Company Quick10K Filing
Quick10K
Houghton Mifflin Harcourt
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$6.81 124 $845
10-Q 2019-03-31 Quarter: 2019-03-31
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-06-11 Officers, Regulation FD
8-K 2019-05-21 Shareholder Vote
8-K 2019-05-09 Earnings, Exhibits
8-K 2018-11-08 Earnings, Exhibits
8-K 2018-10-01 M&A, Regulation FD, Exhibits
8-K 2018-09-12 Enter Agreement, Regulation FD, Exhibits
8-K 2018-08-02 Earnings, Exhibits
8-K 2018-05-22 Shareholder Vote
8-K 2018-03-01 Officers, Exhibits
CACI CACI 5,050
NEOG Neogen 3,190
AMN AMN Healthcare Services 2,410
FLOW SPX Flow 1,660
SAFT Safety Insurance Group 1,440
MMYT MakeMyTrip 1,420
SKY Skyline Champion 1,190
MGIC Magic Software Enterprises 440
IASO IASO BioMed 0
ACUR Acura Pharmaceuticals 0
HMHC 2019-03-31
Part 1 - Financial Information
Item 1. Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 6. Exhibits
EX-31.1 d634408dex311.htm
EX-31.2 d634408dex312.htm
EX-32.1 d634408dex321.htm
EX-32.2 d634408dex322.htm

Houghton Mifflin Harcourt Earnings 2019-03-31

HMHC 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 d634408d10q.htm 10-Q 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2019

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 001-36166

 

 

Houghton Mifflin Harcourt Company

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   27-1566372

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

125 High Street

Boston, MA 02110

(617) 351-5000

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common Stock, $0.01 par value   HMHC   The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

The number of shares of common stock, par value $0.01 per share, outstanding as of May 6, 2019 was 124,110,547.

 

 

 


Table of Contents

Table of Contents

 

     Page (s)  
Special Note Regarding Forward-Looking Statements      3  
PART I.  

FINANCIAL INFORMATION

  
Item 1.  

Consolidated Financial Statements (Unaudited):

     4  
 

Consolidated Balance Sheets

     4  
 

Consolidated Statements of Operations

     5  
 

Consolidated Statements of Comprehensive Loss

     6  
 

Consolidated Statements of Cash Flows

     7  
 

Consolidated Statements of Stockholders’ Equity

     8  
 

Notes to Consolidated Financial Statements

     9  
Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     24  
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     38  
Item 4.  

Controls and Procedures

     39  
PART II.  

OTHER INFORMATION

  
Item 1.  

Legal Proceedings

     39  
Item 1A.  

Risk Factors

     39  
Item 6.  

Exhibits

     40  
SIGNATURES      41  

 

2


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

The statements contained herein include forward-looking statements, which involve risks and uncertainties. These forward-looking statements can be identified by the use of forward-looking terminology, including the terms “believes,” “estimates,” “projects,” “anticipates,” “expects,” “could,” “intends,” “may,” “will,” “should,” “forecast,” “intend,” “plan,” “potential,” “project,” “target” or, in each case, their negative, or other variations or comparable terminology. Forward-looking statements include all statements that are not statements of historical facts. They include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations; financial condition; liquidity; prospects, growth and strategies; our competitive strengths; the industry in which we operate; the impact of new accounting guidance and tax laws; expenses; effective tax rates; future liabilities; the outcome and impact of pending or threatened litigation; decisions of our customers; education expenditures; population growth; state curriculum adoptions and purchasing cycles; the impact of dispositions, acquisitions and other investments; our share repurchase program; the timing, structure and expected impact of our operational efficiency and cost-reduction initiatives and the estimated savings and amounts expected to be incurred in connection therewith; and potential business decisions. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. We caution that it is very difficult to predict the impact of known factors, and, of course, it is impossible for us to anticipate all factors that could affect our actual results. All forward-looking statements are based upon information available to us on the date of this report.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. We caution you that forward-looking statements are not guarantees of future performance and that actual results may differ materially from those made in or suggested by the forward-looking statements contained herein. In addition, even if actual results are consistent with the forward-looking statements contained herein, those results or developments may not be indicative of results or developments in subsequent periods.

Important factors that could cause actual results to vary from expectations include, but are not limited to: changes in state and local education funding and/or related programs, legislation and procurement processes; changes in state academic standards; industry cycles and trends; the rate and state of technological change; state requirements related to digital instructional materials; changes in product distribution channels and concentration of retailer power; changes in our competitive environment, including free and low-cost open educational resources; periods of operating and net losses; our ability to enforce our intellectual property and proprietary rights; risks based on information technology systems and potential breaches of those systems; dependence on a small number of print and paper vendors; third-party software and technology development; possible defects in digital products; our ability to identify, complete, or achieve the expected benefits of, acquisitions; unanticipated consequences of the recently completed disposition of our Riverside clinical and standardized testing business; our ability to execute on our long-term growth strategy; increases in our operating costs; exposure to litigation; major disasters or other external threats; contingent liabilities; risks related to our indebtedness; future impairment charges; changes in school district payment practices; a potential increase in the portion of our sales coming from digital sales; risks related to doing business abroad; changes in tax law or interpretation; management and personnel changes; timing, higher costs and unintended consequences of our operational efficiency and cost-reduction initiatives; and other factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2018 (and our subsequent filings pursuant to the Securities Exchange Act of 1934, as amended). In light of these risks, uncertainties and assumptions, the forward-looking events described herein may not occur.

We undertake no obligation, and do not expect, to publicly update or publicly revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. All subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained herein.

 

3


Table of Contents

PART 1 – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Houghton Mifflin Harcourt Company

Consolidated Balance Sheets

 

(in thousands of dollars, except share information)    March 31,
2019
(Unaudited)
    December 31,
2018
 

Assets

    

Current assets

    

Cash and cash equivalents

   $ 74,185     $ 253,365  

Short-term investments

     9,999       49,833  

Accounts receivable, net of allowances for bad debts and book returns of $18.7 million and $20.7 million, respectively

     183,125       203,574  

Inventories

     261,924       184,209  

Prepaid expenses and other assets

     20,953       15,297  
  

 

 

   

 

 

 

Total current assets

     550,186       706,278  

Property, plant, and equipment, net

     116,095       125,925  

Pre-publication costs, net

     321,837       323,641  

Royalty advances to authors, net

     47,544       47,993  

Goodwill

     716,845       716,073  

Other intangible assets, net

     511,963       520,892  

Operating lease assets

     144,695       —    

Deferred income taxes

     3,259       3,259  

Deferred commissions

     21,861       22,635  

Other assets

     27,180       28,428  
  

 

 

   

 

 

 

Total assets

   $ 2,461,465     $ 2,495,124  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Current liabilities

    

Current portion of long-term debt

   $ 8,000     $ 8,000  

Accounts payable

     115,762       76,313  

Royalties payable

     42,085       66,893  

Salaries, wages, and commissions payable

     17,120       50,225  

Deferred revenue

     234,014       251,944  

Interest payable

     377       136  

Severance and other charges

     1,717       6,020  

Accrued postretirement benefits

     1,512       1,512  

Operating lease liabilities

     14,326       —    

Other liabilities

     22,018       26,649  
  

 

 

   

 

 

 

Total current liabilities

     456,931       487,692  

Long-term debt, net of discount and issuance costs

     754,513       755,649  

Operating lease liabilities

     142,441       —    

Long-term deferred revenue

     373,749       395,500  

Accrued pension benefits

     29,140       29,320  

Accrued postretirement benefits

     13,268       14,300  

Deferred income taxes

     32,972       27,075  

Other liabilities

     5,780       17,118  
  

 

 

   

 

 

 

Total liabilities

     1,808,794       1,726,654  
  

 

 

   

 

 

 

Commitments and contingencies (Note 15)

    

Stockholders’ equity

    

Preferred stock, $0.01 par value: 20,000,000 shares authorized; no shares issued and outstanding at March 31, 2019 and December 31, 2018

     —         —    

Common stock, $0.01 par value: 380,000,000 shares authorized; 148,687,581 and 148,164,854 shares issued at March 31, 2019 and December 31, 2018, respectively; 124,110,547 and 123,587,820 shares outstanding at March 31, 2019 and December 31, 2018, respectively

     1,487       1,481  

Treasury stock, 24,577,034 shares as of March 31, 2019 and December 31, 2018, respectively, at cost

     (518,030     (518,030

Capital in excess of par value

     4,895,556       4,893,174  

Accumulated deficit

     (3,679,608     (3,562,971

Accumulated other comprehensive loss

     (46,734     (45,184
  

 

 

   

 

 

 

Total stockholders’ equity

     652,671       768,470  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,461,465     $ 2,495,124  
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


Table of Contents

Houghton Mifflin Harcourt Company

Consolidated Statements of Operations (Unaudited)

 

     Three Months Ended
March 31,
 
(in thousands of dollars, except share and per share information)    2019      2018  

Net sales

   $ 194,635      $ 199,759  

Costs and expenses

     

Cost of sales, excluding publishing rights and pre-publication amortization

     96,055        99,733  

Publishing rights amortization

     7,605        10,090  

Pre-publication amortization

     33,082        25,621  
  

 

 

    

 

 

 

Cost of sales

     136,742        135,444  

Selling and administrative

     151,983        145,527  

Other intangible asset amortization

     6,524        6,866  

Severance and other charges

     1,221        3,943  

Loss on sale of assets

     —          884  
  

 

 

    

 

 

 

Operating loss

     (101,835      (92,905
  

 

 

    

 

 

 

Other income (expense)

     

Retirement benefits non-service income

     42        320  

Interest expense

     (11,582      (10,936

Interest income

     1,092        506  

Change in fair value of derivative instruments

     (450      372  

Income from transition services agreement

     1,826        —    
  

 

 

    

 

 

 

Loss from continuing operations before taxes

     (110,907      (102,643

Income tax expense for continuing operations

     6,455        3,243  
  

 

 

    

 

 

 

Loss from continuing operations

     (117,362      (105,886
  

 

 

    

 

 

 

Income from discontinued operations, net of tax

     —          4,575  
  

 

 

    

 

 

 

Net loss

   $ (117,362    $ (101,311
  

 

 

    

 

 

 

Net loss per share attributable to common stockholders

     

Basic and diluted:

     

Continuing operations

   $ (0.95    $ (0.86

Discontinued operations

     —          0.04  
  

 

 

    

 

 

 

Net loss

   $ (0.95    $ (0.82
  

 

 

    

 

 

 

Weighted average shares outstanding

     

Basic

     123,798,641        123,222,353  
  

 

 

    

 

 

 

Diluted

     123,798,641        123,222,353  
  

 

 

    

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5


Table of Contents

Houghton Mifflin Harcourt Company

Consolidated Statements of Comprehensive Loss (Unaudited)

 

     Three Months Ended
March 31,
 
(in thousands of dollars, except share and per share information)    2019      2018  

Net loss

   $ (117,362    $ (101,311

Other comprehensive (loss) income, net of taxes:

     

Foreign currency translation adjustments, net of tax

     (232      227  

Unrealized gain on short-term investments, net of tax

     9        18  

Net change in unrealized (loss) gain on derivative financial instruments,
net of tax

     (1,327      3,476  
  

 

 

    

 

 

 

Other comprehensive (loss) income, net of taxes

     (1,550      3,721  
  

 

 

    

 

 

 

Comprehensive loss

   $ (118,912    $ (97,590
  

 

 

    

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6


Table of Contents

Houghton Mifflin Harcourt Company

Consolidated Statements of Cash Flows (Unaudited)

 

     Three Months Ended
March 31,
 
(in thousands of dollars)    2019     2018  

Cash flows from operating activities

    

Net loss

   $ (117,362   $ (101,311

Adjustments to reconcile net loss to net cash used in operating activities

    

Income from discontinued operations, net of tax

     —         (4,575

Loss on sale of assets

     —         884  

Depreciation and amortization expense

     68,402       61,022  

Amortization of debt discount and deferred financing costs

     1,046       1,046  

Deferred income taxes

     5,897       4,230  

Stock-based compensation expense

     3,551       2,893  

Change in fair value of derivative instruments

     450       (372

Changes in operating assets and liabilities, net of acquisitions

    

Accounts receivable

     20,482       34,679  

Inventories

     (77,715     (51,978

Other assets

     (2,771     1,991  

Accounts payable and accrued expenses

     787       3,433  

Royalties payable and author advances, net

     (24,359     (18,218

Deferred revenue

     (39,870     (34,715

Interest payable

     241       19  

Severance and other charges

     (59     3  

Accrued pension and postretirement benefits

     (1,212     (1,311

Other liabilities

     (13,571     2,791  
  

 

 

   

 

 

 

Net cash used in operating activities – continuing operations

     (176,063     (99,489

Net cash provided by operating activities – discontinued operations

     —         2,803  
  

 

 

   

 

 

 

Net cash used in operating activities

     (176,063     (96,686
  

 

 

   

 

 

 

Cash flows from investing activities

    

Proceeds from sales and maturities of short-term investments

     40,000       86,539  

Additions to pre-publication costs

     (25,898     (24,317

Additions to property, plant, and equipment

     (10,375     (11,483

Acquisition of business, net of cash acquired

     (5,447     —    
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities – continuing operations

     (1,720     50,739  

Net cash used in investing activities – discontinued operations

     —         (1,976
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (1,720     48,763  
  

 

 

   

 

 

 

Cash flows from financing activities

    

Payments of long-term debt

     (2,000     (2,000

Tax withholding payments related to net share settlements of restricted stock units and awards

     (1,756     (1,073

Issuance of common stock under employee stock purchase plan

     505       681  

Net collections (remittances) under transition services agreement

     1,854       —    
  

 

 

   

 

 

 

Net cash used in financing activities – continuing operations

     (1,397     (2,392
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (179,180     (50,315

Cash and cash equivalents at the beginning of the period

     253,365       148,979  
  

 

 

   

 

 

 

Cash and cash equivalents at the end of the period

   $ 74,185     $ 98,664  
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information

    

Interest paid

   $ 10,715     $ 9,842  

Income taxes paid (refunded)

     13       (228

Non-cash investing activities

    

Pre-publication costs included in accounts payable and accruals

   $ 18,988     $ 29,420  

Property, plant, and equipment included in accounts payable and accruals

     2,448       15,122  

Property, plant, and equipment acquired under capital leases

     442       —    

The accompanying notes are an integral part of these consolidated financial statements.

 

7


Table of Contents

Houghton Mifflin Harcourt Company

Consolidated Statements of Stockholders’ Equity (Unaudited)

 

 

 

(in thousands of dollars, except share
information)
   Common Stock     Treasury Stock     Capital
in excess
of Par
Value
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Total  
   Shares
Issued
    Par Value  

Balance at December 31, 2017

     147,911,466     $ 1,479     $ (518,030   $ 4,879,793     $ (3,521,527   $ (46,522   $ 795,193  

Net loss

     —         —         —         —         (101,311     —         (101,311

Other comprehensive income, net of tax

     —         —         —         —         —         3,721       3,721  

Effects of adoption of new revenue accounting standard

     —         —         —         —         52,711       —         52,711  

Issuance of common stock for employee purchase plan

     85,542       1       —         864       —         —         865  

Issuance of common stock for vesting of restricted stock units

     245,572       2       —         (2     —         —         —    

Stock withheld to cover tax withholdings requirements upon vesting of restricted stock units

     —         —         —         (1,073     —         —         (1,073

Restricted stock forfeitures and cancellations

     (268,295     (3     —         3     —         —         —    

Stock-based compensation expense

     —         —         —         2,873       —         —         2,873  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2018

     147,974,285     $ 1,479     $ (518,030   $ 4,882,458     $ (3,570,127   $ (42,801   $ 752,979  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2018

     148,164,854     $ 1,481     $ (518,030   $ 4,893,174     $ (3,562,971   $ (45,184   $ 768,470  

Net loss

     —         —         —         —         (117,362     —         (117,362

Other comprehensive loss, net of tax

     —         —         —         —         —         (1,550     (1,550

Effects of adoption of new lease accounting standard

     —         —         —         —         725       —         725  

Issuance of common stock for employee purchase plan

     78,105       1       —         701       —         —         702  

Issuance of common stock for vesting of restricted stock units

     444,622       5       —         (5     —         —         —    

Stock withheld to cover tax withholdings requirements upon vesting of restricted stock units

     —         —         —         (1,756     —         —         (1,756

Stock-based compensation expense

     —         —         —         3,442       —         —         3,442  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2019

     148,687,581     $ 1,487     $ (518,030   $ 4,895,556     $ (3,679,608   $ (46,734   $ 652,671  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Houghton Mifflin Harcourt Company

Notes to Consolidated Financial Statements (Unaudited)

(amounts in tables are in thousands of dollars, except share and per share information)

 

1.

Basis of Presentation

Houghton Mifflin Harcourt Company (“HMH,” “Houghton Mifflin Harcourt,” “we,” “us,” “our,” or the “Company”) is a global learning company, committed to delivering integrated solutions that engage learners, empower educators and improve student outcomes. As a leading provider of Kindergarten through 12th grade (“K-12”) core curriculum, supplemental and intervention solutions and professional learning services, HMH partners with educators and school districts to uncover solutions that unlock students’ potential and extend teachers’ capabilities. HMH serves more than 50 million students and 3 million educators in 150 countries, while its award-winning children’s books, novels, non-fiction, and reference titles are enjoyed by readers throughout the world.

The K-12 market is our primary market, and in the United States, we are a leading provider of educational content by market share. Some of our core educational offerings include HMH Science Dimensions, Collections, GO Math!, Read 180 Universal, and Journeys. We believe our long-standing reputation and trusted brand enable us to capitalize on trends in the education market through our existing and developing channels.

Furthermore, for nearly two centuries, we have published renowned and awarded adult and children’s, fiction, nonfiction, culinary and reference titles enjoyed by readers throughout the world. Our distinguished author list includes ten Nobel Prize winners, forty-eight Pulitzer Prize winners, and fifteen National Book Award winners. We are home to popular characters and titles such as Curious George, Carmen Sandiego, The Lord of the Rings, The Whole30, The Best American Series, the Peterson Field Guides, CliffsNotes, and The Polar Express, and published distinguished authors such as Philip Roth, Temple Grandin, Tim O’Brien, Amos Oz, Kwame Alexander, Lois Lowry, and Chris Van Allsburg.

We sell our products and services across multiple media and distribution channels. Leveraging our portfolio of content, including some of our best-known children’s brands and titles, such as Carmen Sandiego and Curious George, we have created interactive digital content, mobile applications and educational games that can be used by families at home or on the go.

Our digital products portfolio, combined with our content development or distribution agreements with recognized technology leaders such as Apple, Google, Intel and Microsoft, enable us to bring our next-generation educational solutions and content to learners across virtually all platforms and devices. Additionally, we believe our technology and development capabilities allow us to enhance content engagement and effectiveness with embedded assessment, interactivity and personalized adaptable content as well as increased accessibility.

The consolidated financial statements of HMH include the accounts of all of our wholly-owned subsidiaries for all periods presented.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Certain information and footnote disclosures normally included in our annual financial statements prepared in accordance with GAAP have been condensed or omitted consistent with Article 10 of Regulation S-X. In the opinion of management, our unaudited consolidated financial statements and accompanying notes include all adjustments (consisting of normal recurring adjustments) considered necessary by management to fairly state the results of operations, financial position and cash flows for the interim periods presented. Interim results of operations are not necessarily indicative of the results for the full year or for any future period. These financial statements should be read in conjunction with the annual financial statements and the notes thereto also included in our annual report on Form 10-K for the fiscal year ended December 31, 2018.

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.

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. If necessary, management will take steps intended to improve the Company’s financial position and liquidity.

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 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.

 

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Approximately 85% of our net sales for the year ended December 31, 2018 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, for the years ended December 31, 2018, 2017 and 2016, approximately 67% of our consolidated net sales were realized in the second and third quarters. Sales of K-12 instructional materials and customized testing products are also cyclical, with some years offering more sales opportunities than others in light of the state adoption calendar. The amount of funding available at the state level for educational materials also has a significant effect on year-to-year net sales. Although the loss of a single customer would not have a material adverse effect on our business, schedules of school adoptions and market acceptance of our products can materially affect year-to-year net sales performance.

 

2.

Significant Accounting Policies and Estimates

Our financial results are affected by the selection and application of accounting policies and methods. Except for the adoption of the new lease accounting standard discussed below, there were no material changes during the three months ended March 31, 2019 to the application of significant 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 ended December 31, 2018.

Adoption of New Lease Accounting Standard

On January 1, 2019, we adopted the new lease accounting standard using the modified retrospective method. We applied the guidance to each lease as of January 1, 2019 with a cumulative effect adjustment to the opening balance of accumulated deficit as of that date. The standard requires lessees to recognize a lease liability and a right of use asset on the balance sheet for operating leases. Right of use assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease. Right of use assets and lease liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. Accounting for finance leases is substantially unchanged.

Prior comparative periods were not adjusted under this method. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which allowed us to not reassess whether any expired or existing contracts are or contain leases, carry forward the historical lease classification and to not reassess initial direct costs for any existing leases. We did not elect the hindsight practical expedient to determine the lease term for existing leases. Upon implementation of the new guidance, we have elected the practical expedients to combine lease and non-lease components, and to not recognize right of use assets and lease liabilities for short-term leases.

 

3.

Recent Accounting Standards

Recent accounting pronouncements not included below, are not expected to have a material impact on our consolidated financial position or results of operations.

Recently Issued Accounting Standards

In January 2017, the Financial Accounting Standards Board (“FASB”) issued updated guidance to simplify the test for goodwill impairment by the elimination of Step 2 in the determination on whether goodwill should be considered impaired. The annual assessments are still required to be completed. The guidance will be effective in 2020, with early adoption permitted. We do not expect that the adoption of this guidance will have a material impact on our consolidated financial statements.

Recently Adopted Accounting Standards

In February 2016, the FASB issued guidance that primarily requires lessees to recognize most leases on their balance sheets but record expenses on their income statements in a manner similar to current accounting. We adopted the guidance on January 1, 2019 using the modified retrospective method, and did not adjust comparative periods or modify disclosures in those comparative periods. We recognized right of use assets and lease liabilities on January 1, 2019. The new guidance provides a number of optional practical expedients in transition. We elected the package of practical expedients, which among other things, allowed the carryforward of the historical lease classification. Further, we elected the practical expedients to combine lease and non-lease components, and to not recognize right of use assets and lease liabilities for short-term leases. We have identified appropriate changes to our accounting policies, information technology systems, business processes, and related internal controls to support recognition and disclosure requirements under the new guidance. The adoption of this guidance impacted our consolidated balance sheets due to the recognition of the lease rights and obligations related to our office space, automobile fleet and office equipment leases as assets and liabilities of approximately $148.0 million and $161.0 million, respectively. The adjustment to accumulated deficit of approximately $0.7 million related to a previously recorded deferred gain on the sale leaseback of a warehouse. The impact on our results of operations and cash flows was not material.

In May 2014, the FASB issued new guidance related to revenue recognition. This new accounting standard replaced most current U.S. GAAP guidance on this topic and eliminated most industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that an entity should

 

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recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Entities had the choice of adopting the new standard either retrospectively to all periods presented in the financial statements (the full retrospective method) or as a cumulative-effect adjustment as of the date of adoption (modified retrospective method) in the year of adoption without applying to comparative periods financial statements. We adopted the guidance on January 1, 2018 applying the modified retrospective method.

In March 2017, the FASB issued guidance to improve the presentation of net periodic pension cost and net periodic post-retirement benefit cost. The changes to the guidance required employers to report the service cost component in the same line item as other compensation costs arising from services rendered by employees during the reporting period. The other components of net benefit costs have been presented in the income statement separately from the service cost and outside of a subtotal of income from operations. The guidance became effective January 1, 2018 and the adoption of the guidance did not have a material impact on our consolidated financial statements.

In November 2016, the FASB issued guidance on restricted cash, which required amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. The guidance became effective January 1, 2018 using a retrospective transition method to each period presented. The adoption of the guidance did not have a material impact on our consolidated financial statements.

In August 2016, the FASB issued a guidance update to classifications of certain cash receipts and cash payments on the Statement of Cash Flows with the objective of reducing the existing diversity in practice. This updated guidance addresses the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The guidance became effective January 1, 2018 and the adoption of the guidance did not have a material impact on our consolidated financial statements.

 

4.

Acquisitions

On January 14, 2019, we completed the acquisition of certain assets of PV Waggle LLC, which comprised a web-based adaptive learning solution providing Math and ELA instruction for students in grades 2-8 for a total purchase price of approximately $5.4 million. The transaction was accounted for under the acquisition method of accounting. Goodwill, other intangible assets and other liabilities recorded as part of the acquisition totaled approximately $0.7 million, $5.2 million and $0.5 million, respectively. The other intangible assets represent developed technology and were valued using a replacement cost approach.

 

5.

Discontinued Operations

On October 1, 2018, we completed the previously announced sale of all the assets, including intellectual property, used primarily in our Riverside clinical and standardized testing business (“Riverside Business”) for cash consideration received of $140.0 million and the purchaser’s assumption of all liabilities relating to the Riverside Business subject to specified exceptions. Net proceeds from the sale after the payment of transaction costs were approximately $135.0 million with a post-tax book gain on sale of approximately $30.5 million. The gain was recorded in the fourth quarter of 2018 as the transaction closed on October 1, 2018. The tax gain on the sale was offset by 2018 losses. The results of the Riverside Business were previously reported in our Education segment. In connection with the sale of the Riverside Business, we entered into a Transition Services Agreement (TSA) with the purchaser whereby we will perform certain support functions for a period of up to 18 months subsequent to October 1, 2018.

Upon the signing of the asset purchase agreement on September 12, 2018, the Riverside Business qualified as a discontinued operation, and goodwill originally included in the Education reportable segment was transferred to the Riverside Business. The amount of transferred goodwill was $67.0 million and was determined using the relative fair value method. The relative fair value was determined based on the purchase price of the Riverside Business compared to the Education reportable segment fair value. The Education reportable segment fair value was based primarily on the market value of the overall Company at the date that the Riverside Business qualified as a discontinued operation. The allocation also required the assessment for impairment for each of the Riverside Business and Education reportable segment’s goodwill and indefinite-lived intangible assets carrying values. No impairment was deemed to exist.

 

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Selected financial information of the Riverside Business included in income from discontinued operations is as follows:

 

     Three Months
Ended March 31,
2018
 

Net sales

   $ 20,009  

Costs

     12,503  

Amortization

     1,470  
  

 

 

 

Income from discontinued operations before taxes

   $ 6,036  

Income tax expense

     1,461  
  

 

 

 

Income from discontinued operations, net of tax

   $ 4,575  
  

 

 

 

 

6.

Inventories

Inventories consisted of the following:

 

     March 31,
2019
     December 31,
2018
 

Finished goods

   $ 250,056      $ 162,890  

Raw materials

     11,868        21,319  
  

 

 

    

 

 

 

Inventories

   $ 261,924      $ 184,209  
  

 

 

    

 

 

 

 

7.

Contract Assets, Contract Liabilities and Deferred Commissions

Contract assets consist of unbilled amounts at the reporting date and are transferred to accounts receivable when the rights become unconditional. Contract assets are included in prepaid expenses and other assets on our consolidated balance sheets. Contract liabilities consist of deferred revenue (current and long-term). The following table presents changes in contract assets and contract liabilities during the three months ended March 31, 2019:

 

     March 31, 2019      December 31, 2018      $ Change      % Change  

Contract assets

   $ 298      $ 74      $ 224        NM  

Contract liabilities (deferred revenue)

   $ 607,763      $ 647,444      $ (39,681      (6.1 )% 

NM = not meaningful

The $39.5 million decrease in our net contract liabilities from December 31, 2018 to March 31, 2019 was primarily due to the satisfaction of performance obligations related to physical and digital products during the period and lower net sales being deferred in the period attributed to the seasonal nature of our business.

During the three months ended March 31, 2019 and 2018, we recognized the following net sales as a result of changes in the contract asset and contract liabilities balances:

 

     Three Months Ended
March 31, 2019
     Three Months Ended
March 31, 2018
 

Net sales recognized in the period from:

     

Amounts included in contract liabilities at the beginning of the period

   $ 48,529      $ 47,074  

As of March 31, 2019, the aggregate amount of the transaction price allocated to the remaining performance obligations was $653.5 million, and we will recognize approximately 80% to net sales over the next 1 to 3 years.

Prior to the adoption of the new revenue standard, we expensed incremental commissions paid to sales representatives for obtaining product sales as well as service contracts. We expect that the costs are recoverable, and under the new standard, we capitalize these incremental costs of obtaining customer contracts unless the capitalization and amortization of such costs are not expected to have a material impact on the financial statements. Applying the practical expedient, we recognize sales commission expense when incurred if the amortization period of the assets that we otherwise would have recognized is one year or less. We had deferred commissions in the amount of $21.9 million at March 31, 2019 and amortized $1.3 million and $1.1 million during the three months ended March 31, 2019 and 2018, respectively. The amortization is included in selling and administrative expenses.

 

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8.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets consisted of the following:

 

     March 31, 2019      December 31, 2018  
     Cost      Accumulated
Amortization
    Total      Cost      Accumulated
Amortization
    Total  

Goodwill

   $ 716,845      $ —     $ 716,845      $ 716,073      $ —     $ 716,073  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Trademarks and tradenames: indefinite-lived

   $ 161,000      $ —     $ 161,000      $ 161,000      $ —     $ 161,000  

Trademarks and tradenames: definite-lived

     164,130        (30,804     133,326        164,130        (28,087     136,043  

Publishing rights

     1,180,000        (1,120,474     59,526        1,180,000        (1,112,869     67,131  

Customer related and other

     449,840        (291,729     158,111        444,640        (287,922     156,718  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Other intangible assets, net

   $ 1,954,970        (1,443,007   $ 511,963      $ 1,949,770        (1,428,878   $ 520,892  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The change in the carrying amount of goodwill for the three months ended March 31, 2019 is as follows:

 

Balance at December 31, 2018

   $ 716,073  

Acquisitions

     772  
  

 

 

 

Balance at March 31, 2019

   $ 716,845  
  

 

 

 

Amortization expense for definite-lived trademarks and tradenames, publishing rights and customer related and other intangibles were $14.1 million and $17.0 million for the three months ended March 31, 2019 and 2018, respectively.

 

9.

Debt

Our debt consisted of the following:

 

     March 31,
2019
     December 31,
2018
 

$800,000 term loan due May 29, 2021, interest payable
quarterly (net of discount and issuance costs)

   $ 762,513      $ 763,649  

Less: Current portion of long-term debt

     8,000        8,000  
  

 

 

    

 

 

 

Total long-term debt, net of discount and issuance costs

   $ 754,513      $ 755,649  
  

 

 

    

 

 

 

Revolving credit facility

   $ —      $ —  
  

 

 

    

 

 

 

Term Loan Facility

On May 29, 2015, we entered into an amended and restated $800.0 million term loan credit facility (the “term loan facility”). The term loan facility matures on May 29, 2021 and the interest rate is based on LIBOR plus 3.0% or an alternative base rate plus applicable margins. LIBOR is subject to a floor of 1.0% with the length of the LIBOR contracts ranging up to six months at the option of the Company.

The term loan facility is required to be repaid in quarterly installments of $2.0 million, and may be prepaid, in whole or in part, at any time, without premium.

The term loan facility was issued at a discount equal to 0.5% of the outstanding borrowing commitment. As of March 31, 2019, the interest rate of the term loan facility was 5.5%.

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 is subject to 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 annual excess cash flow provision under our term loan facility which is predicated upon our leverage ratio and cash flow. There was no payment required under the excess cash flow provision in 2019 and 2018.

Interest Rate Hedging

On August 17, 2015, we entered into interest rate derivative contracts with various financial institutions having an aggregate notional amount of $400.0 million to convert floating rate debt into fixed rate debt and had $400.0 million outstanding as of March 31, 2019.

 

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We assessed at inception, and re-assess on an ongoing basis, whether the interest rate derivative contracts are highly effective in offsetting changes in the fair value of the hedged variable rate debt.

These interest rate swaps were designated as cash flow hedges and qualify for hedge accounting under the accounting guidance related to derivatives and hedging. Accordingly, we recorded an unrealized loss of $1.3 million and an unrealized gain of $3.5 million in our statements of comprehensive loss to account for the changes in fair value of these derivatives during the three months ended March 31, 2019 and 2018, respectively. The corresponding $1.1 million and $2.4 million hedge assets are included within long-term other assets in our consolidated balance sheet as of March 31, 2019 and December 31, 2018, respectively. The interest rate derivative contracts mature on July 22, 2020.

Revolving Credit Facility

On July 22, 2015, we entered into an amended and restated revolving credit facility (the “revolving credit facility”). The revolving credit facility 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’ (as such terms are defined below) eligible inventory and receivables. 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 revolving credit facility may be prepaid, in whole or in part, at any time, without premium.

The revolving credit facility requires the Company to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 on a trailing four-quarter basis only during certain periods commencing when excess availability under the revolving credit facility is less than certain limits prescribed by the terms of the revolving credit facility. 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. As of March 31, 2019, no amounts are outstanding on the revolving credit facility.

As of March 31, 2019, the minimum fixed charge coverage ratio covenant under our revolving credit facility was not applicable, due to our level of borrowing availability. The minimum fixed charge coverage ratio, which is only tested in limited situations, is 1.0 to 1.0 through the end of the facility.

Guarantees

Under both the revolving credit facility and the term loan facility, Houghton Mifflin Harcourt Publishers Inc., HMH Publishers LLC and Houghton Mifflin Harcourt Publishing Company are the borrowers (collectively, the “Borrowers”), and Citibank, N.A. acts as both the administrative agent and the collateral agent.

The obligations under the revolving credit facility and the term loan 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.

 

10.

Leases

We lease property and equipment under finance and operating leases. We have operating leases for various office space and facilities, warehouse equipment, automobile fleet and office equipment that expire at various dates through 2023 and thereafter. For leases with terms greater than 12 months, we record the related asset and obligation at the present value of lease payments over the lease term. Many of our leases include rental escalation clauses, renewal options and/or termination options that are factored into our determination of lease payments when appropriate. For leases beginning in 2019 and later, we account for lease components (e.g., fixed payments including rent, real estate taxes and insurance costs) as combined with the non-lease components (e.g., common-area maintenance costs). Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. We sublease certain real estate office space to third parties. Our sublease portfolio consists of operating leases.

When available, we use the rate implicit in the lease to discount lease payments to present value; however, most of our leases do not provide a readily determinable implicit rate. Therefore, we must estimate our incremental borrowing rate to discount the lease payments based on information available at lease commencement. We give consideration to our recent debt issuances as well as publicly available data for instruments with similar characteristics when calculating our incremental borrowing rates.

 

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Lease Position as of March 31, 2019

The table below presents the lease assets and liabilities recorded on the balance sheet.

 

Leases

  

Classification

   March 31, 2019  

Assets

     

Operating lease assets

   Operating lease assets    $ 144,695  
     

 

 

 

Total leased assets

      $ 144,695  

Liabilities

     

Current

     

Operating

   Operating lease liabilities    $ 14,326  

Noncurrent

     

Operating

   Operating lease liabilities      142,441  
     

 

 

 

Total lease liabilities

      $ 156,767  

Weighted average remaining lease term

     

Operating leases

        9.4 Years  

Weighted average discount rate

     

Operating leases (1)

        12.23

 

(1)

Upon adoption of the new lease standard, discount rates used for existing leases were established at January 1, 2019.

Lease costs

Operating lease cost and sublease income totaled $9.6 million and $0.7 million, respectively, for the three months ended March 31, 2019. The net lease cost of $8.9 million is included in the selling and administrative line item in our consolidated statements of operations. Operating lease cost includes short term leases and variable lease costs, which are not material.

Undiscounted Cash Flows

The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the operating lease liabilities recorded on the balance sheet.

 

Maturity of Lease Liabilities    Operating
Leases
 

2019

   $ 24,801  

2020

     26,916  

2021

     25,710  

2022

     23,304  

2023

     25,226  

Thereafter

     161,774  
  

 

 

 

Total lease payments

   $ 287,731  

Less: interest

     130,964  
  

 

 

 

Present value of lease liabilities

   $ 156,767  
  

 

 

 

Other Information

The table below presents supplemental cash flow information related to leases during the three months ended March 31, 2019.

 

Cash paid for amounts included in the measurement of lease liabilities

  

Operating cash flows for operating leases

   $ 9,025  

Additional Lease Information Related to the Application of the Previous Lease Accounting Standard

As previously disclosed in our 2018 Annual Report on Form 10-K and under the previous lease accounting standard, the future payments under operating lease agreements as of December 31, 2018 are as follows:

 

    

Operating

Leases

 

2019

   $ 32,694  

2020

     26,889  

2021

     26,118  

2022

     24,549  

2023

     27,469  

Thereafter

     171,203  
  

 

 

 

Total lease payments

   $ 308,922  
  

 

 

 

 

11.

Restructuring, Severance and Other Charges

2017 Restructuring Plan

On an ongoing basis, we assess opportunities for improved operational effectiveness and efficiency and better alignment of expenses with net sales, while preserving our ability to make the investments in content and our people that we believe are important to our long-term success. As a result of these assessments, we undertook a restructuring initiative in order to enhance our growth potential and better position us for long-term success. This initiative is described below.

 

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Beginning at the end of 2016, we worked with a third party consultant to review our operating model and organizational design in order to improve our operational efficiency, better focus on the needs of our customers and right-size our cost structure to create long-term shareholder value.

In March 2017, we committed to certain operational efficiency and cost-reduction actions in order to accomplish these objectives (“2017 Restructuring Plan”). These actions included making organizational design changes across layers of the Company below the executive team and other right-sizing initiatives expected to result in reductions in force, consolidating and/or subletting certain office space under real estate leases as well as other potential operational efficiency and cost-reduction initiatives. We completed the organizational design change actions in 2017 and the remaining actions in 2018.

Our restructuring liabilities are primarily comprised of accruals for severance and termination benefits and office space consolidation ($0.4 million and $6.4 million, respectively, as of December 31, 2018).

In connection with the adoption of the new leasing standard on January 1, 2019, the restructuring liabilities related to office space consolidation were reclassed on the balance sheet as a reduction of operating lease assets.

Severance and Other Charges

2019

Exclusive of the 2017 Restructuring Plan, during the three months ended March 31, 2019, $1.0 million of severance payments were made to employees whose employment ended in 2019 and prior years. Further, we recorded an expense in the amount of $1.2 million to reflect costs for severance, which we expect to be paid over the next twelve months.

2018

Exclusive of the 2017 Restructuring Plan, during the three months ended March 31, 2018, $0.8 million of severance payments were made to employees whose employment ended in 2018 and prior years and $0.2 million of net payments were made for office space no longer utilized by the Company as a result of prior savings initiatives. Further, we recorded an expense in the amount of $3.9 million to reflect costs for severance, which have been fully paid.

A summary of the significant components of the severance/restructuring and other charges, which are not allocated to our segments and included in Corporate and Other, is as follows:

 

     2019  
     Severance/
other
accruals at
December 31, 2018
    Severance/
other
expense
     Cash payments      Severance/
other
accruals at
March 31,
2019
 

Severance costs

   $ 1,420     $ 1,221      $ (1,044    $ 1,597  

Other accruals

     270 (1)      —          —          —    
  

 

 

   

 

 

    

 

 

    

 

 

 
   $ 1,690     $ 1,221      $ (1,044    $ 1,597  
  

 

 

   

 

 

    

 

 

    

 

 

 

 

     2018  
     Severance/
other
accruals at
December 31, 2017
     Severance/
other
expense
     Cash payments      Severance/
other
accruals at
March 31,
2018
 

Severance costs

   $ 341      $ 3,943      $ (794    $ 3,490  

Other accruals

     1,299        —          (173      1,126  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,640      $ 3,943      $ (967    $ 4,616  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

In connection with the adoption of the new leasing standard on January 1, 2019, the restructuring liabilities related to office space consolidation were reclassed on the balance sheet as a reduction of operating lease assets.

The current portion of the severance and other charges was $1.7 million and $6.9 million (inclusive of the 2017 Restructuring Plan) as of March 31, 2019 and December 31, 2018, respectively.

 

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12.

Income Taxes

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment, including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in various jurisdictions, permanent and temporary differences and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, more experience is acquired, additional information is obtained or as the tax environment changes.

At the end of each interim period, we estimate the annual effective tax rate and apply that rate to our ordinary quarterly earnings. The amount of interim tax benefit recorded for the year-to-date ordinary loss is limited to the amount that is expected to be realized during the year or recognizable as a deferred tax asset at year end. The tax expense or benefit related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect, are individually computed, and are recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.

For the three months ended March 31, 2019 and 2018, we recorded income tax expense of approximately $6.5 million and $3.2 million, respectively. For all periods, the income tax expense was impacted by certain discrete tax items, including the accrual of potential interest and penalties on uncertain tax positions. Including the tax effects of these discrete tax items, the effective rate was (5.8)% and (3.2)% for the three months ended March 31, 2019 and 2018, respectively.

Reserves for unrecognized tax benefits, excluding accrued interest and penalties, were $15.7 million at both March 31, 2019 and December 31, 2018.

 

13.

Retirement and Postretirement Benefit Plans

We have a noncontributory, qualified defined benefit pension plan (the “Retirement Plan”), which covers certain employees. The Retirement Plan is a cash balance plan, which accrues benefits based on pay, length of service, and interest. The funding policy is to contribute amounts subject to minimum funding standards set forth by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. The Retirement Plan’s assets consist principally of common stocks, fixed income securities, investments in registered investment companies, and cash and cash equivalents. We also have a nonqualified defined benefit plan, or nonqualified plan, that previously covered employees who earned over the qualified pay limit as determined by the Internal Revenue Service. The nonqualified plan accrues benefits for the participants based on the cash balance plan calculation. The nonqualified plan is not funded. We use a December 31 date to measure the pension and postretirement liabilities. In 2007, both the qualified and nonqualified pension plans eliminated participation in the plans for new employees hired after October 31, 2007.

We recognize the funded status of defined benefit pension and other postretirement plans as an asset or liability in the balance sheet and recognize actuarial gains and losses and prior service costs and credits in other comprehensive income (loss) and subsequently amortize those items in the statement of operations.

Net periodic benefit (credit) cost for our pension and other postretirement benefit plans consisted of the following:

 

     Pension Plans  
     Three Months Ended
March 31,
 
     2019      2018  

Interest cost

   $ 1,511      $ 1,325  

Expected return on plan assets

     (1,918      (1,995

Amortization of net loss

     251        354  
  

 

 

    

 

 

 

Net periodic benefit (credit) cost

   $ (156    $ (316
  

 

 

    

 

 

 

 

     Other Post Retirement Plans  
     Three Months Ended
March 31,
 
     2019      2018  

Service cost

   $ 15      $ 32  

Interest cost

     145        168  

Amortization of prior service cost

     10        (172

Amortization of net loss

     (41      —    
  

 

 

    

 

 

 

Net periodic benefit cost (credit)

   $ 129      $ 28  
  

 

 

    

 

 

 

There were no contributions to the pension plans for the three months ended March 31, 2019 and 2018, and we do not expect to make a contribution to the pension plans during 2019.

 

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14.

Fair Value Measurements

The accounting standard for fair value measurements, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. The accounting standard establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

 

  Level 1

Observable input such as quoted prices in active markets for identical assets or liabilities;

 

  Level 2

Observable inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

 

  Level 3

Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Assets and liabilities measured at fair value are based on one or more of three valuation techniques identified in the tables below. Where more than one technique is noted, individual assets or liabilities were valued using one or more of the noted techniques. The valuation techniques are as follows:

 

  (a) 

Market approach: Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities;

 

  (b) 

Cost approach: Amount that would be currently required to replace the service capacity of an asset (current replacement cost); and

 

  (c) 

Income approach: Valuation techniques to convert future amounts to a single present amount based on market expectations (including present value techniques).

On a recurring basis, we measure certain financial assets and liabilities at fair value, including our money market funds, short-term investments which consist of U.S. treasury securities and U.S. agency securities, foreign exchange forward contracts, and interest rate derivatives contracts. The accounting standard for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as consider counterparty and its credit risk in its assessment of fair value.

Financial Assets and Liabilities

The following tables present our financial assets and liabilities measured at fair value on a recurring basis:

 

     March 31, 2019      Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Valuation
Technique
 

Financial assets

           

Money market funds

   $ 51,094      $ 51,094      $ —        (a

U.S. agency securities

     9,999        —          9,999        (a

Interest rate derivatives

     1,071        —          1,071        (a
  

 

 

    

 

 

    

 

 

    
   $ 62,164      $ 51,094      $ 11,070     
  

 

 

    

 

 

    

 

 

    

Financial liabilities

           

Foreign exchange derivatives

   $ 602      $ —      $ 602        (a
  

 

 

    

 

 

    

 

 

    
   $ 602      $ —      $ 602        (a
  

 

 

    

 

 

    

 

 

    

 

     December 31,
2018
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Valuation
Technique
 

Financial assets

           

Money market funds

   $ 228,587      $ 228,587      $ —        (a

U.S. treasury securities

     24,939        24,939        —          (a

U.S. agency securities

     24,894        —          24,894        (a

Interest rate derivatives

     2,382        —          2,382        (a
  

 

 

    

 

 

    

 

 

    
   $ 280,802      $ 253,526      $ 27,276     
  

 

 

    

 

 

    

 

 

    

Financial liabilities

           

Foreign exchange derivatives

   $ 534      $ —      $ 534        (a
  

 

 

    

 

 

    

 

 

    
   $ 534      $ —      $ 534     
  

 

 

    

 

 

    

 

 

    

 

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Our money market funds and U.S. treasury securities are classified within Level 1 of the fair value hierarchy because they are valued using quoted prices in active markets for identical instruments. Our U.S. agency securities are classified within Level 2 of the fair value hierarchy because they are valued using other than quoted prices in active markets. In addition to $51.1 million and $228.6 million invested in money market funds as of March 31, 2019 and December 31, 2018, respectively, we had $23.1 million and $24.8 million of cash invested in bank accounts as of March 31, 2019 and December 31, 2018, respectively.

Our foreign exchange derivatives consist of forward contracts and are classified within Level 2 of the fair value hierarchy because they are valued based on observable inputs and are available for substantially the full term of our derivative instruments. We use foreign exchange forward contracts to fix the functional currency value of forecasted commitments, payments and receipts. The aggregate notional amount of the outstanding foreign exchange forward contracts was $15.2 million and $15.7 million at March 31, 2019 and December 31, 2018, respectively. Our foreign exchange forward contracts contain netting provisions to mitigate credit risk in the event of counterparty default, including payment default and cross default. At March 31, 2019 and December 31, 2018, the fair value of our counterparty default exposure was less than $1.0 million and spread across several highly rated counterparties.

Our interest rate derivatives are classified within Level 2 of the fair value hierarchy because they are valued based on observable inputs and are available for substantially the full term of our derivative instruments. Our interest rate risk relates primarily to U.S. dollar borrowings, partially offset by U.S. dollar cash investments. We have historically used interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates by converting floating-rate debt into fixed-rate debt. The aggregate notional amount of the outstanding interest rate derivative instruments was $400.0 million as of March 31, 2019. We designate these derivative instruments either as fair value or cash flow hedges under the accounting guidance related to derivatives and hedging. We record changes in the value of fair value hedges in interest expense, which is generally offset by changes in the fair value of the hedged debt obligation. Interest payments made or received related to our interest rate derivative instruments are included in interest expense. We record the effective portion of any change in the fair value of derivative instruments designated as cash flow hedges as unrealized gains or losses in other comprehensive income (loss), net of tax, until the hedged cash flow occurs, at which point the effective portion of any gain or loss is reclassified to earnings. In the event the hedged cash flow does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash flow hedge to interest expense at that time.

We believe we do not have significant concentrations of credit risk arising from our interest rate derivative instruments, whether from an individual counterparty or a related group of counterparties. We manage the concentration of counterparty credit risk on our interest rate derivatives instruments by limiting acceptable counterparties to a diversified group of major financial institutions with investment grade credit ratings, limiting the amount of credit exposure to each counterparty, and actively monitoring their credit ratings and outstanding fair values on an ongoing basis. Furthermore, none of our derivative transactions contain provisions that are dependent on our credit ratings from any credit rating agency.

We also employ master netting arrangements that reduce our counterparty payment settlement risk on any given maturity date to the net amount of any receipts or payments due between us and the counterparty financial institution. Thus, the maximum loss due to counterparty credit risk is limited to the unrealized gains in such contracts net of any unrealized losses should any of these counterparties fail to perform as contracted. Although these protections do not eliminate concentrations of credit risk, as a result of the above considerations, we do not consider the risk of counterparty default to be significant.

Non-Financial Assets and Liabilities

Our non-financial assets, which include goodwill, other intangible assets, property, plant, and equipment, and pre-publication costs, are not required to be measured at fair value on a recurring basis. However, if certain trigger events occur, or if an annual impairment test is required, we evaluate the non-financial assets for impairment. If an impairment did occur, the asset is required to be recorded at the estimated fair value. An impairment analysis was not performed for the preparation of this report, as there were no triggering events for the three months ended March 31, 2019. There were no non-financial liabilities that were required to be measured at fair value on a nonrecurring basis during the three months ended March 31, 2019 and 2018.

Fair Value of Debt

The following table presents the carrying amounts and estimated fair market values of our debt at March 31, 2019 and December 31, 2018. The fair value of debt is deemed to be the amount at which the instrument could be exchanged in an orderly transaction between market participants at the measurement date.

 

     March 31, 2019      December 31, 2018  
     Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Debt

           

Term Loan

   $ 762,513      $ 722,481      $ 763,649      $ 691,102  

 

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The fair market values of our debt were estimated based on quoted market prices on a private exchange for those instruments that are traded and are classified as Level 2 within the fair value hierarchy at March 31, 2019 and December 31, 2018. The fair market values require varying degrees of management judgment. The factors used to estimate these values may not be valid on any subsequent date. Accordingly, the fair market values of the debt presented may not be indicative of their future values.

 

15.

Commitments and Contingencies

There were no material changes in our commitments under contractual obligations, as disclosed in our audited consolidated financial statements, which were included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

While we may incur a loss associated with certain pending or threatened litigation, we are not able to estimate such amount, if any, but we do not expect any of these matters to have a material adverse effect on our results of operations, financial position or cash flows. We have insurance over such amounts and with coverage and deductibles as management believes is reasonable. There can be no assurance that our liability insurance will cover all events or that the limits of coverage will be sufficient to fully cover all liabilities.

In April 2019, we were notified of an unasserted claim by the Commonwealth of Puerto Rico with regards to payments in the amount of approximately $33.0 million that we received in the normal course of business in the four year period prior to the May 3, 2017 bankruptcy petition of the Commonwealth public instrumentalities. Management believes, based on discussions with its legal counsel, that we have meritorious defenses against such unasserted claim. The Company will vigorously defend this matter if such claim is asserted.

In connection with an agreement with a development content provider, we agreed to act as guarantor to that party’s loan to finance such development. Such guarantee is expected to remain until 2020. Under the guarantee, we believe the maximum future payments to approximate $15.0 million. In the unlikely event that we are required to make payments on behalf of the development content provider, we would have recourse against the development content provider.

We were contingently liable for $4.4 million of performance-related surety bonds for our operating activities as of both March 31, 2019 and December 31, 2018. An aggregate of $24.3 million of letters of credit existed as of both March 31, 2019 and December 31, 2018, of which $0.1 million backed the aforementioned performance-related surety bonds as of both March 31, 2019 and December 31, 2018.

We routinely enter into standard indemnification provisions as part of license agreements involving use of our intellectual property. These provisions typically require us to indemnify and hold harmless licensees in connection with any infringement claim by a third party relating to the intellectual property covered by the license agreement. Although the term of these provisions and the maximum potential amounts of future payments we could be required to make is not limited, we have never incurred any costs to defend or settle claims related to these types of indemnification provisions. We therefore believe the estimated fair value of these provisions is inconsequential, and have no liabilities recorded for them as of March 31, 2019 or December 31, 2018.

 

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16.

Net Loss Per Share

The following table sets forth the computation of basic and diluted earnings per share (“EPS”):

 

     Three Months Ended
March 31,
 
     2019      2018  

Numerator

     

Loss from continuing operations

   $ (117,362    $ (105,886

Income from discontinued operations, net of tax

     —          4,575  
  

 

 

    

 

 

 

Net loss attributable to common stockholders

   $ (117,362    $ (101,311
  

 

 

    

 

 

 

Denominator

     

Weighted average shares outstanding

     

Basic

     123,798,641        123,222,353  

Diluted

     123,798,641        123,222,353  

Net loss per share attributable to common stockholders

     

Basic and diluted:

     

Continuing operations

   $ (0.95    $ (0.86

Discontinued operations

     —          0.04  
  

 

 

    

 

 

 

Net loss

   $ (0.95    $ (0.82

As we incurred a net loss in the three month periods ended March 31, 2019 and 2018, presented above, all outstanding stock options and restricted stock units for those periods have an anti-dilutive effect and therefore are excluded from the computation of diluted weighted average shares outstanding. Accordingly, basic and diluted weighted average shares outstanding are equal for such periods.

The following table summarizes our weighted average outstanding common stock equivalents that were anti-dilutive attributable to common stockholders during the periods, and therefore excluded from the computation of diluted EPS:

 

     Three Months Ended
March 31,
 
     2019      2018  

Stock options

     3,488,212        3,465,749  

Restricted stock units

     2,993,508        2,128,620  

 

17.

Segment Reporting

As of March 31, 2019, we had two reportable segments, Education and HMH Books & Media (formerly referred to as Trade Publishing, the composition of this segment has not changed). Our Education segment provides educational products, technology platforms and services to meet the diverse needs of today’s classrooms. These products and services include print and digital content in the form of textbooks, digital courseware, instructional aids, educational assessment and intervention solutions, which are aimed at improving achievement and supporting learning for students who are not keeping pace with peers, professional development and school reform services. Our HMH Books & Media segment primarily develops, markets and sells consumer books in print and digital formats, licenses book rights to other publishers and electronic businesses in the United States and abroad, and licenses brands across media platforms. The principal distribution channels for HMH Books & Media products are retail stores, both physical and online, and wholesalers.

We measure and evaluate our reportable segments based on net sales and segment Adjusted EBITDA from continuing operations. We exclude from our segments certain corporate-related expenses, as our corporate functions do not meet the definition of a segment, as defined in the accounting guidance relating to segment reporting. In addition, certain transactions or adjustments that our Chief Operating Decision Maker considers to be non-operational, such as amounts related to goodwill and other intangible asset impairment charges, derivative instruments charges, acquisition/disposition-related activity, restructuring/integration costs, severance, separation costs and facility closures, equity compensation charges, legal settlement charges, gains or losses from divestitures, amortization and depreciation expenses, as well as interest and taxes, are excluded from segment Adjusted EBITDA from continuing operations. Although we exclude these amounts from segment Adjusted EBITDA from continuing operations, they are included in reported consolidated net loss and are included in the reconciliation below.

As a result of the sale of the Riverside Business, the results of the Riverside Business are no longer presented within continuing operations. Accordingly, the segment disclosures for the Education reportable segment has been recast for all periods to exclude the results of the Riverside Business. These changes had no impact on the previously reported financial results for the HMH Books & Media reportable segment.

 

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Table of Contents
     Three Months Ended
March 31,
 
(in thousands)    Education      HMH
Books &
Media
     Corporate/
Other
 

2019

        

Net sales

   $ 153,844      $ 40,791      $ —  

Segment Adjusted EBITDA

     (20,965      4,169        (9,710

2018

        

Net sales

   $ 163,023      $ 36,736      $ —  

Segment Adjusted EBITDA

     (11,702      (837      (11,122

The following table disaggregates our net sales by major source:

 

     Three Months Ended
March 31, 2019
 
(in thousands)    Education      HMH
Books &
Media
     Consolidated  

Core solutions (1)

   $ 51,994      $ —      $ 51,994  

Extensions (2)

     101,850        —          101,850  

HMH Books & Media products

     —          40,791        40,791  
  

 

 

    

 

 

    

 

 

 

Net sales

   $ 153,844      $ 40,791      $ 194,635  
  

 

 

    

 

 

    

 

 

 

 

     Three Months Ended
March 31, 2018
 
(in thousands)    Education      HMH
Books &
Media
     Consolidated  

Core solutions (1)

   $ 61,230      $ —      $ 61,230  

Extensions (2)

     101,793        —          101,793  

HMH Books & Media products

     —          36,736        36,736  
  

 

 

    

 

 

    

 

 

 

Net sales

   $ 163,023      $ 36,736      $ 199,759  
  

 

 

    

 

 

    

 

 

 

 

(1)

Comprehensive solutions primarily for reading, math, science and social studies programs.

(2)

Primarily consists of our Heinemann brand, intervention, supplemental, and formative assessment products as well as professional services.

 

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Reconciliation of Adjusted EBITDA to the consolidated statements of operations is as follows:

 

     Three Months Ended March 31,  
(in thousands)    2019      2018  

Total Adjusted EBITDA

   $ (26,506    $ (23,661

Interest expense

     (11,582      (10,936

Interest income

     1,092        506  

Depreciation expense

     (16,179      (18,445

Amortization expense – film asset

     (5,012      —    

Amortization expense

     (47,211      (42,577

Non-cash charges – stock-compensation

     (3,551      (2,893

Non-cash charges – (loss) gain on derivative
instruments

     (450      372  

Fees, expenses or charges for equity offerings, debt or acquisitions/dispositions

     (287      (182

Severance, separation costs and facility closures

     (1,221      (3,943

Loss on sale of assets

     —          (884
  

 

 

    

 

 

 

Loss before taxes

     (110,907      (102,643

Provision for income taxes

     6,455        3,243  
  

 

 

    

 

 

 

Loss from continuing operations

   $ (117,362    $ (105,886
  

 

 

    

 

 

 

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 year ended December 31, 2018, which was filed with the Securities Exchange Commission (the “SEC”) on February 28, 2019. 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 global learning company, committed to delivering integrated solutions that engage learners, empower educators and improve student outcomes. We serve over 50 million students and three million teachers in more than 150 countries worldwide. In the United States, we are a leading provider of K-12 educational content by market share. We believe our long-standing reputation and trusted brand enable us to capitalize on consumer and digital trends in the education market through our existing and developing channels. Furthermore, our trade and reference materials, including adult and children’s fiction and non-fiction books, have won industry awards such as the Pulitzer Prize, Newbery and Caldecott medals and National Book Award.

Recent Developments

Sale of Clinical and Standardized Testing Business and Discontinued Operations

On October 1, 2018, we completed the previously announced sale of all the assets, including intellectual property, used primarily in our Riverside clinical and standardized testing business (“Riverside Business”) for cash consideration received of $140.0 million, subject to final working capital adjustment, and the purchaser’s assumption of all liabilities relating to the Riverside Business subject to specified exceptions. Net proceeds from the sale after the payment of transaction costs were approximately $135.0 million with a post-tax book gain on sale of approximately $30.5 million.

The sale of the Riverside Business is considered a Discontinued Operation due to its relative size and strategic rationale, and accordingly, all results of the Riverside Business have been removed from continuing operations for all periods presented, including from discussions of total net sales and other results of operations. The results of the Riverside Business were previously reported in our Education segment.

Key Aspects and Trends of Our Operations

Business Segments

We are organized along two business segments: Education and HMH Books & Media (formerly referred to as Trade Publishing). Our Education segment is our largest segment and represented approximately 85%, 86% and 87% of our total net sales for the years ended December 31, 2018, 2017 and 2016, respectively. Our HMH Books & Media segment represented approximately 15%, 14% and 13% of our total net sales for the years ended December 31, 2018, 2017 and 2016, 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.

Net Sales

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 in the 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.

 

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Core curriculum programs, which typically 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 throughout the United States. Currently, nineteen 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 territories. 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 48% of the U.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 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 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 the U.S. curriculum, which are located primarily in Asia, the Pacific, the Middle East, Latin America, the Caribbean and Africa. Our international sales team utilizes a global network of distributors in local markets around the world.

Our HMH Books & Media segment sells works of fiction and non-fiction in the General Interest and Young Reader’s categories, dictionaries and other reference works. While print remains the primary format in which trade books are produced and distributed, the market for trade titles in digital format, primarily ebooks, generally represents approximately 8% to 10% of our annual HMH Books & Media net sales. Further, HMH Books & Media licenses content to other publishers along with media companies.

Factors affecting our net sales include:

Education

 

   

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 U.S. economy and consumer confidence;

 

   

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.

 

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State or district per-student funding levels, which closely correlate with state and local receipts from income, sales and property taxes, impact our sales as institutional customers are affected by funding cycles. Most public school districts, the primary customers for K-12 products and services, are largely dependent on state and local funding to purchase materials.

We monitor the purchasing cycles for specific disciplines in the adoption states in order to manage our product development and to plan sales campaigns. Our sales may be materially impacted during the years that major adoption states, such as Florida, California and Texas, are or are not scheduled to make significant purchases. For example, Florida adopted Science materials in 2017 for purchase in 2018. Texas adopted Reading/English Language Arts materials in 2018 for purchase in 2019. California adopted history and social science materials in 2017 for purchase in 2018 and continuing through 2020 and adopted Science materials in 2018 for purchase in 2019 and continuing through 2021. Both Florida and Texas, along with several other adoption states, provide dedicated state funding for instructional materials and classroom technology, with funding typically appropriated by the legislature in the first half of the year in which materials are to be purchased. Texas has a two-year budget cycle, and in the 2018 legislative session appropriated funds for purchases in 2018 and 2019. California funds instructional materials in part with a dedicated portion of state lottery proceeds and in part out of general formula funds, with the minimum overall level of school funding determined according to the Proposition 98 funding guarantee. We do not currently have contracts with these states for future instructional materials adoptions and there is no guarantee that our programs will be accepted by the state.

Long-term growth in the U.S. K-12 market is positively correlated with student enrollments, which is a driver of growth in the educational publishing industry. Although economic cycles may affect short-term buying patterns, school enrollments are highly predictable and are expected to trend upward over the longer term. From 2015 to 2027, total public school enrollment, a major long-term driver of growth in the K-12 Education market, is projected to increase by 3% to 52.1 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 HMH Books & Media segment is heavily influenced by the U.S. and broader global economy, consumer confidence and consumer spending. As the economy continues to recover, both consumer confidence and consumer spending have increased.

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 the HMH 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 the past years, a number of our backlist titles such as The Hobbit, The Lord of the Rings, Life of Pi, The Handmaid’s Tale, The Polar Express, The Giver and The Time Traveler’s Wife have benefited in popularity due to movie or series releases and have subsequently resulted in increased trade sales.

We employ several pricing models to serve various customer segments, including institutions, government agencies, consumers and other third parties. In addition to traditional pricing models where a customer receives a product in return for a payment at the time of product receipt, we currently use the following pricing models:

 

   

Pay-up-front: Customer makes a fixed payment at time of purchase and we provide a specific product/service in return;

 

   

Pre-pay Subscription: Customer makes a one-time payment at time of purchase, but receives a stream of goods/services over a defined time horizon; for example, we currently provide customers the option to purchase a multi-year subscription to textbooks where for a one-time charge, a new copy of the work text is delivered to the customer each year for a defined time period. Pre-pay subscriptions to online textbooks are another example where the customer receives access to an online book for a specific period of time; and

 

   

Pay-as-you-go Subscription: Similar to the pre-pay subscription, except that the customer makes periodic payments in a pre-described manner.

Cost of sales, excluding publishing rights and pre-publication amortization

Cost of sales, excluding publishing rights and pre-publication amortization, include expenses directly attributable to the production of our products and services, including the non-capitalizable costs associated with our content and platform development group. The expenses within cost of sales include variable costs such as paper, printing and binding costs of our print materials, royalty expenses paid to our authors, gratis costs or products provided at no charge as part of the sales transaction, and inventory obsolescence. Also included in cost of sales are labor costs related to professional services and the non-capitalized costs associated with our content and platform development group. We also include amortization expense associated with our customer-facing software platforms. Certain products such as trade books and products associated with our renowned authors carry higher royalty costs; conversely, digital offerings usually have a lower cost of sales due to lower costs associated with their production. Also, sales to adoption states usually contain higher cost of sales. A change in the sales mix of our products or services can impact consolidated profitability.

 

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Publishing rights and Pre-publication amortization

A publishing right is an acquired right that allows us to publish and republish existing and future works as well as create new works based on previously published materials. As part of our March 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 our HMH Books & Media segment’s consumer books, for which we generally expense such costs as incurred and the acquired content of our 2015 acquisition, 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 $3.8 million for the three months ended March 31, 2019) 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 three months ended March 31, 2019 was $6.5 million.

Interest expense

Our interest expense includes interest accrued on our term loan facility along with, to a lesser extent, our revolving credit facility, capital 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 ended March 31, 2019 was $11.6 million.

 

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Results of Operations

Consolidated Operating Results for the Three Months Ended March 31, 2019 and 2018

 

(dollars in thousands)    For the Three
Months Ended
March 31,
2019
     For the Three
Months Ended
March 31,
2018
     Dollar
Change
     Percent
Change
 

Net sales

   $ 194,635      $ 199,759      $ (5,124      (2.6 )% 

Costs and expenses:

           

Cost of sales, excluding publishing rights and pre-publication amortization

     96,055        99,733        (3,678      (3.7 )% 

Publishing rights amortization

     7,605        10,090        (2,485      (24.6 )% 

Pre-publication amortization

     33,082        25,621        7,461        29.1
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of sales

     136,742        135,444        1,298        1.0

Selling and administrative

     151,983        145,527        6,456        4.4

Other intangible assets amortization

     6,524        6,866        (342      (5.0 )% 

Severance and other charges

     1,221        3,943        (2,722      (69.0 )% 

Loss on sale of assets

     —          884        (884      NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating loss

     (101,835      (92,905      (8,930      (9.6 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Other income (expense):

           

Retirement benefits non-service income

     42        320        (278      (86.9 )% 

Interest expense

     (11,582      (10,936      (646      (5.9 )% 

Interest income

     1,092        506        586        NM  

Change in fair value of derivative instruments

     (450      372        (822      NM  

Income from transition services agreement

     1,826        —          1,826        NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Loss from continuing operations before taxes

     (110,907      (102,643      (8,264      (8.1 )% 

Income tax expense

     6,455        3,243        3,212        99.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Loss from continuing operations

   $ (117,362    $ (105,886    $ (11,476      (10.8 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from discontinued operations, net tax

     —          4,575        (4,575      NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss

   $ (117,362    $ (101,311    $ (16,051      (15.8 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

NM = not meaningful

Net sales for the three months ended March 31, 2019 decreased $5.1 million, or 2.6%, from $199.8 million for the same period in 2018 to $194.6 million. The net sales decrease was driven by a $9.2 million decrease in our Education segment offset by a $4.1 million increase in our HMH Books & Media segment. Within our Education segment, the decrease was primarily due to lower net sales from Core Solutions, which declined by $9.0 million from $61.0 million in 2018 to $52.0 million. The primary drivers of the decrease in Core Solutions sales were decreases in residual net sales and net sales relating to disciplines reaching the end of their product lifecycle as customers await new product offerings later this year. Further, a large international reseller order which was shipped in the first quarter of 2018 is scheduled to ship in the second quarter of the current year. Our net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, had a slight increase year over year. Heinemann net sales continued to grow driven by sales of the Fountas & Pinnell Classroom and Calkins products. Such net sales were partially offset within Extensions by lower intervention and supplemental product sales. Within our HMH Books & Media segment, the increase in net sales was due to $5.7 million of licensing revenue attributed to the Carmen Sandiego series on Netflix.

Operating loss for the three months ended March 31, 2019 changed unfavorably from a loss of $92.9 million for the same period in 2018 to a loss of $101.8 million, due primarily to the following:

 

   

A $6.5 million increase in selling and administrative expenses, primarily due to higher net labor costs of $5.3 million, mainly attributable to planned merit increases, along with higher stock compensation expense, incentive compensation as well as higher employee benefit and medical expenses. Further, there was an increase of variable expenses such as an increase in samples of $1.6 million due to timing of adoptions, an increase in commissions of $1.4 million due to product mix, and an increase of $1.4 million in travel and entertainment. Partially offsetting the increase in selling and administrative expenses was lower depreciation expense of $1.7 million and cost savings from the auto lease program of $1.6 million, and

 

   

A $4.6 million increase in net amortization expense related to publishing rights, pre-publication and other intangible assets, primarily due to an increase in pre-publication amortization attributed to the timing of 2019 major product releases partially offset by our use of accelerated amortization methods for publishing rights amortization and certain other intangible assets becoming fully amortized, and

 

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A $5.1 million decrease in net sales,

 

   

Partially offset by a $3.7 million decrease in our cost of sales, excluding publishing rights and pre-publication amortization, which is attributed to lower volume and a slight favorable change in profitability due to our product mix of net sales,

 

   

A $2.7 million decrease in severance and other charges due to reduced reductions in force, and

 

   

A $0.9 million loss on sale of assets associated with the divestiture of certain non-core products in the first quarter of 2018.

Retirement benefits non-service income for the three months ended March 31, 2019 changed unfavorably by $0.3 million due to the lowering of the expected return on plan assets assumption and greater interest costs in the calculation of net periodic benefit cost in 2019.

Interest expense for the three months ended March 31, 2019 increased $0.6 million from $10.9 million for the same period in 2018 to $11.6 million, primarily due to an increase in interest on the term loan facility of $1.6 million due to an increase in variable interest rates, offset by a reduction of $0.9 million of net settlement payments on our interest rate derivative instruments during the current period.

Interest income for the three months ended March 31, 2019 increased $0.6 from the same period in 2018 primarily due to higher short-term investments in 2019.

Change in fair value of derivative instruments for the three months ended March 31, 2019, unfavorably changed by $0.8 million from a gain of $0.4 million in 2018 to a loss of $0.4 million in 2019. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the stronger U.S. dollar against the Euro.

Income from transition services agreement for the three months ended March 31, 2019 was $1.8 million and was related to transition service fees under the transition services agreement with the purchaser of the Riverside Business whereby we provide certain support functions for a period of up to 18 months from the disposition date in the fourth quarter of 2018.

Income tax expense for the three months ended March 31, 2019 increased $3.2 million, from an expense of $3.2 million for the same period in 2018, to an expense of $6.5 million in 2019. For 2019, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (4.9)%. For 2018, our effective annual tax rate exclusive of discrete items was (3.8)%. For both periods income tax expense was primarily attributed to the movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions.

Adjusted EBITDA From Continuing Operations

To supplement our financial statements presented in accordance with GAAP, we have presented Adjusted EBITDA from continuing operations, which is not prepared in accordance with GAAP. This information should be considered as supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. Management believes that the presentation of Adjusted EBITDA provides useful information to investors regarding our results of operations because it assists both investors and management in analyzing and benchmarking the performance and value of our business. Adjusted EBITDA provides an indicator of general economic performance that is not affected by debt restructurings, fluctuations in interest rates or effective tax rates, non-cash charges, or levels of depreciation or amortization along with costs such as severance, separation and facility closure costs, acquisition/disposition-related activity costs, restructuring costs and integration costs. Accordingly, our management believes that this measurement is useful for comparing general operating performance from period to period. In addition, targets in Adjusted EBITDA (further adjusted to include changes in deferred revenue) are used as performance measures to determine certain compensation of management, and Adjusted EBITDA is used as the base for calculations relating to incurrence covenants in our debt agreements. Other companies may define Adjusted EBITDA differently and, as a result, our measure of Adjusted EBITDA may not be directly comparable to Adjusted EBITDA of other companies. Although we use Adjusted EBITDA as a financial measure to assess the performance of our business, the use of Adjusted EBITDA is limited because it does not include certain material costs, such as interest and taxes, necessary to operate our business. Adjusted EBITDA should be considered in addition to, and not as a substitute for, net loss/income in accordance with GAAP as a measure of performance. Adjusted EBITDA is not intended to be a measure of liquidity or free cash flow for discretionary use. You are cautioned not to place undue reliance on Adjusted EBITDA.

 

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Below is a reconciliation of our net loss to Adjusted EBITDA from continuing operations for the three months ended March 31, 2019 and 2018:

 

     Three Months Ended March 31,  
     2019      2018  

Net loss from continuing operations

   $ (117,362    $ (105,886

Interest expense

     11,582        10,936  

Interest income

     (1,092      (506

Provision for income taxes

     6,455        3,243  

Depreciation expense

     16,179        18,445  

Amortization expense – film asset

     5,012        —    

Amortization expense

     47,211        42,577  

Non-cash charges – stock compensation

     3,551        2,893  

Non-cash charges – loss (gain) on derivative instrument

     450        (372

Fees, expenses or charges for equity offerings, debt or acquisitions/dispositions

     287        182  

Severance, separation costs and facility closures

     1,221        3,943  

Loss on sale of assets

     —          884  
  

 

 

    

 

 

 

Adjusted EBITDA from continuing operations

   $ (26,506    $ (23,661
  

 

 

    

 

 

 

 

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Table of Contents

Segment Operating Results

Results of Operations – Comparing Three Months Ended March 31, 2019 and 2018

Education

 

     Three Months Ended
March 31,
     Dollar
Change
     Percent
Change
 
     2019      2018  

Net sales

   $ 153,844      $ 163,023      $ (9,179      (5.6 )% 

Costs and expenses:

           

Cost of sales, excluding publishing rights and pre-publication amortization

     66,983        74,460        (7,477      (10.0 )% 

Publishing rights amortization

     6,042        8,338        (2,296      (27.5 )% 

Pre-publication amortization

     32,969        25,552        7,417        29.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of sales

     105,994        108,350        (2,356      (2.2 )% 

Selling and administrative

     119,402        114,098        5,304        4.6

Other intangible asset amortization

     5,018        5,384        (366      (6.8 )% 

Loss on sale of assets

     —          884        (884      NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating loss from continuing operations

     (76,570      (65,693      (10,877      (16.6 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss from continuing operations

   $ (76,570    $ (65,693    $ (10,877      (16.6 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjustments from net loss from continuing operations to Education segment Adjusted EBITDA

           

Depreciation expense

   $ 11,576      $ 13,833      $ (2,257      (16.3 )% 

Amortization expense

     44,029        39,274        4,755        12.1

Loss on sale of assets

     —          884        (884      NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Education segment Adjusted EBITDA

   $ (20,965    $ (11,702    $ (9,263      (79.2 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

NM = not meaningful

Our Education segment net sales for the three months ended March 31, 2019 decreased $9.2 million, or 5.6%, from $163.0 million for the same period in 2018 to $153.8 million. The decrease was primarily due to lower net sales from Core Solutions, which declined by $9.0 million from $61.0 million in 2018 to $52.0 million. The primary drivers of the decrease in Core Solutions net sales were decreases in residual net sales and net sales relating to disciplines reaching the end of their product lifecycle as customers await new product offerings later this year. Further, a large international reseller order which was shipped in the first quarter of 2018 is scheduled to ship in the second quarter of the current year. Our net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, had a slight increase year over year. Heinemann net sales continued to grow driven by sales of the Fountas & Pinnell Classroom and Calkins products. Such net sales were largely offset within Extensions by lower intervention and supplemental product sales.

Our Education segment cost of sales for the three months ended March 31, 2019 decreased $2.4 million, or 2.2%, from $108.3 million for the same period in 2018 to $106.0 million. Our cost of sales, excluding publishing rights and pre-publication amortization, decreased $7.5 million from $74.5 million in 2018 to $67.0 million of which $4.2 million is attributed to lower sales volume coupled with $3.3 million of improved profitability as our cost of sales excluding publishing rights and pre-publication amortization, as a percentage of sales, decreased to 43.5% from 45.7%, primarily due to product mix. Pre-publication amortization increased by $7.4 million from the same period in 2018 primarily due to the timing of product releases partially offset by a $2.3 million decrease in publishing rights amortization attributed to our use of accelerated amortization methods.

Our Education segment selling and administrative expense for the three months ended March 31, 2019 increased $5.3 million, or 4.6%, from $114.1 million for the same period in 2018 to $119.4 million. The increase was driven by higher net labor costs attributed to planned merit increases, increased incentive compensation as well as higher employee benefit and medical expenses. Further, there was an increase in variable expenses such as samples and increases in commissions and travel and entertainment. Offsetting the increase in selling and administrative expenses was cost savings from the auto lease program.

Our Education segment other intangible asset amortization expense for the three months ended March 31, 2019 decreased $0.4 million, or 6.8%, from the same period in 2018, which was due to our use of accelerated amortization methods.

Our Education segment Adjusted EBITDA for the three months ended March 31, 2019 decreased $9.3 million, from a loss of $11.7 million for the same period in 2018 to a loss of $21.0 million in 2019. Our Education segment Adjusted EBITDA excludes depreciation, amortization and loss on sale of assets. 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.

 

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Table of Contents

HMH Books & Media

 

     Three Months Ended
March 31,
    Dollar
Change
    Percent
Change
 
     2019     2018  

Net sales

   $ 40,791     $ 36,736     $ 4,055       11.0

Costs and expenses:

        

Cost of sales, excluding publishing rights and pre-publication amortization

     29,072       25,273       3,799       15.0

Publishing rights amortization

     1,563       1,752       (189     (10.8 )% 

Pre-publication amortization

     113       69       44       63.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

     30,748       27,094       3,654       13.5

Selling and administrative

     13,034       12,472       562       4.5

Other intangible asset amortization

     1,506       1,482       24       1.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (4,497     (4,312     (185     (4.3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (4,497   $ (4,312   $ (185     (4.3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjustments from net loss to HMH Books & Media segment Adjusted EBITDA

        

Depreciation expense

   $ 472     $ 172     $ 300       NM  

Amortization expense film asset

     5,012       —         5,012       NM  

Amortization expense

     3,182       3,303       (121     (3.7 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

HMH Books & Media segment Adjusted EBITDA

   $ 4,169     $ (837   $ 5,006       NM  
  

 

 

   

 

 

   

 

 

   

 

 

 

NM = not meaningful

Our HMH Books & Media segment net sales for the three months ended March 31, 2019 increased $4.1 million, or 11.0%, from $36.7 million for the same period in 2018 to $40.8 million. The increase was primarily due to licensing revenue driven by the Carmen Sandiego series on Netflix. Partially offsetting the aforementioned was a decrease in print titles due to the prior year strength of the Instant Pot series and the Whole 30 series.

Our HMH Books & Media segment cost of sales for the three months ended March 31, 2019 increased $3.7 million, or 13.5%, from $27.1 million for the same period in 2018 to $30.7 million. The majority of the increase was driven by our cost of sales, excluding publishing rights and pre-publication amortization, which increased $3.8 million of which $2.8 million was due to higher sales volume. Our cost of sales, excluding publishing rights and pre-publication amortization as a percentage of net sales increased to 71.3% from 68.8%, resulting in $1.0 million of unfavorable profitability due to product mix.

Our HMH Books & Media segment selling and administrative expense for the three months ended March 31, 2018 increased $0.6 million, or 4.5%, from $12.5 million for the same period in 2018 to $13.0 million. The increase was primarily due to higher variable expenses such as samples and commissions.

Our HMH Books & Media segment other intangible asset amortization expense for the three months ended March 31, 2019 increased slightly from the same period in 2018.

Our HMH Books & Media segment Adjusted EBITDA for the three months ended March 31, 2019 changed favorably from a loss of $0.8 million for the same period in 2018 to $4.2 million due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in our HMH Books & Media segment Adjusted EBITDA. Our HMH Books & Media segment Adjusted EBITDA excludes depreciation and amortization costs.

 

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Corporate and Other

 

     Three Months Ended
March 31,
     Dollar
Change
     Percent
Change
 
     2019      2018  

Net sales

   $ —      $ —      $ —        NM  

Costs and expenses:

           

Cost of sales, excluding publishing rights and pre-publication amortization

     —          —          —          NM  

Publishing rights amortization

     —          —          —          NM  

Pre-publication amortization

     —          —          —          NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cost of sales

     —          —          —          NM  

Selling and administrative

     19,547        18,957        590        3.1

Severance and other charges

     1,221        3,943        (2,722      (69.0 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating loss

     (20,768      (22,900      2,132        9.3
  

 

 

    

 

 

    

 

 

    

 

 

 

Retirement benefits non-service income

     42        320        (278      (86.9 )% 

Interest expense

     (11,582      (10,936      (646      (5.9 )% 

Interest income

     1,092        506        586        NM  

Change in fair value of derivative instruments

     (450      372        (822      NM  

Income from transition services agreement

     1,826        —          1,826        NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss before taxes

     (29,840      (32,638      2,798        8.6

Income tax expense

     6,455        3,243        3,212        99.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss

   $ (36,295    $ (35,881    $ (414      (1.2 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjustments from net loss to Corporate and Other segment Adjusted EBITDA

           

Interest expense

   $ 11,582      $ 10,936      $ 646        5.9

Interest income

     (1,092      (506      (586      NM  

Provision for income taxes

     6,455        3,243        3,212        99.0

Depreciation expense

     4,131        4,440        (309      (7.0 )% 

Non-cash charges loss (gain) on derivative instruments

     450        (372      822        NM  

Non-cash charges – stock compensation

     3,551        2,893        658        22.7

Fees, expenses or charges for equity offerings, debt or acquisitions/dispositions

     287        182        105        57.7

Severance, separation costs and facility closures

     1,221        3,943        (2,722      (69.0 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate and Other segment Adjusted EBITDA

   $ (9,710    $ (11,122    $ 1,412        12.7
  

 

 

    

 

 

    

 

 

    

 

 

 

NM = not meaningful

The Corporate and Other category represents certain general overhead costs not fully allocated to the business segments such as legal, accounting, treasury, human resources, technology and executive functions along with severance and other non-operating costs.

Our selling and administrative expense for the Corporate and Other category for the three months ended March 31, 2019 increased $0.6 million to $19.5 million primarily attributed to planned merit increases, increased management incentive compensation and higher stock compensation, partially offset by lower technology costs, professional fees and depreciation.

Our severance and other charges for the three months ended March 31, 2019 decreased $2.7 million, or 69.0%, from $3.9 million for the same period in 2018 to $1.2 million, due to reduced severance for terminated employees.

Retirement benefits non-service income for the three months ended March 31, 2019 changed unfavorably by $0.3 million due to the lowering of the expected return on plan assets assumption and greater interest costs in the calculation of net periodic benefit cost in 2019.

 

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Interest expense for the three months ended March 31, 2019 increased $0.6 million from $10.9 million for the same period in 2018 to $11.6 million, primarily due to an increase in interest on the term loan facility of $1.6 million due to an increase in variable interest rates, offset by a reduction of $0.9 million of net settlement payments on our interest rate derivative instruments during the current period.

Interest income for the three months ended March 31, 2019 increased $0.6 from the same period in 2018 primarily due to higher short-term investments in 2019.

Our change in fair value of derivative instruments for the three months ended March 31, 2019 unfavorably changed by $0.8 million from a gain of $0.4 million in 2018 to a loss of $0.4 million in 2019. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the stronger U.S. dollar against the Euro.

Income from transition services agreement for the three months ended March 31, 2019 was $1.8 million and was related to transition service fees under the transition services agreement with the purchaser of the Riverside Business whereby we provide certain support functions for a period of up to 18 months from the disposition date in the fourth quarter of 2018.

Income tax expense for the three months ended March 31, 2019 increased $3.2 million, from an expense of $3.2 million for the same period in 2018, to an expense of $6.5 million in 2019. For 2019, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (4.9)%. For 2018, our effective annual tax rate exclusive of discrete items was (3.8)%. For both periods, income tax expense was primarily attributed to the movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions.

Adjusted EBITDA for the Corporate and Other category for the three months ended March 31, 2019 favorably changed $1.4 million, or 12.7%, from a loss of $11.1 million for the same period in 2018 to a loss of $9.7 million. Our Adjusted EBITDA for the Corporate and Other category excludes interest, taxes, depreciation, derivative instruments charges, equity compensation charges, acquisition/disposition-related activity, severance and facility vacant space costs. The 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. 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.

Approximately 85% of our net sales for the year ended December 31, 2018 were derived from our Education segment, which is a markedly seasonal business. Schools conduct the majority of their purchases in the second and third quarters of the calendar year in preparation for the beginning of the school year. Thus, over the past three completed fiscal years, approximately 67% of our consolidated net sales were realized in the second and third quarters. Sales of K-12 instructional materials are also cyclical, with some years offering more sales opportunities than others 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

 

(in thousands)    March 31,
2019
     December 31,
2018
 

Cash and cash equivalents

   $ 74,185      $ 253,365  

Short-term investments

     9,999        49,833  

Current portion of long-term debt

     8,000        8,000  

Long-term debt, net of discount and issuance costs

     754,513        755,649  

 

     For the Three
Months Ended
March 31,
2019
     For the Three
Months Ended
March 31,
2018
 

Net cash used in operating activities

   $ (176,063    $ (96,686

Net cash (used in) provided by investing activities

     (1,720      48,763  

Net cash used in financing activities

     (1,397      (2,392

 

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Operating activities

Net cash used in operating activities was $176.1 million for the three months ended March 31, 2019, a $79.4 million increase from the $96.7 million of net cash used in operating activities for the three months ended March 31, 2018. Net cash used in operating activities included $2.8 million of cash flow provided by discontinued operations in 2018. Net cash used in operating activities from continuing operations was $176.1 million in the three months ended March 31, 2019 compared to $99.5 million in the three months ended March 31, 2018. The $76.6 million increase in cash used in operating activities from continuing operations was primarily driven by unfavorable changes in net operating assets and liabilities of $74.7 million primarily due to unfavorable changes in inventories of $25.7 million in advance of current year large opportunity, unfavorable changes in accounts receivable of $14.2 million, and unfavorable changes in net other assets and liabilities of $34.8 million. Additionally, there were less profitable operations, net of non-cash items, of $1.9 million.

Investing activities

Net cash used in investing activities was $1.7 million for the three months ended March 31, 2019, a decrease of $50.5 million from the $48.8 million provided by investing activities for the three months ended March 31, 2018. Net cash provided by investing activities included $2.0 million of expenditures from discontinued operations in 2018. Net cash used in investing activities from continuing operations was $1.7 million in the three months ended March 31, 2019 compared to net cash provided by investing activities from continuing operations of $50.7 million in the three months ended March 31, 2018. The increase in cash used in investing activities from continuing operations of $52.5 million was primarily due to lower net proceeds from sales and maturities of short-term investments of $46.5 million compared to 2018, the acquisition of a business for $5.4 million and an increase in capital investing expenditures related to pre-publication costs and property, plant, and equipment of $0.5 million, primarily due to the timing of spend.

Financing activities

Net cash used in financing activities was $1.4 million for the three months ended March 31, 2019, a decrease of $1.0 million from the $2.4 million of net cash used in financing activities for the three months ended March 31, 2018. The decrease in cash used in financing activities was due to $1.9 million of net collections under our transition services agreement with the purchaser of the Riverside Business in 2019. Offsetting the aforementioned were higher tax withholding payments related to net share settlements of restricted stock units of $0.7 million and lower proceeds from our employee stock purchase plan of $0.2 million.

Debt

Under both our revolving credit facility and term loan facility, Houghton Mifflin Harcourt Publishers Inc., HMH Publishers LLC and Houghton Mifflin Harcourt Publishing Company are the borrowers (collectively, the “Borrowers”), and Citibank, N.A. acts as both the administrative agent and the collateral agent.

The obligations under the revolving credit facility and the term loan 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 Borrower 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.

Term Loan Facility

On May 29, 2015, we entered into an amended and restated $800.0 million term loan credit facility (the “term loan facility”). As of March 31, 2019, we had approximately $770.0 million ($762.5 million, net of discount and issuance costs) outstanding under the term loan facility.

The term loan facility has a six-year term and matures on May 29, 2021. The interest rate applicable to borrowings under the facility is based, at our election, on LIBOR plus 3.0% or an alternative base rate plus applicable margins. LIBOR is subject to a floor of 1.0%, with the length of the LIBOR contracts ranging up to six months at the option of the Company. As of March 31, 2019, the interest rate of the term loan facility was 5.5%.

 

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The term loan facility is required to be repaid in quarterly installments of $2.0 million, and may be prepaid, in whole or in part, at any time, without premium.

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 is subject to 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 annual excess cash flow provision under the 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 2019 and 2018.

Revolving Credit Facility

On July 22, 2015, we entered into an amended and restated revolving credit facility (the “revolving credit facility”) to, among other things, reduce the pricing, extend the maturity, conform certain terms to those of our term loan facility and to provide greater availability and operational flexibility. The revolving credit facility provides borrowing availability in an amount equal to the lesser of $250.0 million and a borrowing base that is computed monthly or weekly as the case may be and comprised of the Borrowers’ and certain Guarantors’ eligible inventory and receivables.

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 of March 31, 2019, no loans are currently drawn on the revolving credit facility. As of March 31, 2019, we had approximately $24.3 million of outstanding letters of credit and approximately $149.3 million of borrowing availability under the revolving credit facility. As of May 8, 2019, there was $10.0 million drawn on the revolving credit facility.

The revolving credit facility has a five year term and matures on July 22, 2020. The interest rate applicable to borrowings under the facility is based, at our election, on LIBOR plus 1.75% or an alternative base rate plus 0.75%; such applicable margins may increase up to 2.25% and 1.25%, respectively, 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 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 of March 31, 2019, due to our level of borrowing availability.

The revolving credit facility is subject to 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 $74.2 million of cash and cash equivalents and $10.0 million of short-term investments at March 31, 2019. We had $253.4 million of cash and cash equivalents and $49.8 million of short-term investments at December 31, 2018.

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.

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.

Critical Accounting Policies and Estimates

Our financial results are affected by the selection and application of critical accounting policies and methods. Except for the adoption of the new lease accounting standard discussed below, there were no material changes in the three months ended March 31, 2019 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 ended December 31, 2018.

 

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Leases

Refer to Note 3 to the consolidated financial statements included under Part I, Item 1 of this Quarterly Report on Form 10-Q for a detailed description of the impact of the adoption of the new leasing standard on our consolidated balance sheets and statements of operations.

Impact of Inflation and Changing Prices

We believe that inflation has not had a material impact on our results of operations during the years ended December 31, 2018 and 2017. 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 March 31, 2019, we were in compliance with all of our debt covenants.

We are currently required to meet certain incurrence-based financial covenants as defined under our term loan facility and revolving credit facility. We have incurrence based financial covenants primarily pertaining to a maximum leverage ratio, fixed charge coverage ratio, and liquidity. 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.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Recently Issued Accounting Pronouncements

See Note 3 and Note 10 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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Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk from foreign currency exchange rates and interest rates, which could affect operating results, financial position and cash flows. We manage exposure to these market risks through our regular operating and financing activities and, when appropriate, through the use of derivative financial instruments. These derivative financial instruments are utilized to hedge economic exposures as well as reduce our earnings and cash flow volatility resulting from shifts in market rates. As permitted, we may designate certain of these derivative contracts for hedge accounting treatment in accordance with authoritative guidance regarding accounting for derivative instruments and hedging activities. However, certain of these instruments may not qualify for, or we may choose not to elect, hedge accounting treatment and, accordingly, the results of our operations may be exposed to some level of volatility. Volatility in our results of operations will vary with the type and amount of derivative hedges outstanding, as well as fluctuations in the currency and interest rate market during the period. Periodically, we may enter into derivative contracts, including interest rate swap agreements and interest rate caps and collars to manage interest rate exposures, and foreign currency spot, forward, swap and option contracts to manage foreign currency exposures. The fair market values of all of these derivative contracts change with fluctuations in interest rates and/or currency rates and are designed so that any changes in their values are offset by changes in the values of the underlying exposures. Derivative financial instruments are held solely as risk management tools and not for trading or speculative purposes.

By their nature, all derivative instruments involve, to varying degrees, elements of market and credit risk not recognized in our financial statements. The market risk associated with these instruments resulting from currency exchange and interest rate movements is expected to offset the market risk of the underlying transactions, assets and liabilities being hedged. Our policy is to deal with counterparties having a single A or better credit rating at the time of the execution. We manage our exposure to counterparty risk of derivative instruments by entering into contracts with a diversified group of major financial institutions and by actively monitoring outstanding positions.

We continue to review liquidity sufficiency by performing various stress test scenarios, such as cash flow forecasting, which considers hypothetical interest rate movements. Furthermore, we continue to closely monitor current events and the financial institutions that support our credit facility, including monitoring their credit ratings and outlooks, credit default swap levels, capital raising and merger activity.

As of March 31, 2019, we had $770.0 million ($762.5 million, net of discount and issuance costs) of aggregate principal amount indebtedness outstanding under our term loan facility that bears interest at a variable rate. An increase or decrease of 1% in the interest rate will change our interest expense by approximately $7.7 million on an annual basis. We also have up to $250.0 million of borrowing availability, subject to borrowing base availability, under our revolving credit facility, and borrowings under the revolving credit facility bear interest at a variable rate. As of March 31, 2019, there were no amounts outstanding on the revolving credit facility. Assuming that the revolving credit facility is fully drawn, an increase or decrease of 1% in the interest rate will change our interest expense associated with the revolving credit facility by $2.5 million on an annual basis.

Our interest rate risk relates primarily to U.S. dollar borrowings partially offset by U.S. dollar cash investments. We have historically used interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates. On August 17, 2015, we entered into interest rate derivative contracts with various financial institutions having an aggregate notional amount of $400.0 million to convert floating rate debt into fixed rate debt, which we designated as cash flow hedges, and for which we had $400.0 million outstanding as of March 31, 2019. These contracts were effective beginning September 30, 2016 and mature on July 22, 2020.

We conduct various digital development activities in Ireland, and as such, our cash flows and costs are subject to fluctuations from changes in foreign currency exchange rates. We manage our exposures to this market risk through the use of short-term foreign exchange forward and option contracts, when deemed appropriate, which were not significant as of March 31, 2019 and December 31, 2018. We do not enter into derivative transactions or use other financial instruments for trading or speculative purposes.

 

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Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer (“CEO”), and our Executive Vice President and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2019 pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Based on their evaluation, our CEO and CFO concluded that, as of March 31, 2019, our disclosure controls and procedures were effective.

During the quarter ended March 31, 2019, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except for the following.

On January 1, 2019, we adopted the new lease accounting standard. We have identified appropriate changes to our accounting policies, information technology systems, business processes, and related internal controls to support recognition and disclosure requirements as a result of the adoption. These included the development of new policies including the capitalization of right of use assets and the recognition of the present value of lease liabilities for identified leases, ongoing contract review requirements, and gathering of information for disclosures.

Part II. Other Information

Item 1. Legal Proceedings

We are involved in legal actions, claims, litigation and other matters incidental to our business. Litigation alleging infringement of copyrights and other intellectual property rights, particularly with respect to proprietary photographs and images, is common in the educational publishing industry.

While management believes there is a reasonable possibility we may incur a loss associated with existing legal actions, claims and litigation, we are not able to estimate such amount, but we do not expect any of these matters to have a material adverse effect on our results of operations, financial position or cash flows. We have insurance in such amounts and with such coverage and deductibles as management believes is reasonable. However, there can be no assurance that our liability insurance will cover all events or that the limits of such coverage will be sufficient to fully cover all potential liabilities thereunder.

Item 1A. Risk Factors

There have been no material changes since the beginning of the period covered by this Quarterly Report on Form 10-Q to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018. For more information regarding the risks associated with our business and industry, please see our Annual Report on Form 10-K for the year ended December 31, 2018.

 

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Item 6. Exhibits

 

Exhibit

No.

  

Description

  31.1*    Certification of CEO Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.
  31.2*    Certification of CFO Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.
  32.1**    Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2**    Certification of CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*    XBRL Instance Document.
101.SCH*    XBRL Taxonomy Extension Schema Document.
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document.
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document.

 

*

Filed herewith.

**

This certification shall not be deemed “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities under that section. Furthermore, this certification shall not be deemed to be incorporated by reference into the filings of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, regardless of any general incorporation language in such filing.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   

Houghton Mifflin Harcourt Company

(Registrant)

May 9, 2019     By:   /s/ John J. Lynch, Jr.
      John J. Lynch, Jr.
      Chief Executive Officer (Principal Executive Officer)
   

Houghton Mifflin Harcourt Company

(Registrant)

May 9, 2019     By:   /s/ Joseph P. Abbott, Jr.
      Joseph P. Abbott, Jr.
      Executive Vice President and Chief Financial Officer (Principal Financial Officer)

 

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