalize on our strong content, our digital expertise and the consumer demand for these products. In theHMH Books & Media segment, annual results can be driven by bestselling trade titles. Furthermore, backlist titles can experience resurgence in sales when made into films or series. In past years, a number of our backlist titles such as The Hobbit, The Lord of the Rings, Life of Pi, The Handmaid's Tale, The Polar Express, The Giver and The Time Traveler's Wife have benefited in popularity due to movie or series releases and have subsequently resulted in increased trade sales. We employ several pricing models to serve various customer segments, including institutions, government agencies, consumers and other third parties. In addition to traditional pricing models where a customer receives a product in return for a payment at the time of product receipt, we currently use the following pricing models:
• Pay-up-front: Customer makes a fixed payment at time of purchase and we
provide a specific product/service in return;
• Pre-pay Subscription: Customer makes a one-time payment at time of
purchase, but receives a stream of goods/services over a defined time
horizon; for example, we currently provide customers the option topurchase a multi-year subscription to textbooks where for a one-time
charge, a new copy of the work text is delivered to the customer each year
for a defined time period. Pre-pay subscriptions to online textbooks are
another example where the customer receives access to an online book for a
specific period of time; and
• Pay-as-you-go Subscription: Similar to the pre-pay subscription, except
that the customer makes periodic payments in a pre-described manner.
Cost of sales, excluding publishing rights and pre-publication amortization
Cost of sales, excluding publishing rights and pre-publication amortization,
include expenses directly attributable to the production of our products and
services, including the non-capitalizable costs associated with our content and
platform development group. The expenses within cost of sales include variable
costs such as paper, printing and binding costs of our print materials, royalty
expenses paid to our authors, gratis costs or products provided at no charge as
part of the sales transaction, and inventory obsolescence. Also included in cost
of sales are labor costs related to professional services and the
non-capitalized costs associated with our content and platform development
group. We also include amortization expense associated with our customer-facing
software platforms. Certain products such as trade books and products associated
with our renowned authors carry higher royalty costs; conversely, digital
offerings usually have a lower cost of sales due to lower costs associated with
their production. Also, sales to adoption states usually contain higher cost of
sales. A change in the sales mix of our products or services can impact
consolidated profitability.
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Publishing rights and Pre-publication amortization
A publishing right is an acquired right that allows us to publish and republish existing and future works as well as create new works based on previously published materials. As part of ourMarch 9, 2010 restructuring, we recorded an intangible asset for publishing rights and amortize such asset on an accelerated basis over the useful lives of the various copyrights involved. This amortization will continue to decrease approximately 25% annually through March of 2023. We capitalize the art, prepress, manuscript and other costs incurred in the creation of the master copy of our content, known as the pre-publication costs. Pre-publication costs are primarily amortized from the year of sale over five years using the sum-of-the-years-digits method, which is an accelerated method for calculating an asset's amortization. Under this method, the amortization expense recorded for a pre-publication cost asset is approximately 33% (year 1), 27% (year 2), 20% (year 3), 13% (year 4) and 7% (year 5). We utilize this policy for all pre-publication costs, except with respect to ourHMH Books & Media segment's consumer books, for which we generally expense such costs as incurred, and the acquired content of certain intervention products acquired in 2015, which we amortize over 7 years using an accelerated amortization method. The amortization methods and periods chosen best reflect the pattern of expected sales generated from individual titles or programs. We periodically evaluate the remaining lives and recoverability of capitalized pre-publication costs, which are often dependent upon program acceptance by state adoption authorities.
Selling and administrative expenses
Our selling and administrative expenses include the salaries, benefits and related costs of employees engaged in sales and marketing, fulfillment and administrative functions. Also included within selling and administrative expenses are variable costs such as commission expense, outbound transportation costs (approximately$5.0 million for the three months endedMarch 31, 2020 ) and depository fees, which are fees paid to state-mandated depositories that fulfill centralized ordering and warehousing functions for specific states. Additionally, significant fixed and discretionary costs include facilities, telecommunications, professional fees, promotions, sampling and advertising, along with depreciation.
Other intangible asset amortization
Our other intangible asset amortization expense primarily includes the amortization of acquired intangible assets consisting of tradenames, customer relationships, content rights and licenses. The tradenames, customer relationships, content rights and licenses are amortized over varying periods of 5 to 25 years. The expense for the three months endedMarch 31, 2020 was$6.3 million .
Interest expense
Our interest expense includes interest accrued on our$306.0 million in aggregate principal amount of 9.0% Senior Secured Notes due 2025 ("notes"), our$380.0 million term loan credit facility ("term loan facility") and, for 2019 only, our previous$800.0 million term loan credit facility ("previous term loan facility") along with, to a lesser extent, our revolving credit facility, finance leases, the amortization of any deferred financing fees and loan discounts, and payments in connection with interest rate hedging agreements. Our interest expense for the three months endedMarch 31, 2020 was$16.8 million . 30
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Results of Operations
Consolidated Operating Results for the Three Months EndedMarch 31, 2020 and 2019 Dollar Percent Three Months Ended March 31, Change Change (dollars in thousands) 2020 2019 2020 2019 Net sales$ 189,925 $ 194,635 $ (4,710 ) (2.4 )% Costs and expenses: Cost of sales, excluding publishing rights and pre-publication amortization 90,012 96,055 (6,043 ) (6.3 )% Publishing rights amortization 5,825 7,605 (1,780 ) (23.4 )% Pre-publication amortization 30,638 33,082 (2,444 ) (7.4 )% Cost of sales 126,475 136,742 (10,267 ) (7.5 )% Selling and administrative 133,353 151,983 (18,630 ) (12.3 )% Impairment charge for goodwill 262,000 - 262,000 NM Other intangible assets amortization 6,273 6,524 (251 ) (3.8 )% Restructuring/severance and other charges - 1,221 (1,221 ) NM Operating loss (338,176 ) (101,835 ) (236,341 ) NM Other income (expense): Retirement benefits non-service income 61 42 19 45.2 % Interest expense (16,783 ) (11,582 ) (5,201 ) (44.9 )% Interest income 766 1,092 (326 ) (29.9 )% Change in fair value of derivative instruments (380 ) (450 ) 70 15.6 % Income from transition services agreement - 1,826 (1,826 ) NM Loss before taxes (354,512 ) (110,907 ) (243,605 ) NM Income tax (benefit) expense (8,539 ) 6,455 (14,994 ) NM Net loss$ (345,973 ) $ (117,362 ) $ (228,611 ) NM NM = not meaningful Net sales for the three months endedMarch 31, 2020 decreased$4.7 million , or 2.4%, from$194.6 million in 2019 to$189.9 million . The net sales decrease was driven by a$2.4 million decrease in ourHMH Books & Media segment, coupled with a$2.3 million decrease in our Education segment. Within ourHMH Books & Media segment, the decrease in net sales was primarily due to 2019 licensing revenue attributed to the Carmen Sandiego series on Netflix, which did not repeat in the first quarter of 2020 but is expected later in the year. Partially offsetting the aforementioned were an increase in net sales of the Little Blue Truck series and strong net sales of the frontlist titles Chosen Ones and Maybe You Should Talk to Someone. Within our Education segment, the decrease was due to lower net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, which decreased by$16.0 million from$102.0 million in 2019 to$86.0 million . Within Extensions, Heinemann net sales decreased due to lower sales of the LLI Leveled Literacy and Calkins products due to the economic slowdown, partially offset by stronger net sales from Core Solutions which increased by$13.0 million from$52.0 million in 2019 to$65.0 million . The primary drivers of the increase in Core Solutions net sales was the recognition of revenue previously deferred. Operating loss for the three months endedMarch 31, 2020 unfavorably changed from a loss of$101.8 million in 2019 to a loss of$338.2 million , due primarily to the following:
• An impairment charge for goodwill for the three months ended
2020 of
adverse impact that COVID-19 has had on the Company,
• A $4.7 million decrease in net sales,
• Partially offset by a
expenses, primarily due to lower labor costs of
savings associated with our 2019 Restructuring Plan. Also, there was a
decrease of
commissions due to lower billings, which decreased
first quarter of 2019. Further, there were lower discretionary costs of
$4.0 million related to travel and expense reduction measures along with lower depreciation expense of$3.3 million , 31
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• A
and pre-publication amortization, from
excluding publishing rights and pre-publication amortization, as a
percentage of sales, decreased to 47.4% from 49.4% due to lower film asset
amortization costs attributed to the timing of delivery of the Carmen
Sandiego series on Netflix, which did not repeat in the first quarter of
2020 but is expected later in the year,
• A
rights, pre-publication and other intangible assets, primarily due to a
decrease in pre-publication amortization attributed to the timing of 2019
major product releases and, to a lesser extent, our use of accelerated
amortization methods for publishing rights amortization,
• A $1.2 million decrease in costs associated with our
restructuring/severance and other charges in the first quarter of 2019
that did not repeat.
Interest expense for the three months ended March 31, 2020 increased
$5.2 million from $11.6 million in 2019 to $16.8 million , primarily due to our
debt refinancing during the fourth quarter of 2019 in which the previous term
loan facility was replaced with the term loan facility and the notes with higher
interest rates (the "2019 Refinancing"). Further, there was an increase of
$0.8 million of net settlement payments on our interest rate derivative
instruments during 2020.
Interest income for the three months ended
Change in fair value of derivative instruments for the three months endedMarch 31, 2020 , favorably changed by a small amount. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were favorably impacted by the weakening of theU.S. dollar against the Euro. Income from transition services agreement for the three months endedMarch 31, 2019 was$1.8 million and was related to transition service fees under the transition services agreement with the purchaser of ourRiverside clinical and standardized testing business ("Riverside Business") pursuant to which we performed certain support functions throughSeptember 30, 2019 . Income tax (benefit) expense for the three months endedMarch 31, 2020 increased$15.0 million , from an expense of$6.5 million in 2019, to a benefit of$8.5 million . An income tax benefit was recorded in the first quarter of 2020 and was due primarily to the book impairment on goodwill, which reduced the related deferred tax liabilities. For 2020, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (2.1)%. For 2019, our effective annual tax rate exclusive of discrete items was (4.9)%. For both periods income tax expense was primarily attributed to movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes, as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions.
Adjusted EBITDA
To supplement our financial statements presented in accordance with GAAP, we
have presented Adjusted EBITDA, which is not prepared in accordance with GAAP.
This information should be considered as supplemental in nature and should not
be considered in isolation or as a substitute for the related financial
information prepared in accordance with GAAP. Management believes that the
presentation of Adjusted EBITDA provides useful information to investors
regarding our results of operations because it assists both investors and
management in analyzing and benchmarking the performance and value of our
business. Adjusted EBITDA provides an indicator of general economic performance
that is not affected by debt restructurings, fluctuations in interest rates or
effective tax rates, non-cash charges, or levels of depreciation or amortization
along with costs such as severance, separation and facility closure costs,
inventory obsolescence related to our strategic transformation plan,
acquisition/disposition-related activity costs, restructuring costs and
integration costs. Accordingly, our management believes that this measurement is
useful for comparing general operating performance from period to period. In
addition, targets in Adjusted EBITDA (further adjusted to include changes in
deferred revenue) are used as performance measures to determine certain
compensation of management, and Adjusted EBITDA is used as the base for
calculations relating to incurrence covenants in our debt agreements. Other
companies may define Adjusted EBITDA differently and, as a result, our measure
of Adjusted EBITDA may not be directly comparable to Adjusted EBITDA of other
companies. Although we use Adjusted EBITDA as a financial measure to assess the
performance of our business, the use of Adjusted EBITDA is limited because it
does not include certain material costs, such as interest and taxes, necessary
to operate our business. Adjusted EBITDA should be considered in addition to,
and not as a substitute for, net loss/income in accordance with GAAP as a
measure of performance. Adjusted EBITDA is not intended to be a measure of
liquidity or free cash flow for discretionary use. You are cautioned not to
place undue reliance on Adjusted EBITDA.
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Below is a reconciliation of our net loss to Adjusted EBITDA for the three
months ended
Three Months Ended March 31,
2020 2019
Net loss $ (345,973 ) $ (117,362 )
Interest expense 16,783 11,582
Interest income (766 ) (1,092 )
Provision (benefit) for income taxes (8,539 ) 6,455
Depreciation expense 12,489 16,179
Amortization expense - film asset - 5,012
Amortization expense 42,736 47,211
Non-cash charges - goodwill impairment 262,000 -
Non-cash charges - stock compensation 3,476 3,551
Non-cash charges - loss on derivative instruments 380 450
Fees, expenses or charges for equity offerings, debt or
acquisitions/dispositions 27 287 Restructuring/severance and other charges - 1,221 Adjusted EBITDA$ (17,387 ) $ (26,506 ) Segment Operating Results Results of Operations - Comparing Three Months EndedMarch 31, 2020 and 2019 Education Three Months Ended March 31, Dollar Percent 2020 2019 Change Change Net sales$ 151,585 $ 153,844 $ (2,259 ) (1.5 )% Costs and expenses: Cost of sales, excluding publishing rights and pre-publication amortization 63,650 66,983 (3,333 ) (5.0 )% Publishing rights amortization 4,432 6,042 (1,610 ) (26.6 )% Pre-publication amortization 30,589 32,969 (2,380 ) (7.2 )% Cost of sales 98,671 105,994 (7,323 ) (6.9 )% Selling and administrative 101,684 119,402 (17,718 ) (14.8 )% Other intangible asset amortization 5,737 5,018 719 14.3 % Impairment charge for goodwill 262,000 - 262,000 NM Operating loss (316,507 ) (76,570 ) (239,937 ) NM Net loss$ (316,507 ) $ (76,570 ) $ (239,937 ) NM
Adjustments from net loss to
Education segment Adjusted EBITDA Depreciation expense$ 8,884 $ 11,576 $ (2,692 ) (23.3 )% Amortization expense 40,758 44,029
(3,271 ) (7.4 )%
Non-cash charges - goodwill impairment 262,000 - 262,000 NM
Education segment Adjusted EBITDA
NM
NM = not meaningful
Our Education segment net sales for the three months ended March 31, 2020
decreased $2.3 million , or 1.5%, from $153.8 million in 2019 to $151.6 million .
The decrease was due to lower net sales in Extensions, which primarily consist
of our Heinemann brand, intervention and supplemental products as well as
professional services, which decreased by $16.0 million from $102.0 million in
2019 to $86.0 million . Within Extensions, Heinemann net sales decreased due to
lower sales of the LLI Leveled Literacy and Calkins products due to the economic
slowdown, partially offset by stronger net sales from Core Solutions which
increased by $13.0 million from $52.0 million in 2019 to $65.0 million . The
primary driver of the increase in Core Solutions net sales was the recognition
of revenue previously deferred.
Our Education segment cost of sales for the three months ended March 31, 2020
decreased $7.3 million , or 6.9%, from $106.0 million in 2019 to $98.7 million .
Our cost of sales, excluding publishing rights and pre-publication amortization,
decreased
33
--------------------------------------------------------------------------------$3.3 million from$67.0 million in 2019 to$63.7 million . Our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of sales, decreased to 42.0% from 43.5% due to product mix. Pre-publication amortization decreased by$2.4 million from 2019 primarily due to the timing of 2019 major product releases, and$1.6 million decrease in publishing rights amortization attributed to our use of accelerated amortization methods. Our Education segment selling and administrative expense for the three months endedMarch 31, 2020 decreased$17.7 million , or 14.8%, from$119.4 million in 2019 to$101.7 million . The decrease was driven by lower labor costs due to the 2019 Restructuring Plan and lower variable expenses such as samples, transportation, depository fees and commissions attributed to lower billings from the prior year. Further, discretionary spending is lower due to travel reductions and the economic slowdown. Our Education segment other intangible asset amortization expense for the three months endedMarch 31, 2020 decreased$0.7 million from 2019, which was due to our use of accelerated amortization methods. Our Education segment impairment charge for goodwill for the three months endedMarch 31, 2020 was$262.0 million . This non-cash impairment is a direct result of the adverse impact that COVID-19 has had on the Company. Our Education segment Adjusted EBITDA for the three months endedMarch 31, 2020 increased$16.1 million , from a loss of$21.0 million in 2019 to a loss of$4.9 million . Our Education segment Adjusted EBITDA excludes depreciation, amortization and goodwill impairment charges. The increase is due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in Education segment Adjusted EBITDA.HMH Books & Media Three Months Ended March 31, Dollar Percent 2020 2019 Change Change Net sales$ 38,340 $ 40,791 $ (2,451 ) (6.0 )% Costs and expenses: Cost of sales, excluding publishing rights and pre-publication amortization 26,362 29,072 (2,710 ) (9.3 )% Publishing rights amortization 1,393 1,563 (170 ) (10.9 )% Pre-publication amortization 49 113 (64 ) (56.6 )% Cost of sales 27,804 30,748 (2,944 ) (9.6 )% Selling and administrative 12,829 13,034 (205 ) (1.6 )% Other intangible asset amortization 536 1,506 (970 ) (64.4 )% Operating loss (2,829 ) (4,497 ) 1,668 37.1 % Net loss$ (2,829 ) $ (4,497 ) $ 1,668 37.1 % Adjustments from net loss toHMH Books & Media segment Adjusted EBITDA Depreciation expense$ 171 $ 472 $ (301 ) (63.8 )% Amortization expense film asset - 5,012 (5,012 ) NM Amortization expense 1,978 3,182 (1,204 ) (37.8 )%HMH Books & Media segment Adjusted EBITDA$ (680 ) $ 4,169 $ (4,849 ) NM NM = not meaningful OurHMH Books & Media segment net sales for the three months endedMarch 31, 2020 decreased$2.5 million , or 6.0%, from$40.8 million in 2019 to$38.3 million . The decrease in net sales was primarily due to 2019 licensing revenue attributed to the Carmen Sandiego series on Netflix, which did not repeat in the first quarter of 2020, but is expected later in the year. Partially offsetting the aforementioned was an increase in net sales of the Little Blue Truck series and strong net sales of the frontlist titles Chosen Ones and Maybe You Should Talk to Someone. OurHMH Books & Media segment cost of sales for the three months endedMarch 31, 2020 decreased$2.9 million , or 9.6%, from$30.7 million in 2019 to$27.8 million . The majority of the decrease was driven by our cost of sales, excluding publishing rights and pre-publication amortization, which decreased$2.7 million primarily due to volume. Our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of net sales, decreased to 68.8% from 71.3% due to higher film asset amortization from the Carmen Sandiego series in 2019. 34
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Our
OurHMH Books & Media segment other intangible asset amortization expense for the three months endedMarch 31, 2020 decreased$1.0 million from 2019, due to certain definite-lived intangible assets being fully depreciated in 2019. OurHMH Books & Media segment Adjusted EBITDA for the three months endedMarch 31, 2020 changed unfavorably from$4.2 million in 2019 to a loss of$0.7 million due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in ourHMH Books & Media segment Adjusted EBITDA. OurHMH Books & Media segment Adjusted EBITDA excludes depreciation and amortization. Corporate and Other Three Months Ended March 31, Dollar Percent 2020 2019 Change Change Net sales $ - $ - $ - - Costs and expenses: Cost of sales, excluding publishing rights and pre-publication amortization - - - - Publishing rights amortization - - - - Pre-publication amortization - - - - Cost of sales - - - - Selling and administrative 18,840 19,547 (707 ) (3.6 )% Restructuring/severance and other charges - 1,221 (1,221 ) NM Operating loss (18,840 ) (20,768 ) 1,928 9.3 % Retirement benefits non-service income 61 42 19 45.2 % Interest expense (16,783 ) (11,582 ) (5,201 ) (44.9 )% Interest income 766 1,092 (326 ) (29.9 )% Change in fair value of derivative instruments (380 ) (450 ) 70 15.6 % Income from transition services agreement - 1,826 (1,826 ) NM Net loss before taxes (35,176 ) (29,840 ) (5,336 ) (17.9 )% Income tax (benefit) expense (8,539 ) 6,455 (14,994 ) NM Net loss$ (26,637 ) $ (36,295 ) $ 9,658 26.6 % Adjustments from net loss to Corporate and Other segment Adjusted EBITDA Interest expense$ 16,783 $ 11,582 $ 5,201 44.9 % Interest income (766 ) (1,092 ) 326 29.9 % Provision for income taxes (8,539 ) 6,455 (14,994 ) NM Depreciation expense 3,434 4,131 (697 ) (16.9 )% Non-cash charges - loss on derivative instruments 380 450 (70 ) (15.6 )% Non-cash charges - stock compensation 3,476 3,551 (75 ) (2.1 )% Fees, expenses or charges for equity offerings, debt or acquisitions/dispositions 27 287 (260 ) (90.6 )% Restructuring/severance and other charges - 1,221 (1,221 ) NM Corporate and Other segment Adjusted EBITDA$ (11,842 ) $ (9,710 ) $ (2,132 ) (22.0 )% NM = not meaningful The Corporate and Other category represents certain general overhead costs not fully allocated to the business segments such as legal, accounting, treasury, human resources, technology and executive functions along with severance and other non-operating costs. Our selling and administrative expense for the Corporate and Other category for the three months endedMarch 31, 2020 decreased$0.7 million from$19.5 million in 2019 to$18.8 million , primarily attributed to lower labor costs due to the 2019 Restructuring Plan. Our restructuring/severance and other charges for the three months endedMarch 31, 2020 decreased by$1.2 million due to severance costs in the first quarter of 2019 that did not repeat. 35
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Interest expense for the three months ended
Interest income for the three months ended
Change in fair value of derivative instruments for the three months endedMarch 31, 2020 , favorably changed by a small amount. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were favorably impacted by the weakening of theU.S. dollar against the Euro. Income from transition services agreement for the three months endedMarch 31, 2019 was$1.8 million and was related to transition service fees under the transition services agreement with the purchaser of the Riverside Business pursuant to which we performed certain support functions throughSeptember 30, 2019 . Income tax benefit for the three months endedMarch 31, 2020 increased$15.0 million , from an expense of$6.5 million in 2019, to a benefit of$8.5 million . An income tax benefit was recorded in the first quarter of 2020 and was due primarily to the book impairment on goodwill, which reduced the related deferred tax liabilities. For 2020, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (2.1)%. For 2019, our effective annual tax rate exclusive of discrete items was (4.9)%. For both periods, income tax expense was primarily attributed to movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes, as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions. Adjusted EBITDA for the Corporate and Other category for the three months endedMarch 31, 2020 unfavorably changed$2.1 million , or 22.0%, from a loss of$9.7 million in 2019 to a loss of$11.8 million . Our Adjusted EBITDA for the Corporate and Other category excludes interest, taxes, depreciation, derivative instruments charges, equity compensation charges, acquisition/disposition-related activity, severance and facility vacant space costs. The unfavorable change in our Adjusted EBITDA for the Corporate and Other category was due to the factors described above after removing those items not included in Adjusted EBITDA for the Corporate and Other category.
Seasonality and Comparability
Our net sales, operating profit or loss and net cash provided by or used in operations are impacted by the inherent seasonality of the academic calendar, which typically results in a cash flow usage in the first half of the year and a cash flow generation in the second half of the year. Consequently, the performance of our businesses may not be comparable quarter to consecutive quarter and should be considered on the basis of results for the whole year or by comparing results in a quarter with results in the same quarter for the previous year. Moreover, uncertainty resulting from the COVID-19 pandemic may result in 2020 not following this historic pattern. Approximately 87% of our net sales for the year endedDecember 31, 2019 were derived from our Education segment, which is a markedly seasonal business. Schools conduct the majority of their purchases in the second and third quarters of the calendar year in preparation for the beginning of the school year. Thus, over the past three completed fiscal years, approximately 67% of our consolidated net sales were realized in the second and third quarters. Sales of K-12 instructional materials are also cyclical, with some years offering more sales opportunities than others in light of the state adoption calendar. The amount of funding available at the state level for educational materials also has a significant effect on year-to-year net sales. Although the loss of a single customer would not have a material adverse effect on our business, schedules of school adoptions and market acceptance of our products can materially affect year-to-year net sales performance.
Liquidity and Capital Resources
March 31, December 31,
(in thousands) 2020 2019
Cash and cash equivalents $ 254,665 $ 296,353
Current portion of long-term debt 19,000 19,000
Long-term debt, net of discount and issuance costs 634,800
638,187
Revolving credit facility 150,000 -
Borrowing availability under revolving credit facility 34,694
161,961
36
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Three Months Ended March 31,
2020 2019
Net cash used in operating activities $ (156,767 ) $ (176,063 )
Net cash used in investing activities (30,626 ) (1,720 )
Net cash provided by (used in) financing activities 145,705 (1,397 )
Operating activities
Net cash used in operating activities was $156.8 million for the three months
ended March 31, 2020 , a $19.3 million decrease from the $176.1 million of net
cash used in operating activities for the three months ended March 31, 2019 . The
decrease in cash used in operating activities was primarily driven by favorable
changes in net operating assets and liabilities of $13.7 million primarily due
to favorable period over period inventory changes of $25.4 million , favorable
period over period changes in accounts receivable of $24.0 million due to
continued collections from greater billings in 2019, an increase in net other
assets and liabilities of $14.9 million and operating lease liabilities of $0.9
million , offset by unfavorable changes in accounts payable of $21.5 million
related to timing of disbursements, deferred revenue of $19.7 million , severance
and other charges of $5.3 million due to payments on actions taken during the
fourth quarter of 2019 and royalties of $4.8 million . Additionally, operating
profit, net of non-cash items, increased by $5.6 million .
Investing activities
Net cash used in investing activities was$30.6 million for the three months endedMarch 31, 2020 , an increase of$28.9 million from the three months endedMarch 31, 2019 . The increase in cash used in investing activities was primarily due to lower net proceeds from sales and maturities of short-term investments of$40.0 million compared to 2019, offset by lower capital investing expenditures related to pre-publication costs and property, plant, and equipment of$5.6 million , and by the acquisition of a business for$5.4 million in 2019.
Financing activities
Net cash provided by financing activities was$145.7 million for the three months endedMarch 31, 2020 , an increase of$147.1 million from the$1.4 million of net cash used in financing activities for the three months endedMarch 31, 2019 . The increase in cash provided by financing activities was primarily due to proceeds from our revolving credit facility of$150.0 million , offset by an increase in principal payments on our term loan of$2.8 million in 2020.
Debt
Under each of the notes, the term loan facility and the revolving credit facility,Houghton Mifflin Harcourt Publishers Inc. ,Houghton Mifflin Harcourt Publishing Company andHMH Publishers LLC are the borrowers (collectively, the "Borrowers"), andCitibank, N.A . acts as both the administrative agent and the collateral agent. The obligations under the senior secured notes, the term loan facility and the revolving credit facility are guaranteed by the Company and each of its direct and indirect for-profit domestic subsidiaries (other than the Borrowers) (collectively, the "Guarantors") and are secured by all capital stock and other equity interests of the Borrowers and the Guarantors and substantially all of the other tangible and intangible assets of the Borrowers and the Guarantors, including, without limitation, receivables, inventory, equipment, contract rights, securities, patents, trademarks, other intellectual property, cash, bank accounts and securities accounts and owned real estate. The revolving credit facility is secured by first priority liens on receivables, inventory, deposit accounts, securities accounts, instruments, chattel paper and other assets related to the foregoing (the "Revolving First Lien Collateral"), and second priority liens on the collateral which secures the term loan facility on a first priority basis. The term loan facility is secured by first priority liens on the capital stock and other equity interests of the Borrowers and the Guarantors, equipment, owned real estate, trademarks and other intellectual property, general intangibles that are not Revolving First Lien Collateral and other assets related to the foregoing, and second priority liens on the Revolving First Lien Collateral.
Senior Secured Notes
OnNovember 22, 2019 , we completed the sale of$306.0 million in aggregate principal amount of 9.0% Senior Secured Notes due 2025 (the "notes") in a private placement to qualified institutional buyers under Rule 144A under the Securities Act of 1933, as amended (the "Securities Act"), and to persons outsidethe United States pursuant to Regulation S under the Securities Act. The notes mature onFebruary 15, 2025 and bear interest at a rate of 9.0% per annum. Interest is payable semi-annually in arrears onFebruary 15 andAugust 15 of each year, beginning onFebruary 15, 2020 . As ofMarch 31, 2020 , we had$306.0 million ($296.3 million , net of discount and issuance costs) outstanding under the notes. 37
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We may redeem all or a portion of the notes at redemption prices as described in the notes.
The notes do not require us to comply with financial maintenance covenants. We are currently required to meet certain incurrence based financial covenants as defined under the notes. The notes are subject to customary events of default. If an event of default occurs and is continuing, the administrative agent may, or at the request of certain required lenders shall, accelerate the obligations outstanding under the notes. Term Loan Facility OnNovember 22, 2019 , we entered into a second amended and restated term loan credit agreement for an aggregate principal amount of$380.0 million (the "term loan facility"). As ofMarch 31, 2020 , we had$375.3 million ($357.5 million , net of discount and issuance costs) outstanding under the term loan facility. The term loan facility matures onNovember 22, 2024 and the interest rate per annum is equal to, at the option of the Company, either (a) LIBOR plus a margin of 6.25% or (b) an alternate base rate plus a margin of 5.25%. As ofMarch 31, 2020 , the interest rate on the term loan facility was 7.25%.
The term loan facility is required to be repaid in quarterly installments of
approximately
The term loan facility does not require us to comply with financial maintenance covenants. We are currently required to meet certain incurrence based financial covenants as defined under our term loan facility. The term loan facility contains customary mandatory prepayment requirements, including with respect to excess cash flow, proceeds from certain asset sales or dispositions of property, and proceeds from certain incurrences of indebtedness. The term loan facility permits the Company to voluntarily prepay outstanding amounts at any time without premium or penalty, other than customary breakage costs with respect to LIBOR loans; provided, however, that any voluntary prepayment in connection with certain repricing transactions that occur before the date that is twelve months after the closing of the term loan facility shall be subject to a prepayment premium of 1.00% of the principal amount of the amounts prepaid. The term loan facility is subject to usual and customary conditions, representations, warranties and covenants, including restrictions on additional indebtedness, liens, investments, mergers, acquisitions, asset dispositions, dividends to stockholders, repurchase or redemption of our stock, transactions with affiliates and other matters. The term loan facility is subject to customary events of default. If an event of default occurs and is continuing, the administrative agent may, or at the request of certain required lenders shall, accelerate the obligations outstanding under the term loan facility. We are subject to an excess cash flow provision under our term loan facility which is predicated upon our leverage ratio and cash flow. The excess cash flow provision did not apply in 2019.
Revolving Credit Facility
OnNovember 22, 2019 , we entered into a second amended and restated revolving credit agreement that provides borrowing availability in an amount equal to the lesser of either$250.0 million or a borrowing base that is computed monthly or weekly and comprised of the Borrowers' and the Guarantors' eligible inventory and receivables (the "revolving credit facility"). The revolving credit facility includes a letter of credit subfacility of$50.0 million , a swingline subfacility of$20.0 million and the option to expand the facility by up to$100.0 million in the aggregate under certain specified conditions. The amount of any outstanding letters of credit reduces borrowing availability under the revolving credit facility on a dollar-for-dollar basis. As ofMarch 31, 2020 , there was$150.0 million drawn on the revolving credit facility. As ofMarch 31, 2020 , we had approximately$20.1 million of outstanding letters of credit and approximately$34.7 million of borrowing availability under the revolving credit facility. As ofMay 7, 2020 , there was$150.0 million drawn on the revolving credit facility. The revolving credit facility has a five-year term and matures onNovember 22, 2024 . The interest rate applicable to borrowings under the facility is based, at our election, on LIBOR plus a margin between 1.50% and 2.00% or an alternative base rate plus a margin between 0.50% and 1.00%, which margins are based on average daily availability. The revolving credit facility may be prepaid, in whole or in part, at any time, without premium. 38 -------------------------------------------------------------------------------- The revolving credit facility requires us to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 on a trailing four-quarter basis for periods in which excess availability under the revolving credit facility is less than the greater of$25.0 million and 12.5% of the lesser of the total commitment and the borrowing base then in effect, or less than$20.0 million if certain conditions are met. The minimum fixed charge coverage ratio was not applicable under the facility as ofMarch 31, 2020 , due to our level of borrowing availability. The revolving credit facility is subject to usual and customary conditions, representations, warranties and covenants, including restrictions on additional indebtedness, liens, investments, mergers, acquisitions, asset dispositions, dividends to stockholders, repurchase or redemption of our stock, transactions with affiliates and other matters. The revolving credit facility is subject to customary events of default. If an event of default occurs and is continuing, the administrative agent may, or at the request of certain required lenders shall, accelerate the obligations outstanding under the revolving credit facility.
General
We had$254.7 million of cash and cash equivalents and no short-term investments atMarch 31, 2020 . We had$296.4 million of cash and cash equivalents and no short-term investments atDecember 31, 2019 . Our business is impacted by the inherent seasonality of the academic calendar, which typically results in a cash flow usage in the first half of the year and a cash flow generation in the second half of the year. We expect our net cash provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund our current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months. Our primary credit facilities do not require us to comply with financial maintenance covenants. The ability of the Company to fund planned operations is based on assumptions which involve significant judgment and estimates of future revenues, capital spend and other operating costs. Our current assumptions are that businesses will reopen for selling and school districts will gradually resume purchasing during the second quarter of 2020 and most or all will become fully operational, either in-person or virtually, by the third quarter of 2020. We have performed a sensitivity analysis on these assumptions to forecast the impact of a slower-than-anticipated recovery and believe we can take additional financial and operational actions to mitigate the impact of lower billings than our current plans assume. These actions include additional expense reductions, asset sales, and capital raising activities including utilization of funding provided under the CARES Act.
Critical Accounting Policies and Estimates
Our financial results are affected by the selection and application of critical accounting policies and methods. There were no material changes in the three months endedMarch 31, 2020 to the application of critical accounting policies and estimates as described in our audited consolidated financial statements, which were included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 . The critical accounting estimates used in the preparation of the Company's consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and the Company's operating environment changes. Actual results may differ from these estimates due to the uncertainty around the magnitude and duration of the COVID-19 pandemic, as well as other factors.
Impact of Inflation and Changing Prices
We believe that inflation has not had a material impact on our results of operations during the year endedDecember 31, 2019 or year to date in 2020. We cannot be sure that future inflation will not have an adverse impact on our operating results and financial condition in future periods. Our ability to adjust selling prices has always been limited by competitive factors and long-term contractual arrangements which either prohibit price increases or limit the amount by which prices may be increased. Further, a weak domestic economy at a time of low inflation could cause lower tax receipts at the state and local level, and the funding and buying patterns for textbooks and other educational materials could be adversely affected.
Covenant Compliance
As of
We are currently required to meet certain incurrence-based financial covenants
as defined under our term loan facility, notes and revolving credit facility. We
have incurrence based financial covenants primarily pertaining to a maximum
leverage ratio and fixed charge coverage ratio. A breach of any of these
covenants, ratios, tests or restrictions, as applicable, for which a waiver is
not obtained could result in an event of default, in which case our lenders
could elect to declare all amounts outstanding to be immediately due and payable
and result in a cross-default under other arrangements containing such
provisions. A default would permit lenders to
39
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accelerate the maturity for the debt under these agreements and to foreclose
upon any collateral securing the debt owed to these lenders and to terminate any
commitments of these lenders to lend to us. If the lenders accelerate the
payment of the indebtedness, our assets may not be sufficient to repay in full
the indebtedness and any other indebtedness that would become due as a result of
any acceleration. Further, in such an event, the lenders would not be required
to make further loans to us, and assuming similar facilities were not
established and we are unable to obtain replacement financing, it would
materially affect our liquidity and results of operations.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Recently Issued Accounting Pronouncements
See Note 3 to the consolidated financial statements included under Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recently issued accounting pronouncements.
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