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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, 2020

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 4, 2020 was 125,406,121.

 

 

 


Table of Contents

 

 

  

Page (s)

 

 

 

 

 

 

Special Note Regarding Forward-Looking Statements

  

 

3

 

 

 

 

PART I.

 

FINANCIAL INFORMATION

  

 

4

 

 

 

 

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

  

 

26

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

  

 

40

 

 

 

 

Item 4.

 

Controls and Procedures

  

 

41

 

 

 

 

PART II.

 

OTHER INFORMATION

  

 

41

 

 

 

 

Item 1.

 

Legal Proceedings

  

 

41

 

 

 

 

Item 1A.

 

Risk Factors

  

 

41

 

 

 

 

Item 6.

 

Exhibits

  

 

42

 

 

 

SIGNATURES

  

 

43

 

 

2


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; the expected impact of the COVID-19 pandemic; 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; 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: major disasters or other external threats, such as COVID-19; the duration and severity of the COVID-19 pandemic and its impact on the federal, state and local economies and K-12 schools; 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; our ability to execute on our long-term growth strategy; increases in our operating costs; exposure to litigation; 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, including our recently announced workforce reduction; and other factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (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


PART 1 – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Houghton Mifflin Harcourt Company

Consolidated Balance Sheets (Unaudited)

 

(in thousands of dollars, except share information)

 

March 31,

2020

 

 

December 31,

2019

 

Assets

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

254,665

 

 

$

296,353

 

Accounts receivable, net of allowances for bad debts and book returns of

   $17.6 million and $19.7 million, respectively

 

 

139,981

 

 

 

184,425

 

Inventories

 

 

265,364

 

 

 

213,059

 

Prepaid expenses and other assets

 

 

22,032

 

 

 

19,257

 

Total current assets

 

 

682,042

 

 

 

713,094

 

Property, plant, and equipment, net

 

 

101,692

 

 

 

100,388

 

Pre-publication costs, net

 

 

256,808

 

 

 

268,197

 

Royalty advances to authors, net

 

 

41,761

 

 

 

44,743

 

Goodwill

 

 

454,977

 

 

 

716,977

 

Other intangible assets, net

 

 

462,127

 

 

 

474,225

 

Operating lease assets

 

 

135,087

 

 

 

132,247

 

Deferred income taxes

 

 

2,520

 

 

 

2,520

 

Deferred commissions

 

 

28,431

 

 

 

29,291

 

Other assets

 

 

29,961

 

 

 

31,490

 

Total assets

 

$

2,195,406

 

 

$

2,513,172

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Revolving credit facility

 

$

150,000

 

 

$

 

Current portion of long-term debt

 

 

19,000

 

 

 

19,000

 

Accounts payable

 

 

73,217

 

 

 

52,128

 

Royalties payable

 

 

40,796

 

 

 

72,985

 

Salaries, wages, and commissions payable

 

 

14,250

 

 

 

54,938

 

Deferred revenue

 

 

274,187

 

 

 

305,285

 

Interest payable

 

 

3,814

 

 

 

3,826

 

Severance and other charges

 

 

7,087

 

 

 

12,407

 

Accrued postretirement benefits

 

 

1,571

 

 

 

1,571

 

Operating lease liabilities

 

 

9,171

 

 

 

8,685

 

Other liabilities

 

 

27,044

 

 

 

24,325

 

Total current liabilities

 

 

620,137

 

 

 

555,150

 

Long-term debt, net of discount and issuance costs

 

 

634,800

 

 

 

638,187

 

Operating lease liabilities

 

 

137,676

 

 

 

134,994

 

Long-term deferred revenue

 

 

514,390

 

 

 

542,821

 

Accrued pension benefits

 

 

23,423

 

 

 

23,648

 

Accrued postretirement benefits

 

 

14,228

 

 

 

15,113

 

Deferred income taxes

 

 

21,743

 

 

 

30,871

 

Other liabilities

 

 

5,049

 

 

 

6,028

 

Total liabilities

 

 

1,971,446

 

 

 

1,946,812

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

Preferred stock, $0.01 par value: 20,000,000 shares authorized; no shares

   issued and outstanding at March 31, 2020 and December 31, 2019

 

 

 

 

 

 

Common stock, $0.01 par value: 380,000,000 shares authorized;

   149,983,155 and 148,928,328 shares issued at March 31, 2020 and

   December 31, 2019, respectively; 125,406,121 and 124,351,294 shares

   outstanding at March 31, 2020 and December 31, 2019, respectively

 

 

1,500

 

 

 

1,489

 

Treasury stock, 24,577,034 shares as of March 31, 2020 and December 31,

   2019, respectively, at cost

 

 

(518,030

)

 

 

(518,030

)

Capital in excess of par value

 

 

4,910,171

 

 

 

4,906,165

 

Accumulated deficit

 

 

(4,121,965

)

 

 

(3,775,992

)

Accumulated other comprehensive loss

 

 

(47,716

)

 

 

(47,272

)

Total stockholders’ equity

 

 

223,960

 

 

 

566,360

 

Total liabilities and stockholders’ equity

 

$

2,195,406

 

 

$

2,513,172

 

 

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

4


Houghton Mifflin Harcourt Company

Consolidated Statements of Operations (Unaudited)

 

 

 

Three Months Ended

March 31,

 

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

 

2020

 

 

2019

 

Net sales

 

$

189,925

 

 

$

194,635

 

Costs and expenses

 

 

 

 

 

 

 

 

Cost of sales, excluding publishing rights and pre-publication

   amortization

 

 

90,012

 

 

 

96,055

 

Publishing rights amortization

 

 

5,825

 

 

 

7,605

 

Pre-publication amortization

 

 

30,638

 

 

 

33,082

 

Cost of sales

 

 

126,475

 

 

 

136,742

 

Selling and administrative

 

 

133,353

 

 

 

151,983

 

Other intangible asset amortization

 

 

6,273

 

 

 

6,524

 

Impairment charge for goodwill

 

 

262,000

 

 

 

 

Restructuring/severance and other charges

 

 

 

 

 

1,221

 

Operating loss

 

 

(338,176

)

 

 

(101,835

)

Other income (expense)

 

 

 

 

 

 

 

 

Retirement benefits non-service income

 

 

61

 

 

 

42

 

Interest expense

 

 

(16,783

)

 

 

(11,582

)

Interest income

 

 

766

 

 

 

1,092

 

Change in fair value of derivative instruments

 

 

(380

)

 

 

(450

)

Income from transition services agreement

 

 

 

 

 

1,826

 

Loss before taxes

 

 

(354,512

)

 

 

(110,907

)

Income tax (benefit) expense

 

 

(8,539

)

 

 

6,455

 

Net loss

 

$

(345,973

)

 

$

(117,362

)

Net loss per share attributable to common stockholders

 

 

 

 

 

 

 

 

Basic and diluted:

 

 

 

 

 

 

 

 

Net loss

 

$

(2.77

)

 

$

(0.95

)

Weighted average shares outstanding

 

 

 

 

 

 

 

 

Basic and diluted

 

 

124,688,974

 

 

 

123,798,641

 

 

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

5


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)

 

2020

 

 

2019

 

Net loss

 

$

(345,973

)

 

$

(117,362

)

Other comprehensive loss, net of taxes:

 

 

 

 

 

 

 

 

Foreign currency translation adjustments, net of tax

 

 

(113

)

 

 

(232

)

Unrealized gain on short-term investments, net of tax

 

 

 

 

 

9

 

Net change in unrealized loss on derivative

   financial instruments, net of tax

 

 

(331

)

 

 

(1,327

)

Other comprehensive loss, net of taxes

 

 

(444

)

 

 

(1,550

)

Comprehensive loss

 

$

(346,417

)

 

$

(118,912

)

 

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

6


Houghton Mifflin Harcourt Company

Consolidated Statements of Cash Flows (Unaudited)

 

 

 

Three Months Ended

March 31,

 

(in thousands of dollars)

 

2020

 

 

2019

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(345,973

)

 

$

(117,362

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

55,225

 

 

 

68,402

 

Amortization of operating lease assets

 

 

3,632

 

 

 

3,501

 

Amortization of debt discount and deferred financing costs

 

 

1,488

 

 

 

1,046

 

Deferred income taxes

 

 

(9,128

)

 

 

5,897

 

Stock-based compensation expense

 

 

3,476

 

 

 

3,551

 

Impairment charge for goodwill

 

 

262,000

 

 

 

 

Change in fair value of derivative instruments

 

 

380

 

 

 

450

 

Changes in operating assets and liabilities, net of acquisitions

 

 

 

 

 

 

 

 

Accounts receivable

 

 

44,444

 

 

 

20,482

 

Inventories

 

 

(52,305

)

 

 

(77,715

)

Other assets

 

 

(1,680

)

 

 

(6,272

)

Accounts payable and accrued expenses

 

 

(20,732

)

 

 

787

 

Royalties payable and author advances, net

 

 

(29,207

)

 

 

(24,359

)

Deferred revenue

 

 

(59,529

)

 

 

(39,870

)

Interest payable

 

 

(12

)

 

 

241

 

Severance and other charges

 

 

(5,320

)

 

 

(59

)

Accrued pension and postretirement benefits

 

 

(1,108

)

 

 

(1,212

)

Operating lease liabilities

 

 

(3,304

)

 

 

(4,194

)

Other liabilities

 

 

886

 

 

 

(9,377

)

Net cash used in operating activities

 

 

(156,767

)

 

 

(176,063

)

Cash flows from investing activities

 

 

 

 

 

 

 

 

Proceeds from sales and maturities of short-term investments

 

 

 

 

 

40,000

 

Additions to pre-publication costs

 

 

(18,751

)

 

 

(25,898

)

Additions to property, plant, and equipment

 

 

(11,875

)

 

 

(10,375

)

Acquisition of business, net of cash acquired

 

 

 

 

 

(5,447

)

Net cash used in investing activities

 

 

(30,626

)

 

 

(1,720

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds under revolving credit facility

 

 

150,000

 

 

 

 

Payments of long-term debt

 

 

(4,750

)

 

 

(2,000

)

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

 

 

(48

)

 

 

(1,756

)

Issuance of common stock under employee stock purchase plan

 

 

503

 

 

 

505

 

Net collections under transition services agreement

 

 

 

 

 

1,854

 

Net cash provided by (used in) financing activities

 

 

145,705

 

 

 

(1,397

)

Net decrease in cash and cash equivalents

 

 

(41,688

)

 

 

(179,180

)

Cash and cash equivalents at the beginning of the period

 

 

296,353

 

 

 

253,365

 

Cash and cash equivalents at the end of the period

 

$

254,665

 

 

$

74,185

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

 

Interest paid

 

$

15,353

 

 

$

10,715

 

Income taxes paid

 

 

1

 

 

 

13

 

Non-cash investing activities

 

 

 

 

 

 

 

 

Pre-publication costs included in accounts payable and accruals

 

$

5,978

 

 

$

18,988

 

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

 

 

3,787

 

 

 

2,448

 

Property, plant, and equipment acquired under finance leases

 

 

288

 

 

 

442

 

 

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

7


Houghton Mifflin Harcourt Company

Consolidated Statements of Stockholders’ Equity (Unaudited)

 

 

 

Common Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands of dollars, except share information)

 

Shares

Issued

 

 

Par

Value

 

 

Treasury

Stock

 

 

Capital

in excess

of Par

Value

 

 

Accumulated

Deficit

 

 

Accumulated

Other

Comprehensive

Loss

 

 

Total

 

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

 

Balance at December 31, 2019

 

 

148,928,328

 

 

$

1,489

 

 

$

(518,030

)

 

$

4,906,165

 

 

$

(3,775,992

)

 

$

(47,272

)

 

$

566,360

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(345,973

)

 

 

 

 

 

(345,973

)

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(444

)

 

 

(444

)

Issuance of common stock for employee purchase plan

 

 

104,331

 

 

 

1

 

 

 

 

 

 

678

 

 

 

 

 

 

 

 

 

679

 

Issuance of common stock for vesting of restricted stock units

 

 

950,496

 

 

 

10

 

 

 

 

 

 

(10

)

 

 

 

 

 

 

 

 

 

Stock withheld to cover tax withholdings

   requirements upon vesting of restricted stock units

 

 

 

 

 

 

 

 

 

 

 

(48

)

 

 

 

 

 

 

 

 

(48

)

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

 

 

3,386

 

 

 

 

 

 

 

 

 

3,386

 

Balance at March 31, 2020

 

 

149,983,155

 

 

$

1,500

 

 

$

(518,030

)

 

$

4,910,171

 

 

$

(4,121,965

)

 

$

(47,716

)

 

$

223,960

 

 

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

8


 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 learning company committed to delivering connected 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 estimates that it serves more than 50 million students and three 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.

We are organized along two business segments: Education and HMH Books & Media. Within our Education segment, we focus on the K-12 market and, in the United States, we are a market leader. We specialize in comprehensive core curriculum, supplemental and intervention solutions, and we provide ongoing support in professional learning and coaching for educators and administrators. Our offerings are rooted in learning science, and we work with research partners, universities and third-party organizations as we design, build, implement and iterate our offerings to maximize their effectiveness. We are purposeful about innovation, leveraging technology to create engaging and immersive experiences designed to deepen learning experiences for students and to extend teachers’ capabilities so that they can focus on making meaningful connections with their students.

Our diverse portfolio enables us to help ensure that every student and teacher has the tools needed for success. We are able to build deep partnerships with school districts and leverage the scope of our offerings to provide holistic solutions at scale with the support of our far-reaching sales force and talented field-based specialists and consultants. We provide print, digital, and blended print/digital solutions that are tailored to a district’s needs, goals and technological readiness.

Furthermore, for nearly two centuries, our HMH Books & Media segment has brought renowned and awarded children’s, fiction, non-fiction, culinary and reference titles to readers throughout the world. Our distinguished author list includes ten Nobel Prize winners, forty-nine Pulitzer Prize winners, and twenty-six National Book Award winners. We are home to popular characters and titles such as Curious George, Carmen Sandiego, The Lord of the Rings, The Whole30, The Best American Series, the Peterson Field Guides, CliffsNotes, and The Polar Express, and published distinguished authors such as Tim O’Brien, Temple Grandin, Tim Ferriss, Kwame Alexander, Lois Lowry, and Chris Van Allsburg.

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, 2019. Our accompanying consolidated financial statements include the results of operations of the Company and our wholly-owned subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation.

Seasonality and Comparability

Our net sales, operating profit or loss and net cash provided by or used in operations are impacted by the inherent seasonality of the academic calendar, which typically results in a cash flow usage in the first half of the year and a cash flow generation in the second half of the year. Consequently, the performance of our businesses may not be comparable quarter to consecutive quarter and should be considered on the basis of results for the whole year or by comparing results in a quarter with results in the same quarter for the previous year.

Approximately 87% of our net sales for the year ended December 31, 2019 were derived from our Education segment, which is a markedly seasonal business. Schools conduct the majority of their purchases in the second and third quarters of the calendar year in preparation for the beginning of the school year. Thus, for the years ended December 31, 2019, 2018 and 2017, 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.

9


2.

Impact of the COVID-19 Pandemic

 

The unprecedented and rapid spread of COVID-19 and the resulting social distancing measures, including business and school closures implemented by federal, state and local authorities, have significantly reduced recent customer demand for, disrupted portions of our supply chain and warehousing operations and our ability to deliver our educational solutions and services. We are monitoring indicators of demand recovery, including our sales pipeline, customer orders and product shipments, as well as observing the impact to state revenues and related educational budgets to ascertain an estimate of the full-year impact; however, the length and severity of the reduction in demand due to the pandemic is uncertain. Accordingly, we expect that our second quarter ending June 30, 2020 will be severely impacted.

 

While we are planning for a demand recovery this summer as our customers prepare for the upcoming 2020-2021 school year, the exact timing and pace of recovery is uncertain given the significant disruption of the pandemic on the operations of our customers. Our expense management and liquidity measures may be modified as we obtain additional clarity on the timing of customer demand recovery.

 

In response to these developments, we have implemented measures to help mitigate the impact on our financial position and operations. These measures include, but are not limited to, the following:

Expense Management. With the reduction in net sales, we have, and will continue to implement cost saving initiatives, including:

 

director, executive and senior leadership salary reductions, and for the majority of employees, a four-day work week with associated labor cost reductions;

 

a freeze on spending not directly tied to near-term billings, including a reduction in all discretionary spending such as marketing, advertising, travel, and office supplies; and

 

temporary closures of warehousing and distribution centers.

 

Balance Sheet, Cash Flow and Liquidity. In addition to the expense management actions noted above, we have taken the following actions to increase liquidity and strengthen our financial position.

 

borrowed $150 million of our asset-backed credit facility as a pre-emptive measure to mitigate against capital market disruptions;

 

reduced inventory purchasing;

 

deferred long-term capital projects not directly contributing to billings in 2020; and

 

deferred the payment of our employer payroll taxes allowed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

After reviewing whether conditions and/or events raise substantial doubt about our ability to meet future financial obligations over the next twelve months, including consideration of our recent actions, we have concluded our net cash provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility will provide sufficient liquidity to fund our current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months. Our primary credit facilities do not require us to comply with financial maintenance covenants.

 

The ability of the Company to fund planned operations is based on assumptions which involve significant judgment and estimates of future revenues, capital spend and other operating costs. Our current assumptions are that businesses will reopen for selling and school districts will gradually resume purchasing during the second quarter of 2020 and most or all will become fully operational, either in-person or virtually, by the third quarter of 2020. We have performed a sensitivity analysis on these assumptions to forecast the impact of a slower-than-anticipated recovery and believe we can take additional financial and operational actions to mitigate the impact of lower billings than our current plans assume. These actions include additional expense reductions, asset sales, and capital raising activities including utilization of opportunities provided under the CARES Act.

 

Valuation of Goodwill, Indefinite-Lived Intangible Assets and Long-Lived Assets

 

We perform a fair value-based impairment test to the carrying value of goodwill and indefinite-lived intangible assets on an annual basis (as of October 1) and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. Our fourth quarter 2019 quantitative impairment tests of goodwill and indefinite-lived intangible assets indicated that there was no indication of impairment as the fair value exceeded our carrying value.

10


 

During the three months ended March 31, 2020, our stock price declined to historical lows since our 2013 initial public offering. We determined that the significant decline in our market capitalization and broader economic downturn arising from the COVID-19 pandemic was a triggering event and an indicator that it was more likely than not that the carrying value of goodwill exceeded its fair value. Therefore, we concluded that quantitative analyses were required to be performed due to the triggering event occurring during the quarter.

 

Goodwill is allocated entirely to our Education reporting unit. We utilized an implied market value method under the market approach to calculate the fair value of the Education reporting unit as of March 31, 2020, which we determined was the best approximation of fair value of the Education reporting unit in the current social and economic environment. We have previously used a combination of the implied market value method and guideline public company method approach. The relevant inputs, estimates and assumptions used in the valuation include our market capitalization as of March 31, 2020, selection of a control premium, and the determination of appropriate market comparables to value the HMH Books & Media reporting unit, as well as the fair value of individual assets and liabilities. Based on our interim impairment assessment as of March 31, 2020, we have concluded that our goodwill, which is wholly attributed to the Education reporting unit, has been impaired and, accordingly, have recorded a goodwill impairment charge of $262.0 million.

 

Additionally, as a result of the triggering events identified in the quarter, we initially performed quantitative impairment analyses over our indefinite-lived intangible assets and long-lived assets. With regards to indefinite-lived intangible assets, which includes the Houghton Mifflin Harcourt tradename at March 31, 2020, the recoverability is evaluated using a one-step process whereby we determine the fair value by asset and then compare it to its carrying value to determine if the asset is impaired. We estimated the fair value by preparing a relief-from-royalty discounted cash flow analysis using forward looking revenue projections. The significant assumptions used in discounted cash flow analysis include: future net sales, a long-term growth rate, a royalty rate and a discount rate used to present value future cash flows and the terminal value of the Education reporting unit. The discount rate is based on the weighted-average cost of capital method at the date of the evaluation. The fair value of the indefinite-lived intangible assets was in excess of its carrying value by approximately 12% as of March 31, 2020, and substantially exceeded its carrying value as of October 1, 2019. Adverse changes in our revenue forecast attributable to the indefinite-lived tradename could give rise to an impairment. We also performed an impairment test on our long-lived assets using an undiscounted cash flow model in determining the fair value, which was then compared to book value of the asset groups evaluated. Estimates and significant assumptions included in the long-lived asset impairment analysis included identification of the primary asset in each asset group and undiscounted cash flow projections. We concluded that our indefinite-lived intangible assets and long-lived assets are not impaired based on the results of the quantitative analyses performed.

 

We will continue to monitor and evaluate the carrying value of goodwill. Depending on how long the economic and social conditions resulting from COVID-19 exist and its future impact on state and local budgets with regards to educational spending, as well as discretionary consumer spending, we may be subject to further impairments in the future.   

3.

Significant Accounting Policies and Estimates

Our financial results are affected by the selection and application of accounting policies and methods. There were no material changes during the three months ended March 31, 2020 due 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, 2019.

We evaluate our estimates, judgments and methodologies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable, the results of which form the basis for making judgments about the carrying values of assets, liabilities and equity and the amount of revenues and expenses. The full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations and financial condition will depend on future developments that are highly uncertain, including as a result of new information that may emerge concerning COVID-19 and the actions taken to contain it or treat it, as well as the economic impact on local, regional, national and international customers and markets. We have made estimates of the impact of COVID-19 within our financial statements and there may be changes to those estimates in future periods. Actual results may differ from these estimates.

4.

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.

11


Recently Issued Accounting Standards

In December 2019, the Financial Accounting Standards Board (“FASB”) issued new guidance to simplify the accounting for income taxes by removing certain exceptions to the general principles, including simplification of areas such as franchise taxes, step-up in tax basis of goodwill, intraperiod allocations, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. The standard will be effective in 2021, with early adoption permitted. We are currently evaluating the impact of adopting this new accounting guidance, but do not expect it to have a material impact on our consolidated financial statements.  

 

Recently Adopted Accounting Standards

In August 2018, the FASB issued new guidance on a customer's accounting for implementation, set-up, and other upfront costs incurred in a cloud computing arrangement that is hosted by the vendor (i.e., a service contract). Under the new guidance, customers will apply the same criteria for capitalizing implementation costs as they would for an arrangement to develop or obtain internal use software. Accordingly, the guidance requires a customer to determine the stage of a project that the implementation activity relates to and the nature of the associated costs in order to determine whether those costs should be expensed as incurred or capitalized. The guidance also requires the customer to amortize the capitalized implementation costs as an expense over the term of the hosting arrangement.  We adopted the guidance on January 1, 2020. The adoption of this guidance did not have a material impact on our consolidated financial statements.

In January 2017, the 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. We adopted the guidance on January 1, 2020.  

In June 2016, the FASB issued new guidance that requires credit losses on financial assets measured at amortized cost basis to be presented at the net amount expected to be collected, not based on incurred losses, as well as additional disclosures. The estimate of expected credit losses should consider historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. We adopted the guidance on January 1, 2020.  The adoption of this guidance did not have a material impact on our consolidated financial statements.

We are exposed to credit losses primarily through our accounts receivable. We develop estimates to reflect the risk of credit loss which are based on an evaluation of accounts receivable aging, prior collection experience, current conditions and reasonable and supportable forecasts of the economic conditions that will exist through the contractual life of the financial asset. We write off the asset when it is no longer deemed collectible. We monitor our ongoing credit exposure through an active review of collection trends. Our activities include monitoring the timeliness of payment collection and performing timely account reconciliations. At March 31, 2020, we reported allowances for doubtful accounts of $3.5 million, compared to $3.0 million at December 31, 2019, reflecting an increase of $0.7 million, net of write-offs of $0.2 million for the three months ended March 31, 2020.

We are also exposed to losses on our royalty advances. Royalty advances to authors are capitalized and represent amounts paid in advance of the sale of an author’s product and are recovered as earned. As advances are recorded, a partial reserve may be recorded immediately based primarily upon historical sales experience. Additionally, advances are evaluated periodically to determine if they are expected to be recovered on a title-by-title basis. Any portion of a royalty advance that is not expected to be recovered is fully reserved. At March 31, 2020, we reported a reserve for royalty advances of $123.9 million, compared to $119.7 million at December 31, 2019, reflecting an increase of $4.2 million for the three months ended March 31, 2020.

5.

Inventories

Inventories consisted of the following:

 

 

 

March 31,

2020

 

 

December 31,

2019

 

Finished goods

 

$

258,161

 

 

$

203,103

 

Raw materials

 

 

7,203

 

 

 

9,956

 

Inventories

 

$

265,364

 

 

$

213,059

 

 

12


6.

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, 2020:

 

 

 

March 31,

2020

 

 

December 31,

2019

 

 

$ Change

 

 

% Change

 

Contract assets

 

$

294

 

 

$

109

 

 

$

185

 

 

NM

 

Contract liabilities (deferred revenue)

 

$

788,577

 

 

$

848,106

 

 

$

(59,529

)

 

 

(7.0

%)

 

NM = not meaningful

The $59.3 million net decrease in our contract assets and liabilities from December 31, 2019 to March 31, 2020 was primarily due to the satisfaction of performance obligations related to physical and digital products, and services during the period.

During the three months ended March 31, 2020 and 2019, we recognized the following net sales as a result of changes in the contract assets and contract liabilities balances:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2020

 

2019

 

Net sales recognized in the period from: