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 our consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. The following discussion and analysis of our financial condition and results of operations contains forward-looking statements about our business, operations and industry that involve risks and uncertainties, such as statements regarding our plans, objectives, expectations and intentions. Actual results and the timing of events may differ materially from those expressed or implied in such forward-looking statements due to a number of factors, including those set forth under "Risk Factors" and elsewhere in this Annual Report on Form 10-K. See "Risk Factors" and "Special Note Regarding Forward-Looking Statements."
Overview
We are a learning technology 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. Recent Developments Acquisition by Veritas OnFebruary 21, 2022 , we entered into a merger agreement which provides for the acquisition of our company by entities beneficially owned byThe Veritas Capital Fund VII, L.P. at a price of$21.00 per share of our common stock. The transaction is expected to close in the second quarter of 2022. See Note 20 - Acquisition by Entities Beneficially Owned by Veritas for additional information related to this pending transaction.
OnMay 10, 2021 , we completed the sale of all of the assets and liabilities used primarily in theHMH Books & Media segment, our consumer publishing business, for cash consideration of$349.0 million , subject to a customary working capital adjustment resulting in a payment to the purchaser of$8.4 million , and the purchaser's assumption of all liabilities relating to theHMH Books & Media business subject to specified exceptions (collectively, the "Transaction"). Total net cash proceeds after the payment of transaction costs and exclusive of working capital adjustment, were approximately$337.0 million , which we used to pay down debt. The divestiture enables HMH to focus singularly on K-12 education and accelerate growth momentum in digital sales, annual recurring revenue and free cash flow while paying down a significant portion of our debt. As part of the agreement, allHMH Books & Media business employees joined the acquiring company. Upon entering into the asset purchase agreement onMarch 26, 2021 and qualifying as held-for-sale, theHMH Books & Media business was classified as a discontinued operation due to its relative size and strategic rationale, and accordingly, all results of theHMH Books & Media business have been removed from continuing operations for all periods presented, including from discussions of total net sales and other results of operations. Included within the years endedDecember 31, 2021 , 2020 and 2019 discontinued operations financial results is interest expense of$9.4 million ,$28.3 million and$19.3 million , respectively, based on our required repayment of the Company's debt with the net proceeds from the sale. On the balance sheet, all assets and liabilities that transferred to the acquirer have been classified as Assets of discontinued operations or Liabilities of discontinued operations. The results of theHMH Books & Media business were previously reported in its own reportable segment. We currently report our revenues and financial results from continuing operations under one reportable segment.
Unless otherwise indicated, all financial information refers to continuing operations.
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--------------------------------------------------------------------------------COVID-19
Over the past two years, we implemented a number of measures intended to help protect our shareholders, employees, and customers amid the COVID-19 pandemic. We also took actions to help mitigate some of the adverse impact of COVID-19 to our profitability and cash flow including, but not limited to, furloughs, salary reductions, spending freezes, and proactive outreach to schools to support them through this period of disruption with virtual learning resources.
2020 Restructuring Plan
We revised our cost structure amid the COVID-19 pandemic to further align our cost structure to our net sales and long-term strategy. As part of this effort, onSeptember 4, 2020 , we finalized a voluntary retirement incentive program, which was offered to allU.S. based employees at least 55 years of age with at least five years of service. Of the eligible employees, 165 elected to participate representing approximately 5% of our workforce. The majority of the employees voluntarily retired as ofSeptember 4, 2020 with select employees leaving later in the year. Each of the employees received separation payments in accordance with our severance policy. OnSeptember 30, 2020 , our Board of Directors committed to a restructuring program, including a reduction in force, as part of the ongoing assessment of our cost structure amid the COVID-19 pandemic. The reduction in force resulted in a 22% reduction in our workforce, including positions eliminated as part of the voluntary retirement incentive program mentioned above, and net of newly created positions to support our digital-first operations. The reduction in force resulted in the departure of approximately 525 employees and was completed inOctober 2020 . Each of the employees received separation payments in accordance with our severance policy. The total one-time, non-recurring cost incurred in connection with the 2020 restructuring program, inclusive of the voluntary retirement incentive program (collectively the "2020 Restructuring Plan"), all of which represented cash expenditures, was approximately$30.9 million . These actions streamlined the cost structure of the Company.
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 were 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 resulted in cash expenditures.
Further, as part of the strategic transformation plan, we recorded an
incremental
Key Aspects and Trends of Our Operations
We derive revenue primarily from the sale of print and digital content and instructional materials, multimedia instructional programs, 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 invoices for products and services, less revenue that will be deferred until future recognition 32 -------------------------------------------------------------------------------- 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 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 50% 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 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 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. Further, we also derive net sales from the delivery of services to K-12 educators and administrators to build instructional excellence, cultivate leadership and provide school districts with the comprehensive support they need to raise student achievement. These offerings include ongoing curriculum support and expertise in professional development, coaching, and strategic consulting. 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. 33 --------------------------------------------------------------------------------
Factors affecting our net sales include:
• general economic conditions at the federal and state level; • state and school district per student funding levels; • federal funding levels; • the cyclicality of the purchasing schedule for adoption states; • student enrollments; • adoption of new academic 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.
State and 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 asFlorida ,California andTexas , are or are not scheduled to make significant purchases. For example,Texas adopted Reading/English Language Arts materials in 2018 for purchase in 2019 and 2020 and will call in 2022 for K-12 Science materials for purchase in 2024.California adopted history and social science materials in 2017 for purchase in 2018 through 2020 and adopted Science materials in 2018 for purchase in 2019 and continuing through 2021.Florida called for K-12 English Language Arts materials in 2020 for purchase beginning in 2021 and called for K-12 Mathematics for review in 2021 and purchase beginning in 2022. BothFlorida andTexas , along with several other adoption states, provide dedicated state funding for instructional materials and classroom technology, 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 2021 legislative session appropriated funds for purchases in 2021 and 2022.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. There is no guarantee that our programs will be approved for purchase in future instructional materials adoptions in these states. Long-term growth in theU.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 2029, total public school enrollment, a major long-term driver of growth in the K-12 Education market, is projected to increase by 0.8% to 51.1 million students, according to theNational 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.
We employ different pricing models to serve various customers, 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; and
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• 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 to
purchase 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.
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 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.
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 the 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$27.9 million for the year endedDecember 31, 2021 ) 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 assets amortization
Our other intangible assets 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 year endedDecember 31, 2021 was$30.3 million . 35 --------------------------------------------------------------------------------
Interest expense
Our interest expense includes interest accrued on the outstanding balances of 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"), most of which was repaid with proceeds from the Transaction, and, to a lesser extent, our revolving credit facility, the amortization of any deferred financing fees and loan discounts, and payments in connection with interest rate hedging agreements. Our interest expense for the year endedDecember 31, 2021 was$35.0 million . Results of Operations Consolidated Operating Results for the Years EndedDecember 31, 2021 and 2020 Year Ended Year Ended December 31, December 31, Dollar Percent (dollars in thousands) 2021 2020 change Change Net sales$ 1,050,802 $ 840,454 $ 210,348 25.0 % Costs and expenses: Cost of sales, excluding publishing rights and pre-publication amortization 398,706 370,586 28,120 7.6 % Publishing rights amortization 10,688 14,800 (4,112 ) (27.8 )% Pre-publication amortization 108,621 125,838 (17,217 ) (13.7 )% Cost of sales 518,015 511,224 6,791 1.3 % Selling and administrative 445,660 442,355 3,305 0.7 % Other intangible asset amortization 30,257 23,917 6,340 26.5 % Impairment charge for goodwill - 279,000 (279,000 ) NM Restructuring/severance and other charges 12,349 31,874 (19,525 ) (61.3 )% Gain on sale of assets (3,661 ) - (3,661 ) NM Operating income (loss) 48,182 (447,916 ) 496,098 NM Other income (expense): Retirement benefits non-service income (expense) 105 (856 ) 961 NM Interest expense (34,998 ) (37,931 ) 2,933 7.7 % Interest income 77 899 (822 ) (91.4 )% Change in fair value of derivative instruments (1,221 ) 672 (1,893 ) NM Gain on investments 1,442 2,091 (649 ) (31.0 )% Income from transition services agreement 3,664 - 3,664 NM Loss on extinguishment of debt (12,505 ) - (12,505 ) NM Income (loss) from continuing operations before taxes 4,746 (483,041 ) 487,787 NM Income tax expense (benefit) for continuing operations 2,686 (12,351 ) 15,037 NM Income (loss) from continuing operations, net of tax 2,060 (470,690 ) 472,750 NM Loss from discontinued operations, net of tax (1,005 ) (9,148 ) 8,143 89.0 % Gain on sale of discontinued operations, net of tax 212,523 - 212,523 NM Income (loss) from discontinued operations, net of tax 211,518 (9,148 ) 220,666 NM Net income (loss)$ 213,578 $ (479,838 ) $ 693,416 NM NM = not meaningful Net sales for the year endedDecember 31, 2021 increased$210.3 million , or 25.0%, from$840.5 million in 2020 to$1,050.8 million . Core Solutions increased by$91.0 million from$459.0 million in 2020 to$550.0 million , driven by strong open territory demand resulting from the strength of our connected solutions and the continued market recovery, as well as the success of our digital first, connected strategy. Further, net sales in Extensions, consisting of our Heinemann brand, intervention and supplemental products as well as professional services, increased by$120.0 million from$381.0 million in 2020 to$501.0 million . Within Extensions, net sales of our Heinemann products increased due to strong demand across most product portfolios. 36 -------------------------------------------------------------------------------- Operating income (loss) for the year endedDecember 31, 2021 favorably changed from a loss of$447.9 million in 2020 to income of$48.2 million , due primarily to the following:
• An impairment charge for goodwill in 2020 of
reoccur in 2021. This non-cash impairment was a direct result of the
adverse impact that the COVID-19 pandemic had on the Company and its
stock price in 2020;
• A $210.3 million increase in net sales;
• A
In 2021, there were
and other charges primarily related to vacated office space formerly
utilized by employees of the HMH Books & Media business, of which $11.7
million is reflected as a reduction in operating lease assets and $1.6 million as a reduction in property, plant, and equipment. In 2020, there
were $31.9 million of severance costs associated with the 2020
Restructuring Plan;
• A $15.0 million decrease in net amortization expense related to
publishing rights, pre-publication and other intangible assets,primarily due to a decrease in pre-publication amortization attributed
to a streamlining of capital spend and, to a lesser extent, our use of
accelerated amortization methods for publishing rights amortization,
partially offset by the amortization of certain other intangible assets
due to product life cycle reductions; and
• A $3.7 million gain on sale of assets in 2021 from the sale of
intellectual property, including the copyrights and trademarks, of
certain product titles.
Partially offset by:
• A
rights and pre-publication amortization, from
offset by lower print costs, product mix, increased virtual delivery of
products and services along with favorable inventory obsolescence due to
strong net sales. Our cost of sales, excluding publishing rights and
pre-publication amortization, as a percentage of sales, decreased to
38.0% from 44.1%; and
• A slight increase in selling and administrative expenses, primarily due
to an increase in variable expenses such as sales commissions and
transportation due to higher billings along with an increase in
incentive compensation. Partially offsetting the aforementioned was
reduced labor, professional fees and travel and marketing costs.
Retirement benefits non-service (expense) income for the year ended December 31,
2021 changed favorably by $1.0 million due to lower interest cost related to the
pension plan during 2021.
Interest expense for the year ended December 31, 2021 decreased $2.9 million
from $37.9 million in 2020 to $35.0 million , primarily due to net settlement
payments on our interest rate derivative instruments during 2020, which did not
repeat in 2021, and to a lesser extent lower term loan facility interest expense
driven by lower LIBOR rates.
Interest income for the year ended
Change in fair value of derivative instruments for the year ended
Gain on investments for the year ended
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Income from transition services agreement for the year ended December 31, 2021
was $3.7 million and was related to transition service fees under the transition
services agreement with the purchaser of our HMH Books & Media business. We had
no transition services agreement during 2020.
Loss on extinguishment of debt for the year ended December 31, 2021 consisted of
a $10.0 million write-off of the remaining balance of the debt discount
associated with the term loan facility and a $2.5 million write-off related to
unamortized deferred financing fees associated with the term loan facility. The
total write-off of $12.5 million was proportional to the pay down in term loan
debt in connection with the Transaction.
Income tax benefit for continuing operations for the year ended December 31,
2021 decreased $15.0 million , from a benefit of $12.4 million in 2020 to an
expense of $2.7 million in 2021. For both periods income tax expense (benefit)
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. The effective tax
rate was 56.6% and 2.6% for the years ended December 31, 2021 and 2020,
respectively.
Income (loss) from discontinued operations, net of tax for the year ended
December 31, 2021 favorably changed by $220.7 million from a loss of $9.1
million in 2020, to income of $211.5 million primarily due to the gain on sale
of our HMH Books & Media business, which has been accounted for as a
discontinued operation whereby the direct results of its operations were removed
from the results from continuing operations for the periods presented. Included
within the income (loss) is interest expense of $9.4 million and $28.3 million ,
for 2021 and 2020, respectively, based on the repayment of debt with the net
proceeds from the sale, which was required by our debt facilities, as we did not
reinvest such amounts in the business.
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Consolidated Operating Results for the Years Ended December 31, 2020 and 2019
Year Ended Year Ended
December 31, December 31, Dollar Percent
(dollars in thousands) 2020 2019 change Change
Net sales $ 840,454 $ 1,211,790 $ (371,336 ) (30.6 )%
Costs and expenses:
Cost of sales, excluding publishing
rights and
pre-publication amortization 370,586 549,886 (179,300 ) (32.6 )%
Publishing rights amortization 14,800 20,611 (5,811 ) (28.2 )%
Pre-publication amortization 125,838 149,298 (23,460 ) (15.7 )%
Cost of sales 511,224 719,795 (208,571 ) (29.0 )%
Selling and administrative 442,355 619,811 (177,456 ) (28.6 )%
Other intangible asset amortization 23,917 20,353 3,564 17.5 %
Impairment charge for goodwill 279,000 - 279,000 NM
Restructuring/severance and other
charges 31,874 20,692 11,182 54.0 %
Operating loss (447,916 ) (168,861 ) (279,055 ) (165.3 )%
Other income (expense):
Retirement benefits non-service
(expense) income (856 ) 167 (1,023 ) NM
Interest expense (37,931 ) (29,770 ) (8,161 ) (27.4 )%
Interest income 899 3,157 (2,258 ) (71.5 )%
Change in fair value of derivative
instruments 672 (899 ) 1,571 NM
Gain on investments 2,091 - 2,091 NM
Income from transition services
agreement - 4,248 (4,248 ) NM
Loss on extinguishment of debt - (4,363 ) 4,363 NM
Loss from continuing operations before
taxes (483,041 ) (196,321 ) (286,720 ) NM
Income tax (benefit) expense for
continuing operations (12,351 ) 3,854 (16,205 ) NM
Loss from continuing operations, net of
tax (470,690 ) (200,175 ) (270,515 ) NM
Loss from discontinued operations, net
of tax (9,148 ) (13,658 ) 4,510 33.0 %
Net loss $ (479,838 ) $ (213,833 ) $ (266,005 ) NM
Net sales for the year ended December 31, 2020 decreased $371.3 million , or
30.6%, from $1,211.8 million in 2019 to $840.5 million . The decrease was
primarily 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 $253.0 million from $634.0 million in 2019 to
$381.0 million . Within Extensions, net sales decreased due to lower sales of the
Heinemann's Fountas & Pinnell Classroom, Calkins and LLI Leveled Literacy
products due to a difficult comparison to prior year Texas K-6 sales coupled
with the impact of the COVID-19 pandemic in 2020. Also, contributing to the
decrease was lower professional services with the decline of the in-person
learning environment as a result of the COVID-19 pandemic. Further, there were
lower net sales from Core Solutions which decreased by $119.0 million from
$578.0 million in 2019 to $459.0 million , primarily due to the smaller new
adoption market opportunity in Texas ELA, along with impacts of the COVID-19
pandemic.
Operating loss for the year ended December 31, 2020 unfavorably changed from a
loss of $168.9 million in 2019 to a loss of $447.9 million , due primarily to the
following:
• A
• An impairment charge for goodwill in 2020 of $279.0 million . This
non-cash impairment is a direct result of the adverse impact that the
COVID-19 pandemic has had on the Company and its stock price; and
• A $11.2 million increase in costs associated with our
restructuring/severance and other charges due to $31.9 million of
severance costs associated with the 2020 Restructuring Plan,
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Partially offset by:
• A $177.5 million decrease in selling and administrative expenses,
primarily due to lower labor costs, resulting from cost savings
associated with our employee furlough initiative, which began in April
and ceased at the end of July, in response to COVID-19, our 2020
Restructuring Plan and a freeze on hiring. Also, there was a decrease
of variable expenses such as commissions and transportation due to
lower billings. Further, there were lower discretionary costs
primarily related to travel and expense reduction measures and
marketing along with lower depreciation expense;
• A
rights and pre-publication amortization, from $549.9 million in 2019
to $370.6 million , primarily due to lower billings. Our cost of sales,
excluding publishing rights and pre-publication amortization, as a
percentage of sales, decreased to 44.1% from 45.4%; and
• A $25.7 million decrease in net amortization expense related to
publishing rights, pre-publication and other intangible assets,
primarily due to a decrease in pre-publication amortizationattributed
to the timing and large amount of 2019 major product releases coupled
with our streamlining of capital spend.
Retirement benefits non-service (expense) income for the year ended
Interest expense for the year endedDecember 31, 2020 increased$8.2 million from$29.8 million in 2019 to$37.9 million , primarily due to our 2019 debt refinancing during the fourth quarter of 2019. Further, there was an increase of$2.4 million of net settlement payments on our interest rate derivative instruments during 2020. Interest income for the year endedDecember 31, 2020 decreased$2.3 million from$3.2 million in 2019 to$0.9 million , primarily due to lower interest rates on our money market funds in 2020. Change in fair value of derivative instruments for the year endedDecember 31, 2020 favorably changed by$1.6 million due to foreign exchange forward contracts executed on the Euro that were favorably impacted by the weakening of theU.S. dollar against the Euro.
Gain on investments for the year ended
Income from transition services agreement for the year endedDecember 31, 2019 was$4.2 million and was related to transition service fees under the transition services agreement with the purchaser of our Riverside Business pursuant to which we performed certain support functions throughSeptember 30, 2019 . We had no income from transition services agreement for the year endedDecember 31, 2020 . Loss on extinguishment of debt for the year endedDecember 31, 2019 consisted of a$3.4 million write-off related to unamortized deferred financing fees associated with the portion of our previous term loan facility that was accounted for as an extinguishment. Further, there was a$1.0 million write off of the remaining balance of the debt discount associated with the previous term loan facility. We had no loss on extinguishment of debt for the year endedDecember 31, 2020 . Income tax (benefit) expense for continuing operations for the year endedDecember 31, 2020 decreased$16.2 million , from an expense of$3.9 million in 2019, to a benefit of$12.4 million . The change was due to an income tax benefit primarily due to the impairment charge on goodwill, which reduced related deferred tax liabilities. The effective tax rate was 2.6% and (2.0%) for the years endedDecember 31, 2020 and 2019, respectively. Loss from discontinued operations, net of tax for the year endedDecember 31, 2020 favorably changed by$4.5 million from a loss of$13.7 million in 2019, to a loss of$9.1 million primarily due to higher net sales.The HMH Books & Media business has been accounted for as a discontinued operation whereby the direct results of its 40 -------------------------------------------------------------------------------- operations were removed from the results from continuing operations for the periods presented due to the sale in 2021. Included within the loss is interest expense of$28.3 million and$19.3 million for 2020 and 2019, respectively, based on the repayment of debt with the net proceeds from the sale, which was required by our debt facilities, as we did not reinvest such amounts in the business.
Adjusted EBITDA from Continuing Operations
To supplement our financial statements presented in accordance with GAAP, we
have presented Adjusted EBITDA from continuing operations, 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, gains or losses on investments, non-cash charges and
impairment charges, levels of depreciation or amortization along with costs such
as severance, separation and facility closure costs, inventory obsolescence
related to our strategic transformation plan, gain on sale of assets, legal
settlements, 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 from continuing
operations for the years ended
Years Ended
2021 2020 2019
Net income (loss) from continuing operations$ 2,060 $ (470,690 ) $ (200,175 ) Interest expense 34,998 37,931 29,770 Interest income (77 ) (899 ) (3,157 ) Provision (benefit) for income taxes 2,686 (12,457 ) 3,854 Depreciation expense 44,867 49,874 60,708 Amortization expense 149,566 164,555 190,262 Non-cash charges-goodwill impairment - 279,000 - Non-cash charges-stock-compensation 12,217 11,160
13,196
Non-cash charges- (gain) loss on derivative instruments 1,221 (672 ) 899 Inventory obsolescence related to strategic transformation plan - -
9,758
Fees, expenses or charges for equity offerings,
debt or acquisitions/dispositions 895 1,080 6,327 Gain on investments (1,942 ) (2,091 ) - Gain on sale of assets (3,661 ) - - Loss on extinguishment of debt 12,505 -
4,363
Legal settlement 2,470 - - Restructuring/severance and other charges 12,349 31,874
20,692
Adjusted EBITDA from continuing operations
$ 136,497 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 business 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. Schools typically 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 69% 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 based on 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. 42 --------------------------------------------------------------------------------
The following table is indicative of the seasonality of our business and the related results:
Quarterly Results of Continuing Operations
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
(in thousands) 2020 2020 2020 2020 2021 2021 2021 2021
Net sales $ 151,843 $ 216,239 $ 331,205 $ 141,167 $ 146,195 $ 308,672 $ 417,130 $ 178,805
Costs and expenses:
Cost of sales, excluding
publishing rights and
pre-publication
amortization 63,652 100,544 146,155 60,235 58,137 124,360 152,893 63,316
Publishing rights
amortization 4,432 3,431 3,469 3,468 3,166 2,489 2,516 2,517
Pre-publication
amortization 30,562 31,659 31,570 32,047 25,051 26,506 27,620 29,444
Cost of sales 98,646 135,634 181,194 95,750 86,354 153,355 183,029 95,277
Selling and administrative 123,341 98,199 118,275 102,540 89,235 114,767 134,951 106,707
Other intangible assets
amortization 5,856 5,855 5,857 6,349 7,906 7,869 7,241 7,241
Impairment charge for
goodwill 262,000 - - 17,000 - - - -
Restructuring/severance
and other charges - - 31,776 98 - 9,847 33 2,469
Gain on sale of assets - - - - - - (3,661 ) -
Operating (loss) income (338,000 ) (23,449 ) (5,897 ) (80,570 ) (37,300 ) 22,834 95,537 (32,889 )
Other income (expense):
Retirement benefits
non-service (expense)
income 61 61 61 (1,039 ) (200 ) (26 ) 214 117
Interest expense (9,253 ) (10,614 ) (9,311 ) (8,753 ) (8,564 ) (9,985 ) (8,239 ) (8,210 )
Interest income 766 75 32 26 20 14 18 25
Change in fair value of
derivative instruments (380 ) 120 432 500 (674 ) 127 (368 ) (306 )
Gain on investments - - 1,738 353 - 836 606 -
Income from transition
services agreement - - - - - 854 1,399 1,411
Loss on extinguishment of
debt - - - - - (12,505 ) - -
(Loss) income from
continuing operations
before taxes (346,806 ) (33,807 ) (12,945 ) (89,483 ) (46,718 ) 2,149 89,167 (39,852 )
Income tax (benefit)
expense for continuing
operations (8,780 ) (1,370 ) (1,060 ) (1,141 ) 2,310 (9 ) (6,192 ) 6,577
(Loss) income from
continuing operations (338,026 ) (32,437 ) (11,885 ) (88,342 ) (49,028 ) 2,158 95,359 (46,429 )
(Loss) income from
discontinued operations,
net of tax (7,947 ) (5,731 ) (667 ) 5,197 (2,955 ) 1,950 - -
Gain (loss) on sale of
discontinued operations,
net of tax - - - - - 214,520 - (1,997 )
(Loss) income from
discontinued operations,
net of tax (7,947 ) (5,731 ) (667 ) 5,197 (2,955 ) 216,470 - (1,997 )
Net (loss) income $ (345,973 ) $ (38,168 ) $ (12,552 ) $
(83,145 )
During the fourth quarter of 2020, we recorded an adjustment of$17.0 million and$1.0 million to increase both the goodwill impairment charge and income tax benefit recorded, respectively, to correct an error of the previously recorded goodwill impairment of$262.0 million and related income tax benefit in the first quarter of 2020. Management believes these adjustments are not material to the prior period financial statements. 43 --------------------------------------------------------------------------------
Liquidity and Capital Resources
December 31,
(in thousands) 2021 2020 2019
Cash and cash equivalents $ 463,131 $ 281,200 $ 296,353
Current portion of long-term debt - 19,000 19,000
Long-term debt, net of discount and issuance
costs 317,579 624,692 638,187
Revolving credit facility - - -
Borrowing availability under revolving credit
facility 64,922 104,806 161,961
Years ended December 31,
2021 2020 2019
Net cash provided by operating activities -
continuing operations $ 263,789 $ 106,485 $ 248,540
Net cash provided by (used in) investing
activities - continuing operations 250,290 (111,812 ) (95,486 )
Net cash used in financing activities -
continuing operations (335,381 ) (18,130 ) (115,667 )
Operating activities
Net cash provided by operating activities from continuing operations was
$263.8 million for the year ended December 31, 2021 , a $157.3 million favorable
change from the $106.5 million of net cash provided by operating activities from
continuing operations for the year ended December 31, 2020 . The $157.3 million
improvement in cash provided by operating activities from continuing operations
was primarily due to an increase in operating profit, net of non-cash items, of
$215.0 million . The improvement was partially offset by unfavorable cash flow
changes in net operating assets and liabilities of $57.7 million primarily due
to unfavorable changes in accounts receivable of $61.3 million related to higher
billings and the timing of collections, changes in severance and other charges
of $26.4 million mainly attributable to the 2020 Restructuring Plan, changes in
other operating assets and liabilities of $26.0 million , period over period
inventory changes of $14.9 million and changes in interest payable of $7.0
million due to the timing of payments and changes in pension and postretirement
benefits of $6.4 million , offset by favorable cash flow changes in accounts
payable of $52.8 million due to timing of disbursements and favorable changes in
royalties and author advances of $31.3 million .
Net cash provided by operating activities from continuing operations was
$106.5 million for the year ended December 31, 2020 , a $142.1 million decrease
from the $248.5 million of net cash provided by operating activities from
continuing operations for the year ended December 31, 2020 . The decrease in cash
provided by operating activities was primarily driven by unfavorable changes in
net operating assets and liabilities of $74.3 million primarily due to changes
in deferred revenue of $143.3 million and $25.0 million of royalties related to
greater billings in 2019, accounts payable of $18.7 million related to timing of
disbursements and severance and other charges of $3.4 million due to the 2020
Restructuring Plan, offset by period over period inventory changes of $72.4
million , changes in accounts receivable of $10.5 million , an increase in
operating lease liabilities of $15.3 million , pension and postretirement
benefits of $8.2 million , interest payable of $3.5 million due to the timing of
our 2019 Refinancing and other assets and liabilities of $6.2 million .
Additionally, operating profit, net of non-cash items, decreased by $67.7
million .
Investing activities
Net cash provided by investing activities from continuing operations was$250.3 million for the year endedDecember 31, 2021 , an increase of$362.1 million from the$(111.8) million of net cash used in investing activities from continuing operations for the year endedDecember 31, 2020 . The increase in cash provided by investing activities was primarily due to proceeds from the sale of ourHMH Books & Media business of$340.6 million and from the sale of assets of$5.0 million during 2021 and to a lesser extent, lower capital investing expenditures related to pre-publication costs and property, plant, and equipment of$16.5 million in connection with planned reductions in content development. Net cash used in investing activities from continuing operations was$(111.8) million for the year endedDecember 31, 2020 , an increase of$16.3 million from the year endedDecember 31, 2019 . The increase in cash used in investing activities was primarily due to lower net proceeds from sales and maturities of short-term 44 -------------------------------------------------------------------------------- investments of$50.0 million compared to 2019, offset by lower capital investing expenditures related to pre-publication costs and property, plant, and equipment of$27.5 million in connection with previously planned reductions in content development, and by the acquisition of a business for$5.4 million along with an investment in preferred stock of$0.8 million in 2019.
Financing activities
Net cash used in financing activities, which is all continuing operations, was$335.4 million for the year endedDecember 31, 2021 , an increase of$317.3 million from the$18.1 million used in financing activities for the year endedDecember 31, 2020 . The increase in cash used in financing activities was primarily due to a net increase in our debt repayments of$323.0 million primarily from the proceeds of the sale of ourHMH Books & Media business. Partially offsetting the increase was net collections under the transition services agreement of$6.2 million in 2021. Net cash used in financing activities, which is all continuing operations, was$18.1 million for the year endedDecember 31, 2020 , a decrease of$97.5 million from the year endedDecember 31, 2019 . The decrease in cash used in financing activities was primarily due to a reduction in net debt principal repayments of$88.3 million in connection with the 2019 Refinancing along with payments of financing fees of$8.5 million related to our notes offering, term loan facility and revolving credit facility amendments in 2019. Additionally, there was a decrease in tax withholding payments related to net share settlements of restricted stock units of$2.0 million partially offset by lower net collections under the transition services agreement of$1.1 million .
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 ofDecember 31, 2021 , we had$303.3 million ($296.6 million , net of discount and issuance costs) outstanding under the notes. We may redeem all or a portion of the notes at redemption prices as described in the notes. We redeemed$2.7 million of the notes during the second quarter of 2021 utilizing proceeds from the sale of theHMH Books & Media business. 45 -------------------------------------------------------------------------------- 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 ofDecember 31, 2021 , we had$21.7 million ($21.0 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 ofDecember 31, 2021 , the interest rate on the term loan facility was 7.25%. The term loan facility was required to be repaid in quarterly installments of approximately$4.8 million with the balance being payable on the maturity date. We repaid$334.6 million of the term loan facility during the second quarter of 2021 utilizing proceeds from the sale of theHMH Books & Media business. There are no future quarterly repayment installments required and the balance is payable on the maturity date; however, we are not prohibited from continuing to make debt payments and may elect to do so. 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. 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.
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 ofDecember 31, 2021 , there were no amounts outstanding on the revolving credit facility. As ofDecember 31, 2021 , we had approximately$16.1 million of outstanding letters of credit and approximately$64.9 million of borrowing availability under the revolving credit facility. As ofFebruary 24, 2022 , there were no amounts outstanding under the revolving credit facility. 46 -------------------------------------------------------------------------------- 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. 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 ofDecember 31, 2021 , 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$463.1 million of cash and cash equivalents and no short-term investments atDecember 31, 2021 . We had$281.2 million of cash and cash equivalents and no short-term investments atDecember 31, 2020 . 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.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity withU.S. GAAP requires the use of estimates, assumptions and judgments by management that affect the reported amounts of assets, liabilities, net sales, expenses and related disclosure of contingent assets and liabilities in the amounts reported in the financial statements and accompanying notes. On an on-going basis, we evaluate our estimates and assumptions, including, but not limited to, book returns and variable consideration, deferred revenue and related standalone selling price estimates, allowance for bad debts, recoverability of advances to authors, valuation of inventory, financial instruments valuation, income taxes, pensions and other postretirement benefits obligations, contingencies, litigation, depreciation and amortization periods, and the recoverability of long-term assets such as property, plant and equipment, capitalized pre-publication costs, other identified intangibles, and goodwill. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates. For a complete description of our significant accounting policies, see Note 3 to the consolidated financial statements. The following policies and account descriptions include those identified as critical to our business operations and the understanding of our results of operations.
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 as 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.
47
--------------------------------------------------------------------------------The following are the critical accounting policies and estimates:
Revenue Recognition
Revenue is recognized when a customer obtains control of promised goods or
services, in an amount that reflects the consideration which we expect to
receive in exchange for those goods or services. To determine revenue
recognition for arrangements that we determine are within the scope of the new
revenue recognition accounting standard, we perform the following five steps:
(i) identify the contract with a customer; (ii) identify the performance
obligations in the contract; (iii) determine the transaction price;
(iv) allocate the transaction price to the performance obligations in the
contract; and (v) recognize revenue when (or as) we satisfy a performance
obligation. We only apply the five-step model to contracts when it is probable
that we will collect the consideration we are entitled to in exchange for the
goods or services we transfer to the customer. At contract inception, we assess
the goods or services promised within each contract and determine those that are
performance obligations and assess whether each promised good or service is
distinct. We then recognize as revenue the amount of the transaction price that
is allocated to the respective performance obligation when (or as) the
performance obligation is satisfied.
Revenue is measured as the amount of consideration we expect to receive in
exchange for transferring products or services to a customer. To the extent the
transaction price includes variable consideration, which generally reflects
estimated future product returns, we estimate the amount of variable
consideration that should be included in the transaction price utilizing the
expected value method to which we expect to be entitled. Variable consideration
is included in the transaction price if, in our judgment, it is probable that a
significant future reversal of cumulative revenue under the contract will not
occur. Estimates of variable consideration and the determination of whether to
include estimated amounts in the transaction price are based largely on all
information (historical, current and forecasted) that is reasonably available.
Sales, value add, and other taxes collected on behalf of third parties are
excluded from revenue.
We estimate the collectability of contracts upon execution. For contracts with
rights of return, the transaction price is adjusted to reflect the estimated
returns for the arrangement on these sales and is made at the time of sale based
on historical experience by product line or customer. The transaction prices
allocated are adjusted to reflect expected returns and are based on historical
return rates and sales patterns. Shipping and handling fees charged to customers
are included in net sales.
When determining the transaction price of a contract, an adjustment is made if
payment from a customer occurs either significantly before or significantly
after performance, resulting in a significant financing component. We do not
assess whether a significant financing component exists if the period between
when we perform our obligations under the contract and when the customer pays is
one year or less. Significant financing components' income is included in
interest income.
Contracts are sometimes modified to account for changes in contract
specifications and requirements. Contract modifications exist when the
modification either creates new, or changes the existing, enforceable rights and
obligations. Generally, contract modifications are for products or services that
are not distinct from the existing contract due to the inability to use, consume
or sell the products or services on their own to generate economic benefits and
are accounted for as if they were part of that existing contract. The effect of
such a contract modification on the transaction price and measure of progress
for the performance obligation to which it relates is recognized as an
adjustment to revenue (either as an increase in or a reduction of revenue) on a
cumulative catch-up basis.
Physical product revenue is recognized when the customer obtains control of our
product, which occurs at a point in time, and may be upon shipment or upon
delivery based on the contractual shipping terms of a contract. Revenues from
static digital content commence upon delivery to the customer of the digital
entitlement that is required to access and download the content and is typically
recognized at a point in time. Revenues from subscription software licenses,
related hosting services and product support are recognized evenly over the
license term as we believe this best represents the pattern of transfer to the
customer. The perpetual software licenses provide the customer with a functional
license to our products and their related revenues are recognized when the
customer receives entitlement to the software. Revenue associated with the
digital content hosting services related to perpetual licenses is recognized
evenly over the contract term. The delivery/start date is the date access to the
hosted content is granted. For the technical services provided to customers in
connection with the software license, we
48
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recognize revenue upon delivery of the services. As the invoices are based on
each day of service, this is directly linked to the transfer of benefit to the
customer.
If the contract contains a single performance obligation, the entire transaction
price is allocated to the single performance obligation. We enter into certain
contracts that have multiple performance obligations, one or more of which may
be delivered subsequent to the delivery of other performance obligations. These
performance obligations may include print and digital media, professional
development services, training, software licenses, access to hosted content, and
various services related to the software including but not limited to hosting,
maintenance and support, and implementation. We allocate the transaction price
based on the estimated relative standalone selling prices of the promised
products or services underlying each performance obligation. We determine
standalone selling prices based on the price at which the performance obligation
is sold separately. If the standalone selling price is not observable through
past transactions, we estimate the standalone selling price taking into account
available information such as market conditions and internally approved standard
pricing discounts related to the performance obligations. Generally, our
performance obligations include print and digital textbooks and instructional
materials, formative assessment materials and multimedia instructional programs;
access to hosted content; and services including professional development,
consulting and training. Our contracts may also contain software performance
obligations including perpetual and subscription-based licenses and software
maintenance and support services.
Deferred Revenue
Our contract liabilities consist of advance payments and billings in excess of revenue recognized and are classified as deferred revenue on our consolidated balance sheets. Our contract assets and liabilities are accounted for and presented on a net basis as either a contract asset or contract liability at the end of each reporting period. We classify deferred revenue as current or noncurrent based on the timing of when we expect to recognize revenue. In order to determine revenue recognized in the period from contract liabilities, we first allocate revenue to the individual contract liability balance outstanding at the beginning of the period until the revenue exceeds that balance. If additional advances are received on those contracts in subsequent periods, we assume all revenue recognized in the reporting period first applies to the beginning contract liability as opposed to a portion applying to the new advances for the period.
Allowance for Doubtful Accounts and Reserves for Book Returns
Accounts receivable include amounts billed and currently due from customers and are recorded net of allowances for doubtful accounts and reserves for book returns. In the normal course of business, we extend credit to customers that satisfy predefined criteria. We estimate the collectability of our receivables and develop those estimates to reflect the risk of credit loss. Allowances for doubtful accounts are established through the evaluation of accounts receivable aging, prior collection experience, current conditions and reasonable and supportable forecasts of the economic conditions that will exist through the contractual life of the financial asset. We monitor our ongoing credit exposure through an active review of collection trends and specific facts and circumstances. Our activities include monitoring the timeliness of payment collection and performing timely account reconciliations. At the time we determine that a receivable balance, or any portion thereof, is deemed to be permanently uncollectible, the balance is written off. Reserves for book returns are based on historical return rates and sales patterns. We determine the required reserves by segregating our returns into the applicable product or sales channel pools. Returns in the K-12 market have been historically low. We have experienced higher returns with respect to sales to resellers and international sales, which all result in a greater degree of risk and subjectivity when establishing the appropriate level of reserves for this customer base. We estimate the amount of returns using the expected value method to reduce transaction price at the time of the sale. The allowance for doubtful accounts and reserve for returns are reported as reductions of the accounts receivable balance and amounted to$3.5 million and$4.1 million , and$3.8 million and$4.6 million as ofDecember 31, 2021 and 2020, respectively.
Inventories
Inventories are substantially stated at the lower of weighted average cost or
net realizable value. The level of obsolete and excess inventory is estimated on
a program or title-level basis by comparing the number of units in stock with
the expected future demand. The expected future demand of a program or title is
determined by the copyright year, recent sales history, the future sales
forecast, known forward-looking trends including our development cycle to
replace the title or program and competing titles or programs. A change in sales
trends, or
49
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strategic direction of our product development, could affect the estimated
reserve. The reserve for excess or obsolete inventory is reported as a reduction
of the inventories balance and amounted to $58.6 million and $61.2 million as of
December 31, 2021 and 2020, respectively.
Pre-publication Costs
Pre-publication costs are capitalized and 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 the 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 reflects 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.
Amortization expense related to pre-publication costs for the years ended
For the years ended
Goodwill and indefinite-lived intangible assets (certain tradenames) are not amortized, but are reviewed at least annually for impairment or earlier, if an indication of impairment exists. Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions may include various valuation techniques including an evaluation of our market capitalization and peer company multiples depending on the best approximation of fair value in the current social and economic environment, net sales growth rates and operating margins, risk-adjusted discount rates, future economic and market conditions, the determination of appropriate market comparables as well as the fair value of certain individual assets and liabilities. We have the option of first assessing qualitative factors to determine whether it is necessary to perform a quantitative impairment test for goodwill or we can perform the quantitative impairment test without performing the qualitative assessment. In performing the qualitative assessment, we consider certain events and circumstances specific to the reporting unit and to the entity as a whole, such as macroeconomic conditions, industry and market considerations, overall financial performance and cost factors when evaluating whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the results of the quantitative test indicate the fair value of a reporting unit exceeds the carrying value of the net assets assigned to a reporting unit, goodwill is considered not impaired and no further testing is required. If the carrying value of the net assets assigned to a reporting unit exceeds the fair value of a reporting unit, goodwill is deemed impaired and is written down to the extent of the difference between the fair value of the reporting unit and the carrying value. We estimate the total fair value of the reporting unit by using one or more various valuation techniques including an evaluation of our market capitalization and peer company multiples depending on the best approximation of fair value of the reporting unit in the current social and economic environment. With regard to indefinite-lived intangible assets, which includes only theHoughton Mifflin Harcourt tradename, the recoverability is evaluated using a one-step process whereby we determine the fair value by asset and then compare it to its carrying value to determine if the asset is impaired. We estimate the fair value by preparing a relief-from-royalty discounted cash flow analysis using forward looking revenue projections. The significant assumptions used in discounted cash flow analysis include: future net sales, a long-term growth rate, a royalty rate and a discount rate used to present value future cash flows. The discount rate is based on the weighted-average cost of capital method at the date of the evaluation. Adverse changes in our market capitalization could give rise to an impairment. 50 -------------------------------------------------------------------------------- We completed our annual goodwill impairment tests as ofOctober 1, 2021 and 2020. ForOctober 1, 2021 , we assessed qualitative factors and determined it was not necessary to perform a quantitative impairment test for goodwill. The fair value of the reporting unit was in excess of its carrying value by approximately 18% as ofOctober 1, 2020 . There was no goodwill impairment for the years endedDecember 31, 2021 and 2019. We will continue to monitor and evaluate the carrying value of goodwill. If market and economic conditions or business performance deteriorate, this could increase the likelihood of us recording an impairment charge. We recorded a goodwill impairment charge of$279.0 million for the year endedDecember 31, 2020 . Refer to Note 2 of the consolidated financial statements for a discussion of the factors and circumstances leading to the goodwill impairment. We completed our annual indefinite-lived asset impairment tests as ofOctober 1, 2021 and 2020. No indefinite-lived intangible assets were deemed to be impaired for the years endedDecember 31, 2021 , 2020 and 2019. The fair value significantly exceeded its carrying value as ofOctober 1, 2021 and was in excess of its carrying value by approximately 18% as ofOctober 1, 2020 .
Impact of Inflation and Changing Prices
We believe that inflation has not had a material impact on our results of operations during the years endedDecember 31, 2021 , 2020 and 2019. 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 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.
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