| Debt
|
|
|
|
|
|
|
1. | Basis of Presentation |
Houghton Mifflin Harcourt Company, formerly known as HMH Holdings (Delaware), Inc. (“HMH”, “Houghton Mifflin Harcourt”, “we”, “us”, “our”, or the “Company”), is a leading global provider of education solutions, delivering content, technology, services and media to over 50 million students in over 150 countries worldwide. We deliver our offerings to both educational institutions and consumers around the world. We believe our long-standing reputation and well-known brands enable us to capitalize on consumer and digital trends in the education market through our existing and developing channels. Furthermore, since 1832, we have published trade and reference materials, including adult and children’s fiction and non-fiction books that have won industry awards such as the Pulitzer Prize, Newbery and Caldecott medals and National Book Award, all of which are generally known.
The consolidated financial statements of HMH include the accounts of all of our wholly-owned subsidiaries as of March 31, 2014 and December 31, 2013 and the three month periods ended March 31, 2014 and March 31, 2013.
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 note 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 herein.
During the first quarter of 2014, we recorded an out of period correction of approximately $1.1 million reducing net sales and increasing deferred revenue that should have been deferred previously. In addition, during the first quarter of 2014, we recorded approximately $3.5 million of incremental expense, primarily commissions, related to the prior year. These out of period corrections had no impact on our debt covenant compliance. Management believes these out of period corrections are not material to the current period financial statements or any previously issued financial statements and does not expect them to be material for the full fiscal year 2014. Additionally, we revised previously reported balance sheet amounts to severance and other charges of $7.3 million, which has been reclassified as long term and to current deferred revenue of $5.2 million which has also been reclassified as long term. The revision was not material to the reported consolidated balance sheet for any previously filed periods.
Seasonality and Comparability
Our net sales, operating profit and operating cash flows 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.
Schools make most 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 years, approximately 67% of consolidated net sales have historically been 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. 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. There were no material changes in the three months ended March 31, 2014 to the application of significant accounting policies and estimates as described in our audited financial statements for the year ended December 31, 2013.
|
3. | Recent Accounting Pronouncements |
Recent accounting pronouncements, not included below, are not expected to have a material impact on our consolidated financial position and results of operations.
In July 2013, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance on the presentation of unrecognized tax benefits. This new guidance requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists, with limited exceptions. This new guidance is effective for the periods beginning after December 15, 2013, and should be applied prospectively with retroactive application permitted. Our adoption of the guidance did not impact our consolidated financial statements.
In February 2013, the FASB issued guidance requiring disclosure of amounts reclassified out of accumulated other comprehensive income (loss) by component. The amendment also requires entities to present significant amounts by the respective line items of net income (loss), either on the face of the income statement or in the notes to the financial statements for amounts required to be reclassified out of accumulated other comprehensive income (loss) in their entirety in the same reporting period. For other amounts that are not required to be reclassified to net income (loss) in their entirety, a cross-reference is required to other disclosures that provide additional details about those amounts. This guidance was effective prospectively for annual and interim periods beginning January 1, 2013 and is related to presentation only. Our adoption of the guidance did not impact our consolidated financial statements.
|
4. | Inventories |
Inventories consisted of the following:
March 31, 2014 |
December 31, 2013 |
|||||||
Finished goods |
$ | 201,067 | $ | 177,017 | ||||
Raw materials |
7,764 | 5,177 | ||||||
|
|
|
|
|||||
Inventory |
$ | 208,831 | $ | 182,194 | ||||
|
|
|
|
|
5. | Goodwill and Other Intangible Assets |
Goodwill and other intangible assets consisted of the following:
March 31, 2014 | December 31, 2013 | |||||||||||||||
Cost | Accumulated Amortization |
Cost | Accumulated Amortization |
|||||||||||||
Goodwill |
$ | 531,786 | $ | — | $ | 531,786 | $ | — | ||||||||
Trademarks and tradenames |
440,005 | — | 440,005 | — | ||||||||||||
Publishing rights |
1,180,000 | (814,688 | ) | 1,180,000 | (783,937 | ) | ||||||||||
Customer related and other |
283,172 | (202,191 | ) | 283,172 | (199,246 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 2,434,963 | $ | (1,016,879 | ) | $ | 2,434,963 | $ | (983,183 | ) | |||||||
|
|
|
|
|
|
|
|
Amortization expense for publishing rights and customer related and other intangibles were $33.7 million and $50.2 million for the three months ended March 31, 2014 and 2013, respectively.
|
6. | Debt |
Our debt consisted of the following:
March 31, 2014 |
December 31, 2013 |
|||||||
$250,000 term loan due May 21, 2018 interest payable monthly |
$ | 245,000 | $ | 245,625 | ||||
|
|
|
|
|||||
245,000 | 245,625 | |||||||
Less: Current portion of long-term debt |
2,500 | 2,500 | ||||||
|
|
|
|
|||||
Total long-term debt |
$ | 242,500 | $ | 243,125 | ||||
|
|
|
|
On January 15, 2014, we entered into Amendment No. 4 to our term loan facility, which reduced the interest rate applicable to outstanding borrowings by 1.0%. The transaction was accounted for under the accounting guidance for debt modifications and extinguishments. We recorded an expense of approximately $1.0 million relating to third party transaction fees which was included in the selling and administrative line item in its consolidated statement of operations for the three months ended March 31, 2014.
Loan Covenants
We are required to meet certain restrictive financial covenants as defined under our term loan facility and revolving credit facility. We have financial covenants pertaining to interest coverage, maximum leverage, and fixed charge ratios. The interest coverage ratio is now 9.0 to 1.0 for fiscal quarters ending through maturity. The maximum leverage ratios are set forth as follows: 2.0 to 1.0 for fiscal quarters ending December 31, 2013 and thereafter. The fixed charge ratio, which only pertains to the revolving credit facility and is only tested in limited situations, is 1.0 to 1.0 through the end of the facility. As of March 31, 2014, we were in compliance with all of our debt covenants.
Loan 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 our senior secured credit facilities 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.
|
7. | Severance and Other Charges |
2014
During the three months ended March 31, 2014, $2.4 million of severance payments were made to employees whose employment ended in 2014 and prior years and $1.1 million of net payments for office space no longer utilized by the Company. Further, we recorded an expense in the amount of $1.8 million to reflect additional costs for severance, which we expect to pay over the next twelve months.
2013
During the three months ended March 31, 2013, $1.3 million of severance payments were made to employees whose employment ended in 2013 and prior years and $2.1 million of net payments for office space no longer utilized by the Company. Further, we recorded an expense in the amount of $1.9 million to reflect additional costs for severance , which we expect to pay over the next twelve months.
A summary of the significant components of the severance/restructuring and other charges is as follows:
2014 | ||||||||||||||||
Severance/ restructuring accrual at December 31, 2013 |
Severance/ restructuring expense |
Cash payments | Severance/ restructuring accrual at March 31, 2014 |
|||||||||||||
Severance costs |
$ | 4,115 | $ | 1,757 | $ | (2,442 | ) | $ | 3,430 | |||||||
Other accruals |
11,416 | — | (1,084 | ) | 10,332 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 15,531 | $ | 1,757 | $ | (3,526 | ) | $ | 13,762 | ||||||||
|
|
|
|
|
|
|
|
2013 | ||||||||||||||||
Severance/ restructuring accrual at December 31, 2012 |
Severance/ restructuring expense |
Cash payments | Severance/ restructuring accrual at March 31, 2013 |
|||||||||||||
Severance costs |
$ | 2,142 | $ | 1,648 | $ | (1,276 | ) | $ | 2,514 | |||||||
Other accruals |
16,148 | 280 | (2,059 | ) | 14,369 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 18,290 | $ | 1,928 | $ | (3,335 | ) | $ | 16,883 | ||||||||
|
|
|
|
|
|
|
|
The current portion of the severance and other charges is $7.2 million, and $8.2 million as of March 31, 2014, and December 31, 2013, respectively.
|
8. | 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, and are individually computed, 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, 2014 and 2013, we recorded an income tax expense of approximately $1.8 million and $2.0 million, respectively. For both 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 1.2% and 1.4% for the three months ended March 31, 2014 and 2013, respectively.
Reserves for unrecognized tax benefits, excluding accrued interest, were $62.3 million at March 31, 2014 and December 31, 2013, respectively, and included in other long-term liabilities in the accompanying consolidated balance sheets.
|
9. | 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. 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 U.S. Internal Revenue Service. The nonqualified plan accrues benefits for the participants based on the cash balance plan calculation. In 2007, both the qualified and nonqualified pension plans eliminated participation in the plans for new employees hired after October 31, 2007. We also had a foreign defined benefit plan. On July 20, 2011, we entered into a bulk annuity policy with a third party which effectively terminated the foreign defined benefit plan. This policy covers all known plan beneficiaries and liabilities and represents a full transfer of the plan’s financial and longevity risk to the third party. The policy is held in the name of the plan trustees. This termination did not constitute a settlement of liability under applicable accounting guidance for pension plans. Following a full plan data cleansing, the bulk annuity policy is expected to be converted into individual annuity policies at which point the plan will be discharged of all future liability with respect to the plan beneficiaries. We anticipate the conversion to individual annuity policies along with the liability discharge likely to occur in 2014.
We are required to recognize the funded status of defined benefit pension and other postretirement plans as an asset or liability in the balance sheet and are required to recognize actuarial gains and losses and prior service costs and credits in other comprehensive income and subsequently amortize those items in the statement of operations. Further, we are required to use a measurement date equal to the fiscal year end.
Net periodic benefit cost for our pension and other postretirement benefits plans consisted of the following:
Pension Benefits | ||||||||
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Interest cost |
$ | 2,088 | $ | 1,789 | ||||
Expected return on plan assets |
(2,701 | ) | (2,468 | ) | ||||
Amortization of net (gain) loss |
2 | 83 | ||||||
|
|
|
|
|||||
Net periodic benefit (credit) cost |
$ | (611 | ) | $ | (596 | ) | ||
|
|
|
|
|||||
Other Post Retirement Benefits | ||||||||
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Service cost |
$ | 45 | $ | 56 | ||||
Interest cost |
296 | 274 | ||||||
Amortization of prior service cost |
(345 | ) | (345 | ) | ||||
Amortization of net (gain) loss |
— | 77 | ||||||
|
|
|
|
|||||
Net periodic benefit (credit) cost |
$ | (4 | ) | $ | 62 | |||
|
|
|
|
Contributions for the pension and post-retirement benefit plans for the three months ended March 31, 2014 and March 31, 2013 were $2.0 million and $2.4 million, respectively.
We expect to contribute an additional $6.8 million during the remainder of 2014.
|
10. | 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, and foreign exchange forward and option 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.
The following tables present our financial assets and liabilities measured at fair value on a recurring basis at March 31, 2014 and December 31, 2013:
March 31, 2014 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Valuation Technique |
|||||||||||
Financial assets |
||||||||||||||
Money market funds |
$ | 154,158 | $ | 154,158 | $ | — | (a) | |||||||
U.S. treasury securities |
48,026 | 48,026 | — | (a) | ||||||||||
U.S. agency securities |
52,535 | — | 52,535 | (a) | ||||||||||
Foreign exchange derivatives |
120 | — | 120 | (a) | ||||||||||
|
|
|
|
|
|
|||||||||
$ | 254,839 | $ | 202,184 | $ | 52,655 | |||||||||
|
|
|
|
|
|
December 31, 2013 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Valuation Technique |
|||||||||||
Financial assets |
||||||||||||||
Money market funds |
$ | 259,031 | $ | 259,031 | $ | — | (a) | |||||||
U.S. treasury securities |
57,076 | 57,076 | — | (a) | ||||||||||
U.S. agency securities |
54,645 | — | 54,645 | (a) | ||||||||||
Foreign exchange derivatives |
222 | — | 222 | (a) | ||||||||||
|
|
|
|
|
|
|||||||||
$ | 370,974 | $ | 316,107 | $ | 54,867 | |||||||||
|
|
|
|
|
|
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 $154.2 million and $259.0 million invested in money market funds as of March 31, 2014 and December 31, 2013, respectively, we had $13.6 million and $54.6 million of cash invested in bank accounts as of March 31, 2014 and December 31, 2013, respectively.
Our foreign exchange derivatives consist of forward and option 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 and option contracts to fix the functional currency value of forecasted commitments, payments and receipts. The aggregate notional amount of the outstanding foreign exchange forward and option contracts was $25.3 million and $24.1 million at March 31, 2014 and December 31, 2013, respectively. Our foreign exchange forward and option contracts contain netting provisions to mitigate credit risk in the event of counterparty default, including payment default and cross default. At March 31, 2014 and December 31, 2013, the fair value of our counterparty default exposure was less than $1.0 million and spread across several highly rated counterparties.
The following table presents our nonfinancial assets and liabilities measured at fair value on a nonrecurring basis during 2014 and 2013:
March 31, 2014 |
Significant (Level 3) |
Total Impairment |
Valuation Technique |
|||||||||||
Nonfinancial liabilities |
||||||||||||||
Contingent consideration liability associated with acquisitions |
$ | 1,911 | $ | 1,911 | $ | — | (c) | |||||||
|
|
|
|
|
|
|||||||||
$ | 1,911 | $ | 1,911 | $ | — | |||||||||
|
|
|
|
|
|
|||||||||
December 31, 2013 |
Significant (Level 3) |
Total Impairment |
Valuation Technique |
|||||||||||
Nonfinancial assets |
||||||||||||||
Property, plant, and equipment |
$ | — | $ | — | $ | 7,439 | (b) | |||||||
Pre-publication costs |
— | — | 1,061 | (b) | ||||||||||
Other intangible assets |
4,200 | 4,200 | 500 | (a)(c) | ||||||||||
|
|
|
|
|
|
|||||||||
$ | 4,200 | $ | 4,200 | $ | 9,000 | |||||||||
|
|
|
|
|
|
|||||||||
Nonfinancial liabilities |
||||||||||||||
Contingent consideration liability associated with acquisitions |
$ | 1,881 | $ | 1,881 | $ | — | (c) | |||||||
|
|
|
|
|
|
|||||||||
$ | 1,881 | $ | 1,881 | $ | — | |||||||||
|
|
|
|
|
|
Our nonfinancial 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 nonfinancial assets for impairment. If an impairment did occur, the asset is required to be recorded at the estimated fair value.
We review software development costs, included within property, plant, and equipment, for impairment. For the three months ended March 31, 2014 and March 31, 2013, no software development costs were impaired.
Pre-publication costs recorded on the balance sheet are periodically reviewed for impairment by comparing the unamortized capitalized costs of the assets to the fair value of those assets. For the three months ended March 31, 2014 and March 31, 2013, no pre-publication costs were impaired.
In evaluating goodwill for impairment, we first compare our reporting unit’s fair value to its carrying value. We estimate the fair values of our reporting units by considering market multiple and recent transaction values of peer companies, where available, and projected discounted cash flows, if reasonably estimable. There was no impairment recorded for goodwill for the three months ended March 31, 2014 and March 31, 2013.
We perform an impairment test for our other intangible assets by comparing the assets fair value to its carrying value. Fair value is estimated based on recent market transactions, where available, and projected discounted cash flows, if reasonably estimable. There was no impairment recorded for three months ended March 31, 2014 and March 31, 2013. The fair value of goodwill and other intangible assets are estimates, which are inherently subject to significant uncertainties, and actual results could vary significantly from these estimates.
The fair value of an acquisition-related contingent consideration liability is affected most significantly by changes in the estimated probabilities of the contingencies being achieved.
The following table presents a summary of changes in fair value of the Company’s Level 3 liabilities measured on a recurring basis for March 31, 2014 and December 31, 2013:
Level 3 Inputs Liabilities |
||||
Balance at December 31, 2012 |
$ | 5,055 | ||
Change in fair value of contingent consideration liability, included in selling and administrative expenses |
(1,599 | ) | ||
Payments of contingent consideration liability |
(1,575 | ) | ||
|
|
|||
Balance at December 31, 2013 |
1,881 | |||
Change in fair value of contingent consideration liability, included in selling and administrative expenses |
30 | |||
|
|
|||
Balance at March 31, 2014 |
$ | 1,911 | ||
|
|
Fair Value of Debt
The following table presents the carrying amounts and estimated fair market values of our debt at March 31, 2014 and December 31, 2013. 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, 2014 | December 31, 2013 | |||||||||||||||
Carrying Amount |
Estimated Fair Value |
Carrying Amount |
Estimated Fair Value |
|||||||||||||
Debt |
||||||||||||||||
$250,000 term loan |
$ | 245,000 | $ | 246,531 | $ | 245,625 | $ | 247,774 |
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, 2014 and December 31, 2013. 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.
|
11. | Commitments and Contingencies |
Contingencies
We are involved in ordinary and routine litigation and matters incidental to our business. Litigation alleging infringement of copyrights and other intellectual property rights has become extensive in the educational publishing industry. Specifically, there have been various settled, pending and threatened litigation that allege we exceeded the print run limitation or other restrictions in licenses granted to us to reproduce photographs in our textbooks. While management believes that there is a reasonable possibility we may incur a loss associated with the pending and threatened 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 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. We were contingently liable for $23.0 million of performance related surety bonds for our operating activities as of March 31, 2014 and December 31, 2013. An aggregate of $19.3 million and $19.7 million of letters of credit existed as of March 31, 2014 and December 31, 2013, respectively, of which $2.4 million backed the aforementioned performance related surety bonds as of March 31, 2014 and December 31, 2013, respectively.
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. The assessment business routinely enters into contracts with customers that contain provisions requiring us to indemnify the customer against a broad array of potential liabilities resulting from any breach of the contract or the invalidity of the test. 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 2014 and December 31, 2013.
Concentration of Credit Risk and Significant Customers
As of March 31, 2014, two customers represented approximately $121.9 million, or 46.8%, of our accounts receivable balance. We believe that our accounts receivable credit risk exposure is limited and we have not experienced significant write-downs in our accounts receivable balances. There is a payable by the Company to one of the same customers in the amount of $2.5 million and there is a contractual right to offset such customer.
As of December 31, 2013, two customers represented approximately $127.9 million, or 40.2%, of our accounts receivable balance. We believe that our accounts receivable credit risk exposure is limited and we have not experienced significant write-downs in our accounts receivable balances. There is a payable by the Company to one of the same customers in the amount of $4.6 million and there is a contractual right to offset with such customer.
|
13. | Segment Reporting |
As of March 31, 2014, we had two reportable segments (Education and Trade Publishing). 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 that are not keeping pace with peers, professional development and school reform services. Our Trade Publishing segment primarily develops, markets and sells consumer books in print and digital formats and licenses book rights to other publishers and electronic businesses in the United States and abroad. The principal markets for Trade Publishing products are retail stores, both physical and online, and wholesalers. Reference materials are also sold to schools, colleges, libraries, office supply distributors and other businesses.
We measure and evaluate our reportable segments based on net sales and segment Adjusted EBITDA. We exclude from segment Adjusted EBITDA 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 unusual and/or non-operational, such as amounts related to goodwill and other intangible asset impairment charges and restructuring related charges, as well as amortization expenses, are excluded from segment Adjusted EBITDA. Although we exclude these amounts from segment Adjusted EBITDA, they are included in reported consolidated operating income (loss) and are included in the reconciliation below.
(in thousands) | Three Months Ended March 31, | Total | ||||||||||||||
Education | Trade Publishing |
Corporate/ Other |
||||||||||||||
2014 |
||||||||||||||||
Net sales |
$ | 121,874 | $ | 32,059 | $ | — | $ | 153,933 | ||||||||
Segment Adjusted EBITDA |
(40,227 | ) | (1,318 | ) | (11,650 | ) | (53,195 | ) | ||||||||
2013 |
||||||||||||||||
Net sales |
$ | 126,827 | $ | 39,767 | $ | — | $ | 166,594 | ||||||||
Segment Adjusted EBITDA |
(26,613 | ) | 6,660 | (12,488 | ) | (32,441 | ) |
Reconciliation of Segment Adjusted EBITDA to the consolidated statements of operations is as follows:
(in thousands) | Three Months Ended March 31, | |||||||
2014 | 2013 | |||||||
Total Segment Adjusted EBITDA |
$ | (53,195 | ) | $ | (32,441 | ) | ||
Interest expense |
(4,297 | ) | (5,907 | ) | ||||
Depreciation expense |
(17,239 | ) | (14,342 | ) | ||||
Amortization expense |
(62,670 | ) | (76,358 | ) | ||||
Stock compensation |
(2,397 | ) | (1,587 | ) | ||||
Gain (loss) on derivative instruments |
(103 | ) | (530 | ) | ||||
Purchase accounting adjustments |
(575 | ) | (2,045 | ) | ||||
Fees, expenses or charges for equity offerings, debt or acquisitions |
(2,114 | ) | (288 | ) | ||||
Restructuring |
(205 | ) | — | |||||
Severance, separation costs and facility closures |
(1,757 | ) | (1,928 | ) | ||||
|
|
|
|
|||||
Loss from continuing operations before taxes |
(144,552 | ) | (135,426 | ) | ||||
|
|
|
|
|||||
Provision (benefit) for income taxes |
(1,783 | ) | (1,955 | ) | ||||
|
|
|
|
|||||
Net loss |
$ | (146,335 | ) | $ | (137,381 | ) | ||
|
|
|
|
|
Inventories consisted of the following:
March 31, 2014 |
December 31, 2013 |
|||||||
Finished goods |
$ | 201,067 | $ | 177,017 | ||||
Raw materials |
7,764 | 5,177 | ||||||
|
|
|
|
|||||
Inventory |
$ | 208,831 | $ | 182,194 | ||||
|
|
|
|
|
Goodwill and other intangible assets consisted of the following:
March 31, 2014 | December 31, 2013 | |||||||||||||||
Cost | Accumulated Amortization |
Cost | Accumulated Amortization |
|||||||||||||
Goodwill |
$ | 531,786 | $ | — | $ | 531,786 | $ | — | ||||||||
Trademarks and tradenames |
440,005 | — | 440,005 | — | ||||||||||||
Publishing rights |
1,180,000 | (814,688 | ) | 1,180,000 | (783,937 | ) | ||||||||||
Customer related and other |
283,172 | (202,191 | ) | 283,172 | (199,246 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 2,434,963 | $ | (1,016,879 | ) | $ | 2,434,963 | $ | (983,183 | ) | |||||||
|
|
|
|
|
|
|
|
|
Our debt consisted of the following:
March 31, 2014 |
December 31, 2013 |
|||||||
$250,000 term loan due May 21, 2018 interest payable monthly |
$ | 245,000 | $ | 245,625 | ||||
|
|
|
|
|||||
245,000 | 245,625 | |||||||
Less: Current portion of long-term debt |
2,500 | 2,500 | ||||||
|
|
|
|
|||||
Total long-term debt |
$ | 242,500 | $ | 243,125 | ||||
|
|
|
|
|
A summary of the significant components of the severance/restructuring and other charges is as follows:
2014 | ||||||||||||||||
Severance/ restructuring accrual at December 31, 2013 |
Severance/ restructuring expense |
Cash payments |
Severance/ restructuring accrual at March 31, 2014 |
|||||||||||||
Severance costs |
$ | 4,115 | $ | 1,757 | $ | (2,442 | ) | $ | 3,430 | |||||||
Other accruals |
11,416 | — | (1,084 | ) | 10,332 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 15,531 | $ | 1,757 | $ | (3,526 | ) | $ | 13,762 | ||||||||
|
|
|
|
|
|
|
|
2013 | ||||||||||||||||
Severance/ restructuring accrual at December 31, 2012 |
Severance/ restructuring expense |
Cash payments |
Severance/ restructuring accrual at March 31, 2013 |
|||||||||||||
Severance costs |
$ | 2,142 | $ | 1,648 | $ | (1,276 | ) | $ | 2,514 | |||||||
Other accruals |
16,148 | 280 | (2,059 | ) | 14,369 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 18,290 | $ | 1,928 | $ | (3,335 | ) | $ | 16,883 | ||||||||
|
|
|
|
|
|
|
|
|
Net periodic benefit cost for our pension and other postretirement benefits plans consisted of the following:
Pension Benefits | ||||||||
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Interest cost |
$ | 2,088 | $ | 1,789 | ||||
Expected return on plan assets |
(2,701 | ) | (2,468 | ) | ||||
Amortization of net (gain) loss |
2 | 83 | ||||||
|
|
|
|
|||||
Net periodic benefit (credit) cost |
$ | (611 | ) | $ | (596 | ) | ||
|
|
|
|
|||||
Other Post Retirement Benefits | ||||||||
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Service cost |
$ | 45 | $ | 56 | ||||
Interest cost |
296 | 274 | ||||||
Amortization of prior service cost |
(345 | ) | (345 | ) | ||||
Amortization of net (gain) loss |
— | 77 | ||||||
|
|
|
|
|||||
Net periodic benefit (credit) cost |
$ | (4 | ) | $ | 62 | |||
|
|
|
|
|
The following tables present our financial assets and liabilities measured at fair value on a recurring basis at March 31, 2014 and December 31, 2013:
March 31, 2014 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Valuation Technique |
|||||||||||
Financial assets |
||||||||||||||
Money market funds |
$ | 154,158 | $ | 154,158 | $ | — | (a) | |||||||
U.S. treasury securities |
48,026 | 48,026 | — | (a) | ||||||||||
U.S. agency securities |
52,535 | — | 52,535 | (a) | ||||||||||
Foreign exchange derivatives |
120 | — | 120 | (a) | ||||||||||
|
|
|
|
|
|
|||||||||
$ | 254,839 | $ | 202,184 | $ | 52,655 | |||||||||
|
|
|
|
|
|
December 31, 2013 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Valuation Technique |
|||||||||||
Financial assets |
||||||||||||||
Money market funds |
$ | 259,031 | $ | 259,031 | $ | — | (a) | |||||||
U.S. treasury securities |
57,076 | 57,076 | — | (a) | ||||||||||
U.S. agency securities |
54,645 | — | 54,645 | (a) | ||||||||||
Foreign exchange derivatives |
222 | — | 222 | (a) | ||||||||||
|
|
|
|
|
|
|||||||||
$ | 370,974 | $ | 316,107 | $ | 54,867 | |||||||||
|
|
|
|
|
|
The following table presents our nonfinancial assets and liabilities measured at fair value on a nonrecurring basis during 2014 and 2013:
March 31, 2014 |
Significant (Level 3) |
Total Impairment |
Valuation Technique |
|||||||||||
Nonfinancial liabilities |
||||||||||||||
Contingent consideration liability associated with acquisitions |
$ | 1,911 | $ | 1,911 | $ | — | (c) | |||||||
|
|
|
|
|
|
|||||||||
$ | 1,911 | $ | 1,911 | $ | — | |||||||||
|
|
|
|
|
|
|||||||||
December 31, 2013 |
Significant (Level 3) |
Total Impairment |
Valuation Technique |
|||||||||||
Nonfinancial assets |
||||||||||||||
Property, plant, and equipment |
$ | — | $ | — | $ | 7,439 | (b) | |||||||
Pre-publication costs |
— | — | 1,061 | (b) | ||||||||||
Other intangible assets |
4,200 | 4,200 | 500 | (a)(c) | ||||||||||
|
|
|
|
|
|
|||||||||
$ | 4,200 | $ | 4,200 | $ | 9,000 | |||||||||
|
|
|
|
|
|
|||||||||
Nonfinancial liabilities |
||||||||||||||
Contingent consideration liability associated with acquisitions |
$ | 1,881 | $ | 1,881 | $ | — | (c) | |||||||
|
|
|
|
|
|
|||||||||
$ | 1,881 | $ | 1,881 | $ | — | |||||||||
|
|
|
|
|
|
The following table presents a summary of changes in fair value of the Company’s Level 3 liabilities measured on a recurring basis for March 31, 2014 and December 31, 2013:
Level 3 Inputs Liabilities |
||||
Balance at December 31, 2012 |
$ | 5,055 | ||
Change in fair value of contingent consideration liability, included in selling and administrative expenses |
(1,599 | ) | ||
Payments of contingent consideration liability |
(1,575 | ) | ||
|
|
|||
Balance at December 31, 2013 |
1,881 | |||
Change in fair value of contingent consideration liability, included in selling and administrative expenses |
30 | |||
|
|
|||
Balance at March 31, 2014 |
$ | 1,911 | ||
|
|
The following table presents the carrying amounts and estimated fair market values of our debt at March 31, 2014 and December 31, 2013. 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, 2014 | December 31, 2013 | |||||||||||||||
Carrying Amount |
Estimated Fair Value |
Carrying Amount |
Estimated Fair Value |
|||||||||||||
Debt |
||||||||||||||||
$250,000 term loan |
$ | 245,000 | $ | 246,531 | $ | 245,625 | $ | 247,774 |
|
Although we exclude these amounts from segment Adjusted EBITDA, they are included in reported consolidated operating income (loss) and are included in the reconciliation below.
(in thousands) | Three Months Ended March 31, | Total | ||||||||||||||
Education | Trade Publishing |
Corporate/ Other |
||||||||||||||
2014 |
||||||||||||||||
Net sales |
$ | 121,874 | $ | 32,059 | $ | — | $ | 153,933 | ||||||||
Segment Adjusted EBITDA |
(40,227 | ) | (1,318 | ) | (11,650 | ) | (53,195 | ) | ||||||||
2013 |
||||||||||||||||
Net sales |
$ | 126,827 | $ | 39,767 | $ | — | $ | 166,594 | ||||||||
Segment Adjusted EBITDA |
(26,613 | ) | 6,660 | (12,488 | ) | (32,441 | ) |
Reconciliation of Segment Adjusted EBITDA to the consolidated statements of operations is as follows:
(in thousands) | Three Months Ended March 31, | |||||||
2014 | 2013 | |||||||
Total Segment Adjusted EBITDA |
$ | (53,195 | ) | $ | (32,441 | ) | ||
Interest expense |
(4,297 | ) | (5,907 | ) | ||||
Depreciation expense |
(17,239 | ) | (14,342 | ) | ||||
Amortization expense |
(62,670 | ) | (76,358 | ) | ||||
Stock compensation |
(2,397 | ) | (1,587 | ) | ||||
Gain (loss) on derivative instruments |
(103 | ) | (530 | ) | ||||
Purchase accounting adjustments |
(575 | ) | (2,045 | ) | ||||
Fees, expenses or charges for equity offerings, debt or acquisitions |
(2,114 | ) | (288 | ) | ||||
Restructuring |
(205 | ) | — | |||||
Severance, separation costs and facility closures |
(1,757 | ) | (1,928 | ) | ||||
|
|
|
|
|||||
Loss from continuing operations before taxes |
(144,552 | ) | (135,426 | ) | ||||
|
|
|
|
|||||
Provision (benefit) for income taxes |
(1,783 | ) | (1,955 | ) | ||||
|
|
|
|
|||||
Net loss |
$ | (146,335 | ) | $ | (137,381 | ) | ||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|