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." Discussion and analysis of the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 is included under the heading "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2019 as filed with theSEC onFebruary 27, 2020 .
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, 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 . We implemented a number of measures intended to help protect our shareholders, employees, and customers amid the COVID-19 outbreak. We also have taken 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 mitigate the impact of COVID-19 on our business included: (1) director, executive and senior leadership salary reductions, and for the majority of employees, a four-day work week with associated labor cost reductions, in each case beginning inApril 2020 and ceasing near the end ofJuly 2020 ; (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) deferral of long-term capital projects not directly contributing to billings in 2020; and (5) borrowing$150 million from our asset-backed credit facility as a pre-emptive measure to mitigate against capital market disruptions. Further, we elected to defer the payment of our employer payroll taxes allowed under the Coronavirus Aid, Relief, and Economic Security ("CARES") Act. 31 -------------------------------------------------------------------------------- The majority of the HMH workforce has continued to work remotely subsequent toMarch 2020 . The four-day work week furlough program along with director, executive, and senior leadership salary reductions that we announced inMarch 2020 ended by the end of July. The costs associated with ending the furlough program and the salary reductions were subsequently mitigated by the 2020 Restructuring Plan discussed below. We also repaid$50.0 million of our asset-backed credit facility at the end of June and repaid the remaining outstanding$100.0 million during July and currently have no drawn balance on our asset-backed credit facility. Further, the deferral of the payment of our employer payroll taxes allowed under the CARES Act during 2020 was repaid in full inDecember 2020 . Given the ongoing COVID-19 situation, our Education business will continue to be impacted during 2021, and significant uncertainty is likely to persist in the marketplace. Additionally, ourHMH Books & Media business may continue to be impacted. 2020 Restructuring Plan We are continuing to assess our cost structure amid the COVID-19 pandemic and in line with our Strategic Transformation Plan announced in the fourth quarter of 2019, discussed below, to ensure our cost structure is aligned 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 or will receive 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 and in line with our previously disclosed Strategic Transformation Plan. 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 or will receive 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 represents cash expenditures, is approximately$33.6 million . These actions are aligned with our Strategic Transformation Plan launched in the fourth quarter of 2019 to streamline 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 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 the strategic transformation plan, we recorded an
incremental
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Other Events
InNovember 2020 , the Company announced that it will explore a potential sale of theHMH Books and Media segment. Such a sale would be intended to build on the Company's other strategic restructuring efforts and further align its cost structure to its digital-first strategy.
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 81%, 87% and 85% of our total net sales for the years endedDecember 31, 2020 , 2019 and 2018, respectively. OurHMH Books & Media segment represented approximately 19%, 13% and 15% of our total net sales for the years endedDecember 31, 2020 , 2019 and 2018, 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 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 Education segment net sales is dependent upon our ability to maintain residual sales, which are subsequent 33 -------------------------------------------------------------------------------- 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 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.
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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 and 2020. 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. Florida called for K-12 English Language Arts materials in 2020
for purchase beginning in 2021 and has called for K-12 Mathematics for review in
2021 and purchase beginning in 2022. Both Florida and Texas , 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 2019 legislative
session appropriated funds for purchases in 2019 and 2020. 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, and The Giver have benefited in popularity due to movie or series releases and have subsequently resulted in increased trade sales. We employ different 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; and
• 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.
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
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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.
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$25.6 million for the year endedDecember 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 6 to 25 years. The expense for the year endedDecember 31, 2020 was$25.6 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 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 year endedDecember 31, 2020 was$66.0 million . 36
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Results of Operations
Consolidated Operating Results for the Years EndedDecember 31, 2020 and 2019 Year Ended Year Ended December 31, December 31, Dollar Percent (dollars in thousands) 2020 2019 change Change Net sales$ 1,031,292 $ 1,390,674 $ (359,382 ) (25.8 )% Costs and expenses: Cost of sales, excluding publishing rights and pre-publication amortization 497,816 668,108 (170,292 ) (25.5 )% Publishing rights amortization 20,056 26,557 (6,501 ) (24.5 )% Pre-publication amortization 126,180 149,515 (23,335 ) (15.6 )% Cost of sales 644,052 844,180 (200,128 ) (23.7 )% Selling and administrative 478,101 662,606 (184,505 ) (27.8 )% Other intangible asset amortization 25,585 25,310 275 1.1 % Impairment charge for goodwill 279,000 - 279,000 NM Restructuring/severance and other charges 33,643 21,742 11,901 54.7 % Operating loss (429,089 ) (163,164 ) (265,925 ) NM Other income (expense): Retirement benefits non-service (expense) income (856 ) 167 (1,023 ) NM Interest expense (65,959 ) (48,778 ) (17,181 ) (35.2 )% 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 before taxes (492,242 ) (209,632 ) (282,610 ) NM Income tax (benefit) expense (12,404 ) 4,201 (16,605 ) NM Net loss$ (479,838 ) $ (213,833 ) $ (266,005 ) NM NM = not meaningful Net sales for the year endedDecember 31, 2020 decreased$359.4 million , or 25.8%, from$1,390.7 million in 2019 to$1,031.3 million . The net sales decrease was driven by a$371.1 million decrease in our Education segment, offset by a$11.7 million increase in ourHMH Books & Media segment. Within our Education segment, 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$252.0 million from$632.0 million in 2019 to$380.0 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 yearTexas 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. Within ourHMH Books & Media segment, the increase in net sales was primarily due to$9.6 million of licensing revenue from a new production series, a$3.4 million increase in licensing revenue attributed to the Carmen Sandiego series on Netflix, and strong net sales of the frontlist titles The 99% Invisible City, Compromised and Defined Dish. Offsetting the aforementioned, was lower net sales of both Adult and Young Reader's categories due to the closure of bookstores during the COVID-19 pandemic and the corresponding delay in releases of new frontlist titles. 37 -------------------------------------------------------------------------------- Operating loss for the year endedDecember 31, 2020 unfavorably changed from a loss of$163.2 million in 2019 to a loss of$429.1 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;
• A $11.9 million increase in costs associated with our
restructuring/severance and other charges due to $33.6 million of
severance costs associated with the 2020 Restructuring Plan;
Partially offset by:
• A $184.5 million decrease in selling and administrative expenses,
primarily due to lower labor costs of $77.0 million , 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 $52.0 million of variable expenses such ascommissions and
transportation due to lower billings. Further, there were lower
discretionary costs of $44.0 million primarily related totravel and
expense reduction measures and marketing along with lowerdepreciation
expense of $11.0 million ;
• A
rights and pre-publication amortization, from $668.1 million in 2019
to $497.8 million , primarily due to lower billings. Our cost of sales,
excluding publishing rights and pre-publication amortization, as a
percentage of sales, was essentially flat year over year; and
• A $29.6 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 and, to
a lesser extent, our use of accelerated amortization methods for
publishing rights amortization.
Retirement benefits non-service (expense) income for the year ended
Interest expense for the year endedDecember 31, 2020 increased$17.2 million from$48.8 million in 2019 to$66.0 million , primarily due to our 2019 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 . 38
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Income tax (benefit) expense for the year ended
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, gain or losses on investments, non-cash charges and impairment 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.
Below is a reconciliation of our net loss to Adjusted EBITDA for the years ended
Years Ended December 31,
2020 2019
Net loss $ (479,838 ) $ (213,833 )
Interest expense 65,959 48,778
Interest income (899 ) (3,157 )
Provision (benefit) for income taxes (12,404 ) 4,201
Depreciation expense 50,715
61,475
Amortization expense-film asset 13,953
9,835
Amortization expense 171,821
201,382
Non-cash charges-goodwill impairment 279,000
-
Non-cash charges-stock-compensation 11,573
13,968
Non-cash charges- (gain) loss on derivative
instruments (672 )
899
Inventory obsolescence related to strategic transformation plan -
9,758
Fees, expenses or charges for equity offerings,
debt or acquisitions/dispositions 1,080
6,327
Restructuring/severance and other charges 33,643
21,742
Gain on investments (2,091 )
-
Loss on extinguishment of debt - 4,363 Adjusted EBITDA$ 131,840 $ 165,738 39
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Segment Operating Results
Results of Operations-Comparing Years Ended
Education
2020 vs. 2019
Years Ended December 31, Dollar Percent
2020 2019 change change
Net sales $ 839,553 $ 1,210,646 $ (371,093 ) (30.7 )%
Costs and expenses:
Cost of sales, excluding
publishing rights and
pre-publication amortization 368,876 547,094 (178,218 ) (32.6 )%
Publishing rights amortization 14,800 20,611 (5,811 ) (28.2 )%
Pre-publication amortization 125,966 148,850 (22,884 ) (15.4 )%
Cost of sales 509,642 716,555 (206,913 ) (28.9 )%
Selling and administrative 360,755 520,153 (159,398 ) (30.6 )%
Impairment charge for goodwill 279,000 - 279,000 NM
Other intangible asset
amortization 22,948 19,878 3,070 15.4 %
Operating loss $ (332,792 ) $ (45,940 ) $ (286,852 ) NM
Net loss $ (332,792 ) $ (45,940 ) $ (286,852 ) NM
Adjustments from net loss to
Education segment
Adjusted EBITDA
Depreciation expense $ 35,940 $ 43,749 $ (7,809 ) (17.8 )%
Amortization expense 163,714 189,340 (25,626 ) (13.5 )%
Inventory obsolescence related to
strategic transformation plan - 9,758 (9,758 ) NM
Impairment charge for goodwill 279,000 - 279,000 NM
Education segment
Adjusted EBITDA $ 145,862 $ 196,907 $ (51,045 ) (25.9 )%
NM = not meaningful
Our Education segment net sales for the year ended December 31, 2020 decreased
$371.1 million , or 30.7%, from $1,210.6 million in 2019 to $839.6 million . The
net sales 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 $252.0 million from
$632.0 million in 2019 to $380.0 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 the
COVID-19 pandemic.
Our Education segment cost of sales for the year ended December 31, 2020
decreased $206.9 million , or 28.9%, from $716.6 million in 2019 to
$509.6 million . Our cost of sales, excluding publishing rights and
pre-publication amortization, decreased $178.2 million from $547.1 million in
2019 to $368.9 million , largely due to the decline in net sales. Our cost of
sales, excluding publishing rights and pre-publication amortization, as a
percentage of sales, decreased year over year from 45.2% to 43.9%.
Pre-publication amortization decreased by $22.9 million from 2019 primarily due
to the timing and large amount of 2019 major product releases, and publishing
rights amortization decreased $5.8 million attributed to our use of accelerated
amortization methods.
Our Education segment selling and administrative expense for the year ended
December 31, 2020 decreased $159.4 million , or 30.6%, from $520.2 million in
2019 to $360.8 million . The decrease was driven by lower labor costs primarily
attributed to cost savings associated with our employee furlough initiative in
response to the COVID-19 pandemic and our 2020 Restructuring Plan and a freeze
on hiring. Further, lower variable expenses such
40--------------------------------------------------------------------------------
as commissions, samples, transportation, and depository fees attributed to lower billings from the prior year and lower discretionary spending due to travel reductions and cost reductions throughout the Company.
Our Education segment other intangible asset amortization expense for the year endedDecember 31, 2020 increased$3.1 million from 2019, due to accelerated amortization of certain intangible assets. Our Education segment Adjusted EBITDA for the year endedDecember 31, 2020 decreased$51.0 million , or 25.9%, from$196.9 million in 2019 to$145.9 million . Our Education segment Adjusted EBITDA excludes depreciation, amortization, inventory obsolescence related to our strategic transformation plan and goodwill impairment charges. The decrease is due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in Education segment Adjusted EBITDA.HMH Books & Media 2020 vs. 2019 Years Ended December 31, Dollar Percent 2020 2019 change change Net sales$ 191,739 $ 180,028 $ 11,711 6.5 % Costs and expenses: Cost of sales, excluding publishing
rights and pre-publication
amortization 128,940 121,014 7,926 6.5 % Publishing rights amortization 5,256 5,946 (690 ) (11.6 )% Pre-publication amortization 214 665 (451 ) (67.8 )% Cost of sales 134,410 127,625 6,785 5.3 % Selling and administrative 50,507 55,071 (4,564 ) (8.3 )% Other intangible asset amortization 2,637 5,432 (2,795 ) (51.5 )% Operating income (loss)$ 4,185 $ (8,100 ) $ 12,285 NM Net income (loss)$ 4,185 $ (8,100 ) $ 12,285 NM Adjustments from net income (loss) toHMH Books & Media segment Adjusted EBITDA Depreciation expense $ 382$ 1,131 $ (749 ) (66.2 )% Amortization expense film asset 13,953 9,835 4,118 41.9 % Amortization expense 8,107 12,042 (3,935 ) (32.7 )%HMH Books & Media segment Adjusted EBITDA$ 26,627 $ 14,908 $ 11,719 78.6 % NM = not meaningful OurHMH Books & Media segment net sales for the year endedDecember 31, 2020 increased$11.7 million , or 6.5%, from$180.0 million in 2019 to$191.7 million . The increase in net sales was primarily due to$9.6 million of licensing revenue from a new production series, a$3.4 million increase in licensing revenue attributed to the Carmen Sandiego series on Netflix, and strong net sales of the frontlist titles The 99% Invisible City, Compromised and Defined Dish. Offsetting the aforementioned, was lower net sales of both Adult and Young Reader's categories due to the closure of bookstores during the COVID-19 pandemic and the corresponding delay in releases of certain new frontlist titles. OurHMH Books & Media segment cost of sales for the year endedDecember 31, 2020 increased$6.8 million , or 5.3%, from$127.6 million in 2019 to$134.4 million . The majority of the increase was driven by our cost of sales, excluding publishing rights and pre-publication amortization, which increased$7.9 million due to higher net sales. Our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of net sales, remained essentially flat. OurHMH Books & Media segment selling and administrative expense for the year endedDecember 31, 2020 decreased$4.6 million from$55.1 million in 2019, to$50.5 million . The decrease was due to labor savings 41
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associated with our employee furlough initiative in response to the COVID-19 pandemic, and our 2020 Restructuring Plan and a freeze on hiring.
Our
OurHMH Books & Media segment Adjusted EBITDA for the year endedDecember 31, 2020 changed favorably from$14.9 million in 2019 to$26.6 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. 42
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Corporate and Other
2020 vs. 2019
Years Ended December 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 66,839 87,382 (20,543 ) (23.5 )% Restructuring/severance and other charges 33,643 21,742 11,901 54.7 % Operating loss$ (100,482 ) $ (109,124 ) $ 8,642 7.9 % Retirement benefits non-service (expense) income (856 ) 167 (1,023 ) NM Interest expense (65,959 ) (48,778 ) (17,181 ) (35.2 )% 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 before taxes (163,635 ) (155,592 ) (8,043 ) (5.2 )% Income tax (benefit) expense (12,404 ) 4,201 (16,605 ) NM Net loss$ (151,231 ) $ (159,793 ) $ 8,562 5.4 % Adjustments from net loss to Corporate and Other Adjusted EBITDA Interest expense$ 65,959 $ 48,778 $ 17,181 35.2 % Interest income (899 ) (3,157 ) 2,258 71.5 % Provision for income taxes (12,404 ) 4,201 (16,605 ) NM Depreciation expense 14,393 16,595 (2,202 ) (13.3 )% Non-cash charges-loss on derivative instruments (672 ) 899 (1,571 ) NM Non-cash charges-stock compensation 11,573 13,968 (2,395 ) (17.1 )% Fees, expenses or charges for equity offerings, debt or acquisitions/dispositions 1,080 6,327 (5,247 ) (82.9 )% Severance, separation costs and facility closures 33,643 21,742 11,901 54.7 % Loss on extinguishment of debt - 4,363 (4,363 ) NM Gain on investments (2,091 ) - (2,091 ) NM Corporate and Other Adjusted EBITDA$ (40,649 ) $ (46,077 ) $ 5,428 11.8 % 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 restructuring, severance and other non-operating costs. Our selling and administrative expense for the Corporate and Other category for the year endedDecember 31, 2020 decreased$20.5 million from$87.4 million in 2019 to$66.8 million , primarily attributed to labor savings associated with our employee furlough initiative in response to the COVID-19 pandemic and our 2020 Restructuring Plan and a freeze on hiring. Additionally, selling and administrative expenses were lower due to lower stock compensation charges and depreciation. 43
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Our restructuring/severance and other charges for the year ended
Retirement benefits non-service (expense) income for the year ended
Interest expense for the year endedDecember 31, 2020 increased$17.2 million from$48.8 million in 2019 to$66.0 million , primarily due to our 2019 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 the year ended
Adjusted EBITDA for the Corporate and Other category for the year endedDecember 31, 2020 favorably changed$5.4 million , or 11.8%, from a loss of$46.1 million in 2019 to a loss of$40.6 million . Our Adjusted EBITDA for the Corporate and Other category excludes interest, taxes, depreciation, derivative instruments charges, equity compensation charges, acquisition/disposition-related activity, gains or losses on investments, restructuring costs, and loss on extinguishment of debt. The favorable 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 not following this historic pattern.
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Approximately 81% of our net sales for the year ended December 31, 2020 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 66% 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.
The following table is indicative of the seasonality of our business and the related results:
Quarterly Results of Operations
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter (in thousands)
2019 2019 2019 2019 2020 2020 2020 2020
Education segment
40,791 39,095 48,054 52,088 38,340 35,153 55,664 62,582 Net sales
194,635 388,896 565,668 241,475 189,925 251,216 386,590 203,561
Costs and expenses:
Cost of sales,
excluding publishing
rights and pre-
publication
amortization 96,055 190,831 246,527 134,695 90,012 124,360 182,767 100,677 Publishing rights amortization
7,605 6,271 6,341 6,340 5,825 4,709 4,761 4,761 Pre-publication amortization
33,082 35,739 39,319 41,375 30,638 31,758 31,647 32,137 Cost of sales
136,742 232,841 292,187 182,410 126,475 160,827 219,175 137,575 Selling and administrative
151,983 175,266 188,957 146,400 133,353 106,329 127,324 111,095
Impairment charge for
goodwill - - - - 262,000 - - 17,000
Other intangible asset
amortization 6,524 6,612 6,383 5,791 6,273 6,272 6,274 6,766 Restructuring/severance and other charges
1,221 4,430 270 15,821 - - 33,545 98
Operating (loss) income (101,835 ) (30,253 ) 77,871 (108,947 ) (338,176 ) (22,212 ) 272 (68,973 )
Other income (expense)
Retirement benefits
non-service (expense)
income 42 42 41 42 61 61 61 (1,039 )
Interest expense (11,582 ) (11,963 ) (11,597 ) (13,636 ) (16,783 ) (17,482 ) (16,168 ) (15,526 ) Interest income
1,092 97 509 1,459 766 75 32 26
Change in fair value of derivative instruments (450 ) 16 (737 ) 272
(380 ) 120 432 500
Gain on investments - - - - - - 1,738 353
Income from transition
services agreement 1,826 1,851 571 - - - - -
Loss on extinguishment
of debt - - - (4,363 ) - - - -
(Loss) income before
taxes (110,907 ) (40,210 ) 66,658 (125,173 ) (354,512 ) (39,438 ) (13,633 ) (84,659 ) Income tax expense (benefit)
6,455 403 (2,602 )
(55 ) (8,539 ) (1,270 ) (1,081 ) (1,514 )
Net (loss) income
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-------------------------------------------------------------------------------- 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 current period financial statements or any prior periods.
Liquidity and Capital Resources
December 31,
(in thousands) 2020 2019
Cash and cash equivalents $ 281,200 $ 296,353
Current portion of long-term debt 19,000 19,000
Long-term debt, net of discount and issuance costs 624,692
638,187
Revolving credit facility -
-
Borrowing availability under revolving credit
facility 104,806 161,961
Years ended December 31,
2020 2019
Net cash provided by operating activities
254,975
Net cash used in investing activities (112,271 ) (96,320 ) Net cash used in financing activities (18,130 ) (115,667 ) Operating activities Net cash provided by operating activities was$115.2 million for the year endedDecember 31, 2020 , a$139.7 million decrease from the$255.0 million of net cash provided by operating activities for the year endedDecember 31, 2019 . The decrease in cash provided by operating activities was primarily driven by unfavorable changes in net operating assets and liabilities of$78.4 million primarily due to changes in deferred revenue of$143.3 million and$29.3 million of royalties related to greater billings in 2019, accounts payable of$22.8 million related to timing of disbursements and severance and other charges of$3.4 million due to the 2020 Restructuring Plan, offset by favorable period over period inventory changes of$74.9 million , favorable period over period changes in accounts receivable of$12.4 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$6.1 million . Additionally, operating profit, net of non-cash items, decreased by$61.4 million .
Investing activities
Net cash used in investing activities was$112.3 million for the year endedDecember 31, 2020 , an increase of$16.0 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 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$27.8 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 was$18.1 million for the year endedDecember 31, 2020 , a decrease of$97.6 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 . 46
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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, 2020 , we had$306.0 million ($297.6 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.
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, 2020 , we had$361.0 million ($346.1 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, 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.
47
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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.
To the extent that we are successful in the divestiture of our Books & Media
business, we plan to utilize a portion of the proceeds to reduce our outstanding
indebtedness, which will increase recurring free cash flow resulting from
reduced interest expense. 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. We were not required
to make a payment under the excess cash flow provision in 2020 and 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 ofDecember 31, 2020 , there were no amounts outstanding on the revolving credit facility. As ofDecember 31, 2020 , we had approximately$18.8 million of outstanding letters of credit and approximately$104.8 million of borrowing availability under the revolving credit facility. As ofFebruary 25, 2021 , there were no amounts outstanding under 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. 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, 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. 48
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General
We had$281.2 million of cash and cash equivalents and no short-term investments atDecember 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 our industry will begin to recover as school districts become, or continue being, fully operational, either in-person, fully remote or hybrid, and we have performed a sensitivity analysis on these assumptions to forecast the impact of a slower-than-anticipated recovery. Based on the actions enacted in 2020, we have concluded we have sufficient liquidity to fund our current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months.
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 2 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.
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.
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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 often 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 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, trade books, reference materials, formative assessment materials and
multimedia instructional programs; licenses to book rights and content; 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.
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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, international sales andHMH Books & Media 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$4.0 million and$14.6 million , and$3.0 million and$16.7 million as ofDecember 31, 2020 and 2019, 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, the previous years' sales history, the subsequent year's 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 strategic direction of our product development, could affect the estimated reserve. The inventory obsolescence reserve is reported as a reduction of the inventories balance and amounted to$64.8 million and$57.4 million as ofDecember 31, 2020 and 2019, 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 with respect to ourHMH Books & Media young readers and general interest books, for which we expense such costs as incurred. Additionally, pre-publication costs recorded for most intervention products are amortized over 7 years on a projected sales pattern. The amortization methods and periods chosen best reflects the pattern of expected sales generated from individual titles or programs. On a quarterly basis, we evaluate the remaining lives and recoverability of capitalized pre-publication costs, which are often dependent upon program acceptance by state adoption authorities. 51
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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.Goodwill is allocated entirely to our Education reporting unit. 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 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 Education 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 Education reporting unit in the current social and economic environment. With regard to indefinite-lived intangible assets, which includes theHoughton Mifflin Harcourt tradename atDecember 31, 2020 and 2019, 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 and the terminal value of the Education reporting unit. 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 or peer company multiples by an equivalent amount could give rise to an impairment. 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 goodwill impairment tests as ofOctober 1, 2020 and 2019. The fair value of the Education reporting unit was in excess of its carrying value by approximately 18% as ofOctober 1, 2020 and 2019. There was no goodwill impairment for the years endedDecember 31, 2019 and 2018. 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 completed our annual indefinite-lived asset impairment tests as ofOctober 1, 2020 and 2019. No indefinite-lived intangible assets were deemed to be impaired for the years endedDecember 31, 2020 , 2019 and 2018. 52
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Royalty Advances
Royalty advances to authors are capitalized and represent amounts paid in advance of the sale of an author's product and are recovered as earned. As advances are recorded, a partial reserve may be recorded immediately based primarily upon historical sales experience to estimate the likelihood of recovery. Additionally, advances are evaluated periodically to determine if they are expected to be recovered on a title-by-title basis, with consideration given to the other titles in the author's portfolio also earning against the outstanding advance. Any portion of a royalty advance that is not expected to be recovered is fully reserved. The reserve for royalty advances is reported as a reduction of the royalty advances to authors balance and amounted to$96.7 million and$119.7 million as ofDecember 31, 2020 and 2019, respectively.
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, 2020 , 2019 and 2018. 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. Contractual Obligations
The following table provides information with respect to our estimated
commitments and obligations as of
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
Term loan due November 22, 2024 (1) $ 361,000 $ 19,000 $ 38,000 $ 304,000 $ -
Interest payable on term loan due
November 22,
2024 (2) 92,177 25,540 46,950 19,687 -
9.0% senior secured notes due
February 15, 2025 306,000 - - 306,000 -
Interest payable on 9.0% senior
secured notes due February 15, 2025 123,701 27,464 54,927 41,310 -
Revolver commitment fees 11,033 2,794 5,642 2,597 -
Operating leases (3) 295,393 30,955 64,385 68,817 131,236
Purchase obligations (4) 39,317 24,599 13,249 1,469 -
Total cash contractual obligations
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--------------------------------------------------------------------------------(1) The term loan facility principal amortizes at a rate of 5.0% per annum of
the original
(2) As of
(3) Represents minimum lease payments under non-cancelable operating leases.
(4) Purchase obligations are agreements to purchase goods or services that are
enforceable and legally binding. These goods and services consist primarily
of author advances, subcontractor expenses, information technology licenses,
and outsourcing arrangements.
In addition to the payments described above, we have employee benefit obligations that require future payments. For example, we expect to make$4.8 million of contributions in 2021 relating to our pension and postretirement benefit plans. We expect to periodically draw and repay borrowings under the revolving credit facility. We believe that we will be able to meet our cash interest obligations on our outstanding debt when they are due and payable.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
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