HOUGHTON MIFFLIN HARCOURT COMPANY The following discussion and analysis is intended to facilitate an understanding of our results of operations and financial condition and should be read in conjunction with the interim unaudited consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2020 , which was filed with theSecurities Exchange Commission (the "SEC") onFebruary 25, 2021 . This "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. See "Special Note Regarding Forward-Looking Statements" included elsewhere in this Quarterly Report on Form 10-Q.
Overview
We are a learning 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
OnMarch 26, 2021 , we entered into a definitive asset purchase agreement to sell theHMH Books & Media segment, our consumer publishing business, for cash consideration of$349.0 million , subject to a customary working capital adjustment, and the purchaser's assumption of all liabilities relating to theHMH Books & Media business subject to specified exceptions (collectively, the "Transaction"). We expect total net cash proceeds after the payment of transaction costs to be approximately$337.0 million , which we intend to use 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 will join the acquiring company. The divestiture is subject to customary closing conditions, including regulatory approvals. The transaction is expected to close in the second quarter of 2021. Upon entering into the asset purchase agreement onMarch 26, 2021 , theHMH Books & Media business became 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 first quarter discontinued operations financial results is allocated interest expense of$6.6 million and$7.5 million , for 2021 and 2020, respectively, based on our intent to repay the Company's debt with the net proceeds from the sale. On the balance sheet, all assets and liabilities transferring to the acquirer have been classified as Assets Held for Sale or Liabilities Held for Sale. The results of theHMH Books & Media business were previously reported in its own reportable segment. We will report our revenues and financial results from continuing operations under one reportable segment.
Unless otherwise indicated, all financial information refers to continuing operations.
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 pandemic. We also have taken 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.
Given the ongoing COVID-19 situation, our business will continue to be impacted during 2021 as spending by our customers slowly resumes.
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--------------------------------------------------------------------------------2020 Restructuring Plan We are continuing to assess our cost structure amid the COVID-19 pandemic to 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 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. 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 represented cash expenditures, was approximately$33.6 million . These actions are to streamline the cost structure of the Company.
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 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. 27
-------------------------------------------------------------------------------- We also derive 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.
Factors affecting our net sales include:
• 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.
State or district per-student funding levels, which closely correlate with state and local receipts from income, sales and property taxes, impact our sales as institutional customers are affected by funding cycles. Most public school districts, the primary customers for K-12 products and services, are largely dependent on state and local funding to purchase materials. We monitor the purchasing cycles for specific disciplines in the adoption states in order to manage our product development and to plan sales campaigns. Our sales may be materially impacted during the years that major adoption states, such 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.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. 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 will appropriate 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 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 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. 28 -------------------------------------------------------------------------------- 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 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$3.0 million for the three months endedMarch 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 three months endedMarch 31, 2021 was$7.9 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, to a lesser extent, our revolving credit 29
-------------------------------------------------------------------------------- facility, finance leases, the amortization of any deferred financing fees and loan discounts, and payments in connection with interest rate hedging agreements. Our interest expense for the three months endedMarch 31, 2021 was$8.6 million . Results of Operations Consolidated Operating Results for the Three Months EndedMarch 31, 2021 and 2020 Three Months Ended March 31, Dollar Percent (dollars in thousands) 2021 2020 Change Change Net sales$ 146,195 $ 151,843 $ (5,648 ) (3.7 )% Costs and expenses: Cost of sales, excluding publishing rights and pre-publication amortization 58,137 63,652 (5,515 ) (8.7 )% Publishing rights amortization 3,166 4,432 (1,266 ) (28.6 )% Pre-publication amortization 25,051 30,562 (5,511 ) (18.0 )% Cost of sales 86,354 98,646 (12,292 ) (12.5 )% Selling and administrative 89,235 123,341 (34,106 ) (27.7 )% Other intangible assets amortization 7,906 5,856 2,050 35.0 % Impairment charge for goodwill - 262,000 (262,000 ) NM Operating loss (37,300 ) (338,000 ) 300,700 89.0 % Other income (expense): Retirement benefits non-service (expense) income (200 ) 61 (261 ) NM Interest expense (8,564 ) (9,253 ) 689 7.4 % Interest income 20 766 (746 ) (97.4 )% Change in fair value of derivative instruments (674 ) (380 ) (294 ) (77.4 )% Loss from continuing operations before taxes (46,718 ) (346,806 ) 300,088 86.5 % Income tax expense (benefit) for continuing operations 2,310 (8,780 ) 11,090 NM Loss from continuing operations (49,028 ) (338,026 ) 288,998 85.5 % Loss from discontinued operations, net of tax (2,955 ) (7,947 ) 4,992 62.8 % Net loss$ (51,983 ) $ (345,973 ) $ 293,990 85.0 % NM = not meaningful Net sales for the three months endedMarch 31, 2021 decreased$5.6 million , or 3.7%, from$151.8 million in 2020 to$146.2 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$9.0 million from$86.0 million in 2020 to$77.0 million . Within Extensions, net sales of professional services decreased$14.0 million due to lower professional services with the decline of the in-person learning environment as a result of the COVID-19 pandemic. Partially offsetting the decline in Extensions was an increase in Core Solutions of$3.0 million from$65.0 million in 2020 to$68.0 million , driven by strong international net sales and net sales of social studies and math programs inCalifornia . Operating loss for the three months endedMarch 31, 2021 favorably changed from a loss of$338.0 million in 2020 to a loss of$37.3 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 has had on the Company;
• A
due to lower labor costs of
associated with our 2020 Restructuring Plan and a freeze on hiring. Also,
there was a
and marketing due to expense reduction measures. Further, there was a
decrease of $5.0 million of variable expenses driven primarily by a
reduction of print sampling;
• A
and pre-publication amortization, from
delivery of products and services. Our cost of sales, excluding publishing
rights and pre-publication amortization, as a percentage of sales,
decreased to 39.8% from 41.9%;
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• A
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
accelerated amortization of certain other intangible assets due to product
life cycle reductions;
Partially offset by: • A$5.6 million decrease in net sales.
Retirement benefits non-service (expense) income for the three months ended
Interest expense for the three months endedMarch 31, 2021 decreased$0.7 million from$9.3 million in 2020 to$8.6 million , primarily due to lower term loan facility interest expense which was driven by lower LIBOR and net settlement payments on our interest rate derivative instruments during 2020, which did not repeat in 2021. Interest income for the three months endedMarch 31, 2021 decreased$0.7 million due to lower interest rates on our money market funds in 2021 and to a lesser extent, lower balances. Change in fair value of derivative instruments for the three months endedMarch 31, 2021 , unfavorably changed by a$0.3 million due to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the strengthening of theU.S. dollar against the Euro. Income tax expense (benefit) for continuing operations for the three months endedMarch 31, 2021 increased$11.1 million , from a benefit of$8.8 million in 2020, to an expense of$2.3 million . An income tax benefit was recorded in the first quarter of 2020 and was due primarily to the impairment charge on goodwill, which reduced the related deferred tax liabilities. For 2021, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (4.4)%. For 2020, our effective annual tax rate exclusive of discrete items was (8.7)%. For both periods income tax expense was primarily attributed to movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes, as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions. Loss from discontinued operations, net of tax for the three months endedMarch 31, 2021 decreased$5.0 million from a loss of$7.9 million in 2020, to a loss of$3.0 million primarily due to higher net sales in 2021.The HMH Books & Media business 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 loss is allocated interest expense of$6.6 million and$7.5 million , for 2021 and 2020, respectively, based on the intent to repay our debt with the net proceeds from the sale as required by our debt facilities as we are not intending to 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 fluctuations in interest rates or effective tax rates,
non-cash charges and impairment charges, levels of depreciation or amortization,
and 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 from continuing operations to Adjusted
EBITDA from continuing operations for the three months ended March 31, 2021 and
2020:
Three Months Ended
March 31,
2021 2020
Net loss from continuing operations $ (49,028 ) $ (338,026 )
Interest expense 8,564 9,253
Interest income (20 ) (766 )
Provision (benefit) for income taxes 2,310 (8,780 )
Depreciation expense 11,695 12,183
Amortization expense 36,123 40,850
Non-cash charges - goodwill impairment - 262,000
Non-cash charges - stock compensation 2,607
3,268
Non-cash charges - loss on derivative instruments 674
380
Fees, expenses or charges for equity offerings, debt or
acquisitions/dispositions 1,826
27
Adjusted EBITDA from continuing operations$ 14,751 $ (19,611 ) 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. Moreover, uncertainty resulting from the COVID-19 pandemic may result in our business not following this historic pattern. 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 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.
Liquidity and Capital Resources
March 31, December 31,
(in thousands) 2021 2020
Cash and cash equivalents $ 170,901 $ 281,200
Current portion of long-term debt 19,000 19,000
Long-term debt, net of discount and issuance costs 621,319
624,692
Revolving credit facility - -
Borrowing availability under revolving credit facility 128,060
104,806
Three Months Ended March 31,
2021 2020
Net cash used in operating activities $ (81,256 ) $ (156,767 )
Net cash used in investing activities (24,703 ) (30,626 )
Net cash (used in) provided by financing activities (4,340 ) 145,705
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Operating activities Net cash used in operating activities was$81.3 million for the three months endedMarch 31, 2021 , a$75.5 million favorable change from the$156.8 million of net cash used in operating activities for the three months endedMarch 31, 2020 . Net cash used in operating activities included$19.3 million and$15.2 million of cash flow from discontinued operations in 2021 and 2020, respectively and net cash used in operating activities from continuing operations of$100.5 million and$172.0 million in 2021 and 2020, respectively. The$71.4 million improvement in cash used in operating activities from continuing operations resulted from an increase in operating profit, net of non-cash items, of$32.3 million . Further, the improvement was also due to favorable changes in net operating assets and liabilities of$39.1 million primarily due to favorable changes in accounts payable of$23.2 million related to lower commission and incentive expenses, favorable changes in royalties payable of$21.9 million and inventory of$21.3 million and a favorable change in deferred revenue of$17.3 million , offset by unfavorable changes in accounts receivable of$32.7 million due to higher billings and the timing of collections, interest payable of$6.9 million due to the timing of payments, severance and other charges of$2.8 million and other assets and liabilities of$2.2 million . Investing activities Net cash used in investing activities was$24.7 million for the three months endedMarch 31, 2021 , a decrease of$5.9 million from the$30.6 million used in investing activities for the three months endedMarch 31, 2020 . Net cash used in investing activities included$0.4 million and$0.3 million of expenditures from discontinued operations in 2021 and 2020, respectively and net cash used in investing activities from continuing operations of$24.3 million and$30.4 million in 2021 and 2020, respectively. The decrease in cash used in investing activities was primarily due to lower capital investing expenditures related to pre-publication costs and property, plant, and equipment of$6.1 million in connection with planned reductions in content development.
Financing activities
Net cash used in financing activities, which is all continuing operations, was$4.3 million for the three months endedMarch 31, 2021 , an increase of$150.0 million from the$145.7 million provided by financing activities for the three months endedMarch 31, 2020 . The increase in cash used in financing activities was primarily due to proceeds from our revolving credit facility of$150.0 million during the prior period, which did not repeat in 2021.
Debt
Under each of the notes, the term loan facility and the revolving credit facility,Houghton Mifflin Harcourt Publishers Inc. ,Houghton Mifflin Harcourt Publishing Company andHMH Publishers LLC are the borrowers (collectively, the "Borrowers"), andCitibank, N.A . acts as both the administrative agent and the collateral agent. The obligations under the senior secured notes, the term loan facility and the revolving credit facility are guaranteed by the Company and each of its direct and indirect for-profit domestic subsidiaries (other than the Borrowers) (collectively, the "Guarantors") and are secured by all capital stock and other equity interests of the Borrowers and the Guarantors and substantially all of the other tangible and intangible assets of the Borrowers and the Guarantors, including, without limitation, receivables, inventory, equipment, contract rights, securities, patents, trademarks, other intellectual property, cash, bank accounts and securities accounts and owned real estate. The revolving credit facility is secured by first priority liens on receivables, inventory, deposit accounts, securities accounts, instruments, chattel paper and other assets related to the foregoing (the "Revolving First Lien Collateral"), and second priority liens on the collateral which secures the term loan facility on a first priority basis. The term loan facility is secured by first priority liens on the capital stock and other equity interests of the Borrowers and the Guarantors, equipment, owned real estate, trademarks and other intellectual property, general intangibles that are not Revolving First Lien Collateral and other assets related to the foregoing, and second priority liens on the Revolving First Lien Collateral.
Senior Secured Notes
OnNovember 22, 2019 , we completed the sale of$306.0 million in aggregate principal amount of 9.0% Senior Secured Notes due 2025 (the "notes") in a private placement to qualified institutional buyers under Rule 144A under the Securities Act of 1933, as amended (the "Securities Act"), and to persons outsidethe United States pursuant to Regulation S under the Securities Act. The notes mature onFebruary 15, 2025 and bear interest at a rate of 9.0% per annum. Interest is payable semi-annually in arrears onFebruary 15 andAugust 15 of each year, beginning onFebruary 15, 2020 . As ofMarch 31, 2021 , we had$306.0 million ($298.0 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.
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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
On November 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 of March 31, 2021 , we had $356.3 million ($342.3 million ,
net of discount and issuance costs) outstanding under the term loan facility.
The term loan facility matures on November 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 of March 31,
2021 , the interest rate on the term loan facility was 7.25%.
The term loan facility is required to be repaid in quarterly installments of
approximately
The term loan facility does not require us to comply with financial maintenance covenants. We are currently required to meet certain incurrence based financial covenants as defined under our term loan facility. The term loan facility contains customary mandatory prepayment requirements, including with respect to excess cash flow, proceeds from certain asset sales or dispositions of property, and proceeds from certain incurrences of indebtedness. To the extent that we are successful in closing the divestiture of ourHMH Books & Media business, we intend to use the proceeds to reduce our outstanding indebtedness, which will increase recurring free cash flow resulting from reduced interest expense. We do not intend to reinvest such proceeds in the business. 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 ofMarch 31, 2021 , there were no amounts outstanding on the revolving credit facility. As ofMarch 31, 2021 , we had approximately$16.5 million of outstanding letters of credit and approximately$128.1 million of borrowing availability under the revolving credit facility. As ofMay 6, 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. 34 -------------------------------------------------------------------------------- The revolving credit facility requires us to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 on a trailing four-quarter basis for periods in which excess availability under the revolving credit facility is less than the greater of$25.0 million and 12.5% of the lesser of the total commitment and the borrowing base then in effect, or less than$20.0 million if certain conditions are met. The minimum fixed charge coverage ratio was not applicable under the facility as ofMarch 31, 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
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 and we have performed a sensitivity analysis on various recovery assumptions. Based on the actions 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
Our financial results are affected by the selection and application of critical accounting policies and methods. There were no material changes in the three months endedMarch 31, 2021 to the application of critical accounting policies and estimates as described in our audited consolidated financial statements, which were included in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2020 . The critical accounting estimates used in the preparation of the Company's consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and the Company's operating environment changes. Actual results may differ from these estimates due to the uncertainty around the magnitude and duration of the COVID-19 pandemic, as well as other factors.
Impact of Inflation and Changing Prices
We believe that inflation has not had a material impact on our results of operations during the year endedDecember 31, 2020 or year to date in 2021. 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
35
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accelerate the maturity for the debt under these agreements and to foreclose
upon any collateral securing the debt owed to these lenders and to terminate any
commitments of these lenders to lend to us. If the lenders accelerate the
payment of the indebtedness, our assets may not be sufficient to repay in full
the indebtedness and any other indebtedness that would become due as a result of
any acceleration. Further, in such an event, the lenders would not be required
to make further loans to us, and assuming similar facilities were not
established and we are unable to obtain replacement financing, it would
materially affect our liquidity and results of operations.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Recently Issued Accounting Pronouncements
See Note 4 to the consolidated financial statements included under Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recently issued accounting pronouncements.
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