S-1 1 d570278ds1.htm FORM S-1 Form S-1
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As filed with the Securities and Exchange Commission on August 2, 2013

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

HMH Holdings (Delaware), Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   2731   27-1566372
(State or Other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

 

 

222 Berkeley Street

Boston, MA 02116

(617) 351-5000

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

 

 

William F. Bayers, Esq.

Executive Vice President, Secretary and General Counsel

HMH Holdings (Delaware), Inc.

222 Berkeley Street

Boston, MA 02116

(617) 351-5000

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

John C. Kennedy, Esq.

David S. Huntington, Esq.

Paul, Weiss, Rifkind, Wharton & Garrison LLP

1285 Avenue of the Americas

New York, NY 10019-6064

(212) 373-3000

 

Marc D. Jaffe, Esq.

Ian D. Schuman, Esq.

Latham & Watkins LLP

885 Third Avenue

New York, NY 10022-4834

(212) 906-1200

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

Calculation Of Registration Fee

 

 

Title of Each Class of

Securities to be Registered

 

Proposed

Maximum
Aggregate
Offering Price (1)(2)

  Amount of
Registration Fee (3)

Common stock, par value $0.01 per share

  $100,000,000   $13,640

 

 

(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457 under the Securities Act of 1933.
(2) Includes shares of common stock which the underwriters have the right to purchase to cover over-allotments, if any.
(3) Calculated pursuant to Rule 457(o) of the Securities Act of 1933.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

Dated August 2, 2013

             Shares

 

LOGO

HMH Holdings (Delaware), Inc.

COMMON STOCK

 

 

This is an initial public offering of HMH Holdings (Delaware), Inc. common stock.

The selling stockholders identified in this prospectus are offering all of the shares of common stock under this prospectus. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders. We anticipate that the initial public offering price will be between $         and $         per share.

We intend to apply to list the common stock on a national securities exchange under the symbol “HMHC.”

 

 

Investing in our common stock involves risks. See “Risk Factors” beginning on page 12.

PRICE $         PER SHARE

 

     Price to Public      Underwriting Discounts
and Commissions (1)
 

Per Share

   $                    $                

Total

   $         $     

 

(1) We have agreed to pay all underwriting discounts and commissions applicable to the sale of the common stock and certain expenses of the   selling stockholders incurred in connection with the sale.

The selling stockholders have granted the underwriters the option to purchase from them up to an additional             shares of common stock. We will not receive any proceeds from the sale of shares of our common stock pursuant to this option to purchase additional shares.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of common stock on or about                     , 2013.

 

 

 

   Goldman, Sachs & Co.       Morgan Stanley   
Citigroup    Credit Suisse    Wells Fargo Securities

Prospectus dated                     , 2013


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We, the selling stockholders and the underwriters have not authorized anyone to provide any information other than that contained in this prospectus or any free writing prospectus prepared by us or on our behalf or to which we have referred you. We can take no responsibility for, and can provide no assurances as to the reliability of, any information that others may give you. We and the selling shareholders are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the common stock.

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     12   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     24   

USE OF PROCEEDS

     26   

DIVIDEND POLICY

     27   

CAPITALIZATION

     28   

SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

     29   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     31   

BUSINESS

     59   

MANAGEMENT

     74   

EXECUTIVE COMPENSATION

     80   
 

 

 

As used in this prospectus, the terms “we,” “us,” “our,” “HMH” and the “Company” refer to HMH Holdings (Delaware), Inc. and its consolidated subsidiaries, unless otherwise expressly stated or the context otherwise requires.

 

 

Until                     , 2013 (25 days after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

 

TRADEMARKS

This prospectus contains references to our trademarks and service marks and to those belonging to other entities. Solely for convenience, trademarks and trade names referred to in this prospectus may appear without the ® or ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensor to these trademarks and trade names. We do not intend our use or display of other companies’ trade names, trademarks or service marks to imply a relationship with, or endorsement or sponsorship of us by, any other companies.

 

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STATEMENT REGARDING INDUSTRY AND MARKET DATA

Any market or industry data contained in this prospectus is based on a variety of sources, including internal data and estimates, independent industry publications, government publications, reports by market research firms or other published independent sources. Industry publications and other published sources generally state that the information contained therein has been obtained from third-party sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of such information. Our internal data and estimates are based upon information obtained from trade and business organizations and other contacts in the markets in which we operate and our management’s understanding of industry conditions, and such information has not been verified by any independent sources. Accordingly, investors should not place undue reliance on such data and information.

 

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PROSPECTUS SUMMARY

This summary highlights certain significant aspects of our business and this offering and is a summary of information contained elsewhere in this prospectus. This summary does not contain all of the information that you should consider before deciding whether to invest in our common stock. You should read this entire prospectus carefully, including the “Risk Factors” section and our consolidated financial statements and the notes to those statements included in this prospectus, before making an investment decision. This prospectus includes forward-looking statements that involve risks and uncertainties. See “Special Note Regarding Forward-Looking Statements.”

Overview

Our mission is to change people’s lives by fostering passionate, curious learners. We believe that by combining world-class educational content, products and services with cutting edge technology, digital innovation and research, we can make learning and teaching more effective and engaging.

We are a leading global provider of education solutions, delivering content, technology, services and media to over 60 million students in over 150 countries worldwide. We deliver our offerings to both educational institutions and consumers around the world. In the United States, we are the leading provider of K-12 educational content by market share and our instructional materials are used in every school district within the United States. We believe that nearly every current K-12 student in the United States has utilized our content during the course of his or her education. As a result, we have an established reputation with these students that is difficult for others to replicate and strongly positions us to continue to provide our broader content and services to serve their lifelong learning needs. Our long-standing, global reputation and well-known and trusted brands enable us to capitalize on the consumerization and digitalization of the education market through our existing and developing channels. Furthermore, since 1832, we have published trade and reference materials, including award-winning adult and children’s fiction and non-fiction books.

According to GSV Asset Management, the market for education content, media and services related expenditures is around $4.6 trillion globally. Our long-standing leadership position provides us with strong competitive advantages in this market. We have established trusted relationships with educators, institutions, parents, students and life-long learners around the world. This position of trust is founded on our consistent delivery of best-in-class content and services that meet the evolving needs of our customers. Our portfolio of intellectual property spans educational, general interest, children’s and reference works, and has been developed by award-winning authors—including 8 Nobel Prize winners, 47 Pulitzer Prize winners and 13 National Book Award winners—and industry-leading editors with deep expertise in learning and pedagogy. Our content includes globally recognized characters and titles such as Curious George, Carmen Sandiego, The Oregon Trail, The Little Prince, The Lord of the Rings, Life of Pi, Webster’s New World Dictionary and Cliffs Notes. Through our network of over 300 highly productive and experienced sales professionals, we are able to successfully serve our growing list of institutional customers. We believe that our unique combination of trusted relationships, best-in-class content portfolio, and our committed, effective sales team creates a competitive position that is difficult to replicate.

We monetize our proprietary content portfolio across multiple platforms and distribution channels and are expanding our addressable market beyond institutions, with an increasing focus on individual consumers who comprise a significant target audience of life-long learners. Leveraging our iconic and timeless children’s brands and titles such as Where in the World is Carmen Sandiego? and our Curious George-based Curious About series of mobile apps, we create rich interactive digital content and educational games, build engaging websites and provide effective, technology-based educational solutions. Based on the strength of our content portfolio and its

 

 

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adaptability across multiple distribution channels, we believe that we are also well positioned to expand into the adjacent early childhood development and global English language learning markets without significant additional costs associated with content development.

We believe we are leading the transformation of the traditional educational content and services landscape. Our complete digital portfolio, combined with our development partnerships with recognized technology leaders such as Apple, Samsung, Knewton and Kno, enables us to bring our next-generation learning solutions and media content to all learners across substantially all platforms and devices. Additionally, our technology and development capabilities allow us to enhance content engagement and effectiveness with embedded assessment, interactivity, personalization and adaptivity.

Adding to our comprehensive instructional materials, we provide testing and assessment solutions through our Riverside products. We also provide school improvement and professional development services, through our Heinemann products and The Leadership and Learning Center, that help teachers and administrators meet their academic objectives and regulatory mandates.

For the six months ended June 30, 2013 and for the years ended December 31, 2012, 2011 and 2010, our total net sales were $529.5 million, $1,285.6 million, $1,295.3 and $1,507.0 million, respectively. For the six months ended June 30, 2013 and for the years ended December 31, 2012, 2011 and 2010, our net loss was $151.6 million, $87.1 million, $2,182.4 million and $819.5 million, respectively, and our Adjusted EBITDA, a non-GAAP measure, was $64.7 million, $319.8 million, $238.2 million and $440.7 million, respectively. For a reconciliation of Adjusted EBITDA to net loss, see “—Summary Historical Consolidated Financial and Other Information.”

Market Opportunity

Rising Global Demand for Education

As a leading provider in the global learning and educational content market, we are well positioned to take advantage of the continued growth expected to result as more countries transition to knowledge-based economies, global markets integrate, and consumption, especially in emerging markets, rises. The global education sector is experiencing rising enrollments and increasing government and consumer spending driven by the close connection between levels of educational attainment, evolving standards, personal career prospects and economic growth.

U.S. K-12 Market is Large and Growing

In the United States, which is our primary market today, the K-12 education sector represents one of the largest industry segments accounting for over $638 billion of expenditures, or about 4.4% of the 2011 U.S. gross domestic product as measured by the U.S. Department of Education’s National Center for Education Statistics (“NCES”) for the 2010-2011 school year. The instructional supplies and services component of this market was estimated to be approximately $30 billion in 2011 and is expected to continue growing as a result of several secular and cyclical factors.

In addition to its size, the U.S. K-12 education market is highly decentralized and is characterized by complex content adoption processes. The sector is comprised of approximately 16,000 school districts across the 50 states, and 132,000 elementary and secondary schools. This market structure underscores the importance of scale and industry relationships and the need for broad, diverse coverage across states, districts and schools. Even while certain initiatives in the education sector such as the Common Core State Standards, a set of shared math and literacy standards benchmarked to international standards, have increased standardization in K-12 education

 

 

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content, significant state standard specific customization still exists, ensuring an ongoing need for companies in the sector to maintain deep relationships with individual state and district policymakers and expertise in state-varying academic standards.

Growth in the U.S. K-12 market for educational content and services will be driven by several factors. In the near term, total spend by institutions, which is largely dependent upon state and local funding, is increasing in the wake of the U.S. economic recovery. As tax revenues collected through income, sales and property taxes continue to rebound, institutional customers benefit from improved funding cycles.

Longer-term growth in the U.S. K-12 market is positively correlated with student enrollments. Compared to 55.0 million students in 2010, enrollments are expected to increase to over 58.0 million by the 2021 school year, according to NCES.

In addition, increased investment in areas of government policy focus is expected to further drive market growth. For example, President Obama has identified early childhood development as an important education initiative of his administration, and has developed a Preschool for All program with a $75 billion budget over the next 10 years to increase access to high quality early childhood education.

Increasing Focus on Accountability and Student Outcomes

U.S. K-12 education has come under significant political scrutiny in recent years, due to a recognition of its importance to the U.S. society at large and concern over the perceived decline in U.S. student competitiveness relative to their international peers.

This political focus has generated significant new legislation and government initiatives over the last decade, beginning with No Child Left Behind, implemented in 2002, and continuing with Race to the Top and other programs enacted by the Department of Education (“DOE”) since 2009. These regulatory frameworks have mandated stricter accountability, higher standards and increased transparency in education, and states have been required to measure annual progress towards these standards and make results publicly available for the first time.

As a result of these more rigorous regulations and standards, schools and districts have increased their focus on acquiring high quality, proven content that is aligned with standards and empowers educators to meet new requirements.

Growing Shift Towards Digital Materials

The digitalization of education content and delivery is also driving a substantial shift in the education market. Cloud computing-enabled, internet-based and mobile technologies are being adapted for educational uses and an increasing number of schools are implementing online or blended learning environments, and utilizing digital content in their classrooms. These trends are supported by widespread research which demonstrates improved efficacy in learning derived through online, interactive programs.

While the adoption of technology within the decentralized U.S. K-12 market may differ significantly across districts and states due to varying resources and infrastructure, most schools are seeking to implement more technology and are seeking partners to help them create effective digital learning environments. This presents opportunities for providers of instructional materials to broaden their existing relationships with institutional customers by offering content, service and technology solutions that meet these evolving needs.

 

 

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In addition, as sales of digital educational materials grow as a percentage of the total market, the relatively lower development and distribution costs of digital content relative to print products are expected to enhance the operating margins of companies that create and distribute educational content.

Consumerization of Education

As education continues to increase in importance in the modern knowledge economy, individual consumers are increasingly supplementing their formal education with additional learning programs and services that enhance existing knowledge and skills. In the United States alone, we believe parents spend more than $13 billion on at-home educational products annually. According to GSV Asset Management, the global English language learning market is forecast to grow to $80 billion by 2018. We believe that markets such as these represent important addressable markets for our company as we leverage our broad content portfolio across new growth opportunities.

Competitive Strengths

We believe we are a leader in our market based on our decades-long experience developing valuable content and solutions with strong customer appeal and forming and maintaining trusted customer relationships and industry partnerships. We believe the following to be our key competitive strengths:

 

 

Deep, proven, and high quality content portfolio. Our intellectual property portfolio is one of our most valuable and difficult to replicate assets and reflects multi-billion dollar investments over our history. Our portfolio contains almost 500,000 separate ISBNs spanning education, general interest, children’s and reference works and includes content developed in collaboration with highly respected educational authors such as Irene Fountas, Gay Pinnell and Ed Berger. We leverage this content, which is backed by decades of research, to provide educational products and solutions that are developed to meet or exceed U.S. and global education standards and are relied upon daily by thousands of teachers, students, parents and lifelong learners. Our approach to creating and maintaining our entire content library digitally enables us to provide products and solutions through device-agnostic, digital learning platforms in a variety of formats and allows us to create new solutions with minimal incremental investment.

 

 

Long-standing, trusted relationships with educators and other key education stakeholders. We believe our relationships with educators are an important source of competitive advantage and reflect our expertise in educational policy, content development and ultimate delivery of results-driven education solutions. Given the high-stakes nature of the K-12 education market’s multi-year usage cycle, educators have little room for error in selecting programs for their schools and seek out relationships with trusted providers to minimize curriculum selection risk. Our sales force utilizes a strategic, consultative approach that involves stakeholders at every level of the decision-making process, from state legislators and school districts to school administrators and teachers. Our approach positions us to flexibly respond to schools’ and teachers’ needs, as demonstrated by our growing suite of professional services, which are focused on improving educational effectiveness at both the institutional and instructor levels.

 

 

Iconic, beloved brands with direct connections to learners of all ages around the world. Our brands include globally recognized and beloved characters and titles such as Curious George, Gossie and Gertie, Polar Express and Life of Pi, all of which resonate with students, teachers, educators and parents. We believe that nearly every school-aged child in the United States has used our curriculum as part of their education. Our core instructional materials reach 100% of the top 1,000 school districts in the United States. Recent Q score data, a measurement of the familiarity and appeal of a brand used in the United States, indicates that Curious George’s recognition among mothers of children aged 2 to 11 is greater than Mickey Mouse. This combination of reach and recognition contributes to what we believe is a long-lasting relationship with consumers, who are introduced to our brands as children, use our educational products throughout their pre-K-12 school years, read our general interest titles as adults, and then purchase our

 

 

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content for their own children. With our combination of unique brands and extensive reach both within the United States and worldwide, we have a strong foundation upon which to further monetize our intellectual property across new mediums and channels, including websites, mobile applications, e-books and games.

 

 

Strategic partnerships with industry and technology thought leaders. Our position as a leader in our market allows us to continually expand upon our strategic partnerships with both industry and technology thought leaders. These partnerships enable us to create innovative solutions that meet the evolving needs of the global education market. Our unique partnerships, such as those with Knewton and Kno, allow us to leverage cutting-edge technologies that bring unprecedented levels of interactivity, adaptivity and personalization to our content while enabling us to distribute under newly developed pricing and delivery models. Our relationships also provide us with exclusive content from popular or highly marketable providers, such as the History Channel, from which we integrate into our leading education solutions to further strengthen our appeal to customers.

 

 

Strong financial position and scalable business model. Our strong financial position is derived from our proven ability to generate significant cash flow from operating activities. For the years ended December 31, 2012 and 2011, we generated $104.8 million and $132.8 million of cash flow from operations, respectively. Since 2010, we have reduced our selling and administrative expenses by approximately $183.2 million while reducing headcount by 720 full time employees, or 18%. We believe that as we continue to monetize our content across newly developed channels and implement new revenue and pricing models, we will begin to realize even greater sales while incurring lower incremental costs, which will further improve our operating margins. In addition, as we distribute more of our content in digital formats, our operating margins will benefit from lower development and distribution costs relative to print products. We believe our strong financial position provides the flexibility to continue to invest in new projects and pursue selective acquisitions.

 

 

Experienced, technology-focused and innovation-oriented management team. Our management team consists of industry leaders with a unique combination of technology-based backgrounds and relevant experience from prior positions at technology and media leaders such as IBM, Microsoft, Oracle, Peoplesoft, Texas Instruments and Thomson Reuters, among others. During their tenure, the team has demonstrated their execution capabilities by successfully refocusing the Company to create a digitally-enabled content platform that has better positioned us for growth in a rapidly changing educational content environment. Additionally, the management team has aligned the Company’s sales force and optimized its cost structure to create a more nimble and responsive organization. We believe our management team has the skills necessary to maintain and build upon our position as a leader in the digital transformation of the industry.

Strategies for Growth

Our growth strategies involve broadening our content and service offerings to meet the growing needs of an evolving educational landscape, acquiring new customers while simultaneously cross-selling and upselling our solutions to existing customers and monetizing our existing assets across new channels and markets. We intend to pursue the following strategies to drive our future growth:

 

 

Deepen penetration of existing educational markets by adapting and broadening our content and service offerings. We intend to invest in additional content, value-added services and digital offerings. We offer our content on a wide variety of technology platforms and we continue to explore new, digitally enabled opportunities to reach a broader audience and cater to customer specific needs. We believe our strong brand, combined with our track record of student achievement, customer satisfaction, and strong relationships with educators will allow us to further penetrate existing markets and customers by offering innovative new products and services and will provide new opportunities for growth.

 

 

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Expand into adjacent high-growth education markets. We intend to pursue a number of existing opportunities involving emerging and adjacent education segments by leveraging our expertise in content development and our competencies in addressing the educational needs of learners of all ages. We are designing our proprietary curriculum with the goal of penetrating a diverse set of adjacent markets, which range from early childhood development to workforce re-entry for adults. We believe our strong brand, combined with our track record of learning efficacy, achievement and customer satisfaction will allow us to address a broad array of customer needs, all with minimal, incremental capital spending.

 

 

Grow our international presence and global footprint. Our international strategy leverages the success of and expertise derived from our core U.S. business and is intended to focus on high growth international segments such as English language learning, a market that is estimated to grow at a 15% compound annual growth rate to $80 billion by 2018, according to GSV Asset Management. In many countries, students seek English language learning content and the U.S. curriculum to eventually gain access to higher education in the United States or improved employment opportunities in their home market. In addition, a significant number of English speaking educational institutions require high quality, English language education and pedagogical materials. We plan to continue building on our existing international footprint by targeting areas where demand for our English language offerings is high, including Brazil, China, India, Korea, Mexico, Philippines, and the Middle-Eastern Gulf States.

 

 

Further monetize our content by targeting new customers and channels. We intend to leverage our current portfolio to address a full spectrum of learning needs while increasing the appeal of our solutions to more customers. As parents increasingly seek to improve their students’ scholastic achievement, and as cost effective alternatives for at-home educational enhancement proliferate, the market for online learning products is expected to grow substantially. Our online customers, which in 2012 included over 60 million hits across our various websites and learning management platforms, will serve as the initial target market. We expect to monetize our content across the online channel to ultimately provide opportunities to derive revenues from a variety of models including website advertising and sales of subscription-based learning applications, in addition to direct sales of physical materials and e-books to consumers.

 

 

Continue to pursue strategic acquisitions to extend our leadership position. We intend to complement our organic growth with highly selective acquisitions of content, technologies, solutions and businesses, targeted to enhance our ability to accelerate our strategic initiatives and capitalize on our strengths. Our strength, expertise and scale allows us to reduce time to market, enhance certain features or capabilities, and serve a broader audience for these acquired offerings.

Products and Services

Our products and services are organized under our two reportable segments: Education and Trade Publishing. The Education segment is our largest business, representing approximately 88%, 90% and 92% of our total net sales for the years ended December 31, 2012, 2011 and 2010, respectively.

Education

Our Education segment provides a comprehensive suite of 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, professional development and school reform services. We develop programs aligned to state standards and customized for specific state requests. In addition, our Education segment offers a wide range of standardized testing products targeting the assessment markets.

 

 

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Our Education products consist of the following offerings:

 

 

Comprehensive Curriculum. We develop comprehensive educational programs intended to provide a complete course of study in a subject, either at a single grade level or across multiple grade levels, and serve as the primary source of classroom instruction. The Comprehensive Curriculum publishing portfolio is focused on subjects that consistently receive the highest priority from educators and educational policy makers, namely reading, literature/language arts, mathematics, science, world languages and social studies.

 

 

Supplemental Products. We develop products targeted at addressing struggling learners through comprehensive intervention solutions, products targeted at assisting English language learners and products providing incremental instruction in a particular subject area. Supplemental Products are used both as alternatives and as supplements to Comprehensive Curriculum programs.

 

 

Heinemann. Heinemann produces professional books and developmental resources aimed at empowering pre-K-12 teachers as well as our market-leading literacy program Benchmarks/LLI. The author base includes some of the most prominent experts in teaching, who support the practice of other teachers through books, videos, workshops and classroom tools.

 

 

Professional Services/The Leadership and Learning Center. Through The Leadership and Learning Center, we provide consulting services to assist school districts in increasing accountability for improvement and offering professional development training, comprehensive services and school turnaround solutions. Our services include learning resources that are supported with effective professional development in classroom assessment, teacher effectiveness and high impact leadership, which are all proven to have a measurable and sustainable impact on student achievement.

 

 

Riverside Assessment. Riverside Assessment products provide district and state level solutions focused on clinical, group and formative assessment tools and platform solutions. Clinical solutions provide psychological and special needs testing to assess intellectual, cognitive and behavioral development.

 

 

International. Our International products are educational solutions that are sold into global education markets predominantly to large English language schools in high growth territories primarily in Asia, the Pacific, the Middle East, Latin America, the Caribbean and Africa. In addition to our dedicated sales team, we have a network of international partners and alliances, including distributors, in local markets around the world.

Trade Publishing

Our Trade Publishing segment, established in 1832, 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. We offer a rich library of general interest, children’s and reference works that include beloved characters and well-known brands and featuring numerous Nobel and Pulitzer Prize winners and Newbery and Caldecott medal winners, including a 2012 Caldecott Honor winner.

We are increasingly leveraging the strength of our Trade Publishing brands and characters, such as Curious George, together with our expertise in developing highly effective educational solutions, to further penetrate the large and growing consumer market for at-home educational products and services.

Corporate Information

HMH Holdings (Delaware), Inc. was incorporated under the laws of the State of Delaware on March 5, 2010. Our principal executive offices are located at 222 Berkeley Street, Boston, Massachusetts 02116. Our telephone number is (617) 351-5000. Our website is www.hmhco.com. Information contained on our website does not constitute a part of this prospectus.

 

 

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THE OFFERING

The summary below describes the principal terms of this offering. The “Description of Capital Stock” section of this prospectus contains a more detailed description of the common stock.

 

Common stock offered by us

We are not selling any shares of common stock in this offering.

 

Common stock offered by the selling stockholders

             shares of common stock (             shares if the underwriters exercise their option to purchase additional shares in full).

 

Common stock to be outstanding immediately after this offering

Immediately after this offering, we will have              shares of common stock issued and outstanding.

 

Over-allotment option

The selling stockholders have granted the underwriters the option to purchase up to an additional              shares of common stock within 30 days from the date of this prospectus.

 

Use of proceeds

The selling stockholders will receive all of the proceeds from the sale of the common stock offered under this prospectus. Accordingly, we will not receive any proceeds from the sale of the common stock in this offering.

 

Dividend policy

We do not intend to declare or pay any cash dividends on our common stock for the foreseeable future. See “Dividend Policy.”

 

Listing

We intend to apply to list our common stock on a national securities exchange under the symbol “HMHC.”

 

Risk factors

Investing in our common stock involves substantial risks. See “Risk Factors” for a discussion of risks you should carefully consider before deciding whether to invest in our common stock.

The number of shares of our common stock outstanding after this offering excludes 8,175,135 shares issuable pursuant to the HMH Holdings (Delaware), Inc. 2012 Management Incentive Plan (the “MIP”), including 4,976,860 shares that are subject to options granted pursuant to the MIP as of June 30, 2013 at a weighted average exercise price of $25.00 per share and 68,105 restricted stock units outstanding as of June 30, 2013, and excludes 3,684,211 shares of common stock that we may issue upon exercise of outstanding warrants as of June 30, 2013, with a weighted average exercise price of $42.27 per share. See “Executive Compensation.”

Except as otherwise indicated, all information in this prospectus:

 

   

assumes the underwriters’ option to purchase additional shares will not be exercised; and

 

   

assumes an initial public offering price of $         per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus).

 

 

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SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OTHER INFORMATION

The following table summarizes the consolidated historical financial data of HMH Holdings (Delaware), Inc. (Successor) and HMH Publishing Company (Predecessor) for the periods presented. We derived the consolidated historical financial data as of December 31, 2012 and 2011, for the years ended December 31, 2012 and 2011 (Successor) and for the periods March 10, 2010 to December 31, 2010 (Successor) and January 1, 2010 to March 9, 2010 (Predecessor) from the audited consolidated financial statements included elsewhere in this prospectus. We derived the consolidated historical financial data as of June 30, 2013 and for the six months ended June 30, 2013 and 2012 from our unaudited consolidated interim financial statements included elsewhere in this prospectus. We derived the consolidated historical financial data as of June 30, 2012 from our unaudited consolidated interim financial statements not included in this prospectus. We have prepared our unaudited consolidated interim financial statements on the same basis as our audited consolidated financial statements and, in our opinion, have included all adjustments necessary to state fairly in all material respects our financial position and results of operations. Historical results for any prior period are not necessarily indicative of results to be expected in any future period, and results for any interim period are not necessarily indicative of results for a full fiscal year.

The data set forth in the following table should be read together with the sections of this prospectus entitled “Capitalization,” “Selected Historical Financial and Operating Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes thereto included elsewhere in this prospectus.

 

    Successor          Predecessor  
(in thousands, except share and per share
data)
  Six Months
Ended
June 30,

2013
    Six Months
Ended
June 30,

2012
    Year Ended December 31,     March 10,
2010 to
December 31,
2010
         January 1,
2010 to
March 9,

2010
 
      2012     2011        

Operating Data:

               

Net sales

  $ 529,545      $ 509,433      $ 1,285,641      $ 1,295,295      $ 1,397,142          $ 109,905   

Cost and expenses:

               

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

    245,816        214,272        515,948        512,612        559,593            45,270   

Publishing rights amortization (1)

    72,587        92,677        177,747        230,624        235,977            48,336   

Pre-publication amortization (2)

    56,653        66,433        137,729        176,829        181,521            37,923   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Cost of sales

    375,056        373,382        831,424        920,065        977,091            131,529   

Selling and administrative

    263,703        280,452        533,462        638,023        597,628            119,039   

Other intangible asset amortization

    13,433        26,372        54,815        67,372        57,601            2,006   

Impairment charge for goodwill, intangible assets, pre-publication costs and fixed assets

    8,500        —          8,003        1,674,164        103,933            4,028   

Severance and other charges (3)

    3,481        3,473        9,375        32,801        (11,243         —     

Gain on bargain purchase

    —          —          (30,751     —          —              —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Operating loss

    (134,628     (174,246     (120,687     (2,037,130     (327,868         (146,697
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Other Income (expense):

               

Interest expense

    (11,585     (109,833     (123,197     (244,582     (258,174         (157,947

Other (loss) income, net

    —          —          —          —          (6         9   

Loss on extinguishment of debt

    (598     —          —          —          —              —     

Change in fair value of derivative instruments

    (479     812        1,688        (811     90,250            (7,361
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Loss before reorganization items and taxes

    (147,290     (283,267     (242,196     (2,282,523     (495,798         (311,996

Reorganization items, net (4)

    —          (156,894     (149,114     —          —              —     

Income tax expense (benefit)

    4,357        (6,500     (5,943     (100,153     11,929            (220
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net loss

  $ (151,647   $ (119,873   $ (87,139   $ (2,182,370   $ (507,727       $ (311,776
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net loss per share from continuing operations - basic and diluted

  $ (2.17   $ (0.44   $ (0.51   $ (7.69   $ (1.79       $ (100,572.90
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Net loss per share attributable to common stockholders - basic and diluted

  $ (2.17   $ (0.44   $ (0.51   $ (7.69   $ (1.79       $ (100,572.90
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Weighted average number of common shares used in net loss per share attributable to common stockholders - basic and diluted

    69,959,522        272,624,886        170,459,064        283,636,235        283,636,235            3,100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

 

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    Successor          Predecessor  
    Six Months
Ended
June 30,
2013
    Six Months
Ended
June 30,
2012
   

 

Year Ended December 31,

    March 10,
2010 to
December 31,
2010
         January 1,
2010 to
March 9,
2010
 
(in thousands)             2012                 2011              

Balance Sheet Data (as of period end):

               

Cash, cash equivalents and short-term investments

  $ 212,579      $ 266,083      $ 475,119      $ 413,610      $ 397,740         

Working capital

    508,262        443,129        599,085        440,844        380,678         

Total assets

    2,879,275        3,023,152        3,029,584        3,263,903        5,257,155         

Debt (short-term and long-term)

    246,875        250,000        248,125        3,011,588        2,861,594         

Stockholders’ equity (deficit)

    1,794,839        1,861,514        1,943,701        (674,552     1,517,828         
 

Statement of Cash Flows Data:

               

Net cash provided by (used in):

               

Operating activities

    (152,768     (218,219     104,802        132,796        182,966          $   (41,296

Investing activities

    (69,858     (53,479     (295,998     (195,300     (232,122         (25,616

Financing activities

    (1,250     124,171        106,664        96,041        402,289            (150
 

Other Data:

               

Capital expenditures:

               

Pre-publication capital expenditures (5)

    74,808        59,408        114,522        122,592        96,613            22,057   

Other capital expenditures

    31,213        20,566        50,943        71,817        64,139            3,559   

Depreciation and amortization

    172,898        212,484        428,422        532,996        523,651            99,260   

Adjusted EBITDA (6)

    64,707        50,729        319,812        238,198        472,751            (32,014

 

(1) Publishing rights are intangible assets that allow us to publish and republish existing and future works as well as create new works based on previously published materials and are amortized on an accelerated basis over periods estimated to represent the useful life of the content.
(2) We capitalize the art, prepress, manuscript and other costs incurred in the creation of the master copy of a book or other media and amortize such costs from the year of sale over five years on an accelerated basis.
(3) Represents severance and real estate charges. The credit balance in 2010 relates to the reversal of certain charges recorded in prior periods due to a change in estimate.
(4) Represents net gain associated with our Chapter 11 reorganization in 2012.
(5) Represents capital expenditures for the art, prepress, manuscript and other costs incurred in the creation of the master copy of a book or other media.
(6) 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, or levels of depreciation or amortization. Accordingly, our management believes that this measurement is useful for comparing general operating performance from period to period. Furthermore, the agreements governing our indebtedness contain covenants and other tests based on Adjusted EBITDA. In addition, targets and positive trends in Adjusted EBITDA are used as performance measures and to determine certain compensation of management. 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 earnings 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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The following table reconciles net loss to Adjusted EBITDA:

 

    Successor          Predecessor  
(in thousands)   Six Months
Ended
June 30,

2013
    Six Months
Ended
June 30,

2012
    Year Ended December 31,     March 10,
2010 to
December 31,
2010
         January 1,
2010 to
March 9,
2010
 
            2012                 2011              

Net loss

  $ (151,647   $ (119,873   $ (87,139   $ (2,182,370   $ (507,727       $ (311,776

Interest expense

    11,585        109,833        123,197        244,582        258,174            157,947   

Provision (benefit) for income taxes

    4,357        (6,500     (5,943     (100,153     11,929            (220

Depreciation expense

    30,225        27,003        58,131        58,392        48,649            10,900   

Amortization expense

    142,673        185,482        370,291        474,825        475,099            88,265   

Non-cash charges—stock compensation

    3,275        347        4,227        8,558        4,274            925   

Non-cash charges—gain (loss) on foreign currency and interest hedge

    479        (812     (1,688     811        (90,250         7,361   

Non-cash charges—asset impairment charges

    8,500        —          8,003        1,674,164        103,933            4,028   

Purchase accounting
adjustments (a)

    4,878        6,326        (16,511     22,732        113,182            —     

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

    1,764        267        267        3,839        1,513            —     

Debt restructuring (b)

    —          —          —          —          30,000            9,564   

Restructuring (c)

    1,539        1,788        6,716        —          —              —     

Severance, separation costs and facility
closures (d)

    6,481        3,762        9,375        32,818        23,975            992   

Reorganization items, net (e)

    —          (156,894     (149,114     —          —              —     

Debt extinguishment loss

    598        —          —          —          —              —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Adjusted EBITDA

  $ 64,707      $ 50,729      $ 319,812      $ 238,198      $ 472,751          $ (32,014
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

(a) Represents certain non-cash accounting adjustments, most significantly relating to deferred revenue and inventory costs, that we were required to record as a direct result of the March 9, 2010 restructuring and the acquisitions for the years ended December 31, 2012 and 2011 and the periods March 10, 2010 to December 31, 2010 and January 1, 2010 to March 9, 2010.
(b) Represents fees paid and charged to operations relating to the March 9, 2010 debt restructuring.
(c) Represents restructuring costs (other than severance and real estate) such as consulting and realignment.
(d) Represents costs associated with restructuring. Included in such costs are severance, facility integration and vacancy of excess facilities. 2010 costs also include program integration and related inventory obsolescence and consulting costs.
(e) Represents net gain associated with our Chapter 11 reorganization in 2012.

 

 

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RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the following risks and all of the other information set forth in this prospectus before deciding whether to invest in our common stock. If any of the following risks actually occurs, our business, financial condition or results of operations would likely suffer. In such case, the trading price of our common stock would likely decline due to any of these risks, and you may lose all or part of your investment.

Risks Related to Our Business and Our Industry

Our business and results of operations may be adversely affected by many factors outside of our control, including changes in federal, state and local education funding, general economic conditions and/or changes in the state procurement process.

The performance and growth of our U.S. educational comprehensive curriculum, supplemental and assessment businesses depend in part on federal and state education funding, which in turn is dependent on the robustness of state finances and the level of funding allocated to educational programs. State, local and municipal finances were and continue to be adversely affected by the recent U.S. economic recession and are affected by general economic conditions and factors outside of our control, as well as increasing costs and financial liabilities of under-funded public pension plans. In response to general economic conditions or budget shortfalls, states and districts may reduce educational spending to protect against existing or expected economic conditions or seek cost savings to mitigate budget deficits. Most public school districts, the primary customers for K-12 products and services, depend largely on state and local funding to purchase materials. In school districts in states that primarily rely on local tax proceeds, significant reductions in those proceeds for any reason can severely restrict district purchases of instructional materials. In districts and states that primarily rely on state funding for instructional materials, a reduction in state funds or loosening of restrictions on the use of those funds may reduce net sales. Additionally, many school districts receive substantial amounts through Federal education programs, funding for which may be reduced as a result of the Federal sequester.

Federal and/or state legislative changes can also affect the funding available for educational expenditure, which include the impact of education reform such as the reauthorization of the Elementary and Secondary Education Act (“ESEA”) and the implementation of Common Core State Standards. Existing programs and funding streams could be changed or eliminated in connection with legislation to reauthorize the ESEA and/or the federal appropriations process, in ways that could negatively affect demand and sources of funding for our products and services. Our business, results of operations and financial condition may be materially adversely affected by many factors outside of our control, including, but not limited to, delays in the timing of adoptions, changes in curricula and changes in student testing processes. There can be no assurances that states or districts will have sufficient funding to purchase our products and services, that we will win their business in our competitive marketplace or that schools or districts that have historically purchased our products and services will do so again in the future.

Similarly, changes in the state procurement process for textbooks, supplemental materials and student tests, particularly in adoption states, can also affect our markets and sales. A significant portion of our net sales is derived from sales of K-12 instructional materials pursuant to cyclical adoption schedules. Due to the revolving and staggered nature of state adoption schedules, sales of K-12 instructional materials have traditionally been cyclical, with some years offering more sales opportunities than others. In addition, changes in curricula and changes in the student testing processes can negatively affect our programs and therefore the size of our market in any given year.

For example, over the next few years, adoptions are scheduled in the primary subjects of reading, language arts and literature, social studies and mathematics in, among others, the states of Texas and Florida, two of the largest adoption states. The inability to succeed in these two states, or reductions in their anticipated funding

 

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levels, could materially and adversely affect net sales for the year of adoption and subsequent years. Allowing districts flexibility to use State funds previously dedicated exclusively to the purchase of instructional materials and other items such as technology hardware and training could adversely affect district expenditures on state-adopted instructional materials in the future.

Decreases in federal and state education funding and negative trends or changes in general economic conditions can have a material adverse effect on our business, results of operations and financial condition.

Introduction of new products, services or technologies could impact our profitability.

We operate in highly competitive markets that continue to change to adapt to customer needs. In order to maintain a competitive position, we must continue to invest in new content and new ways to deliver our products and services. These investments may not be profitable or may be less profitable than what we have experienced historically. In particular, in the context of our current focus on key digital opportunities, including e-books, the market is evolving and we may be unsuccessful in establishing ourselves as a significant competitor. New distribution channels, such as digital platforms, the internet, online retailers and delivery platforms (e.g., tablets and e-readers), present both threats and opportunities to our traditional publishing models, potentially impacting both sales volumes and pricing.

Our operating results fluctuate on a seasonal and quarterly basis and our business is dependent on our results of operations for the third quarter.

Our business is seasonal. For the year ended December 31, 2012, we derived approximately 88% of net sales from educational publishing in our Education segment. For sales of educational products, purchases typically are made primarily in the second and third quarters of the calendar year, in preparation for the beginning of the school year, though testing net sales are primarily generated in the second and fourth quarters. We typically realize a significant portion of net sales during the third quarter, making third-quarter results material to full-year performance. This sales seasonality affects operating cash flow from quarter to quarter. We normally incur a net cash deficit from all of our activities through the middle of the third quarter of the year. In addition, changes in our customers’ ordering patterns may impact the comparison of results in a quarter with the same quarter of the previous year, in a quarter with the consecutive quarter or a fiscal year with the prior fiscal year.

We may not be able to identify successful business models for generating sales of technology-enabled programs. Furthermore, customers’ expectations for the number and sophistication of technology-enabled programs that are given to them at no additional charge may increase, as may development costs.

The core curriculum elementary school, core curriculum secondary school and educational testing customers have become accustomed to being given technology-enabled products at no additional charge from publishers, such as us, as incentives to adopt programs and other products. The sophistication and expense of technology-enabled products continues to grow. Our profitability may decrease materially if we are unable to realize sales of these products, customers continue to expect/insist on an increasing number of technology-enabled materials of increasing quality being given to them, or costs of these products continue to rise.

Our business will be impacted by the rate of and state of technological change, including the digital evolution and other disruptive technologies, and the presence and development of open-sourced content could continue to increase, which could adversely affect our revenue.

The publishing industry has been impacted by the digitalization of content and proliferation of distribution channels, either over the internet, or via other electronic means, replacing traditional print formats. The digital migration brings the need for change in product distribution, consumers’ perception of value and the publisher’s position between retailers and authors. Such digitalization increases competitive threats both from large media

 

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players and from smaller businesses, online and mobile portals. If we are unable to adapt and transition to the move to digitalization at the rate of our competitors, our ability to effectively compete in the marketplace will be affected.

In recent years there have been initiatives by non-profit organizations such as the Gates Foundation and the Hewlett Foundation to develop educational content that can be “open sourced” and made available to educational institutions for free or nominal cost. To the extent that such open sourced content is developed and made available to educational customers and is competitive with our instructional materials, our sales opportunities and net sales could be adversely affected.

Technological changes and the availability of free or relatively inexpensive information and materials may also affect changes in consumer behavior and expectations. Public and private sources of free or relatively inexpensive information and lower pricing for digital products may reduce demand and impact the prices we can charge for our products and services. To the extent that technological changes and the availability of free or relatively inexpensive information and materials limit the prices we can charge or demand for our products and services, our business, financial position and results of operations may be materially adversely affected.

Changes in product distribution channels and/or customer bankruptcy may restrict our ability to grow and affect our profitability in our Trade Publishing segment.

New distribution channels such as digital formats, the internet, online retailers, growing delivery platforms (e.g., tablets and e-readers), combined with the concentration of retailer power, pose threats and provide opportunities to our traditional consumer publishing models in our Trade Publishing segment, potentially impacting both sales volumes and pricing. The economic slowdown combined with the trend to e-books has created contraction in the consumer books retail market that has increased the risk of bankruptcy of major retail customers. Additional bankruptcies of traditional “bricks and mortar” retailers of Trade Publishing could negatively affect our business, financial condition and results of operations.

Expansion of our investments and business outside of our traditional core U.S. market may result in lower than expected returns and incremental risks.

To take advantage of international growth opportunities and to reduce our reliance on our core U.S. market, we are increasing our investments in a number of countries and emerging markets, including Asia and the Middle East, some of which are inherently more risky than our investments in the U.S. market. Political, economic, currency, reputational and corporate governance risks, including fraud, as well as unmanaged expansion are all factors which could limit our returns on investments made in these markets. For example, current political instability in the Middle East has caused uncertainty in the region, which could affect our results of operations in the region. Also, certain international customers require longer payment terms, increasing our credit risk. As we expand internationally, these risks will become more pertinent to us and could have a bigger impact on our business.

We operate in a highly competitive environment that is subject to rapid change and we must continue to invest and adapt to remain competitive.

Our businesses operate in highly competitive markets, with significant established competitors, such as Pearson Education, Inc., McGraw Hill Education, Cengage Learning, Inc., Scholastic Corporation and K12 Inc. These markets continue to change in response to technological innovations and other factors. Profitability is affected by developments in our markets beyond our control, including: changing U.S. federal and state standards for educational materials; rising development costs due to customers’ requirements for more customized instructional materials and assessment programs; changes in prevailing educational and testing methods and philosophies; higher technology costs due to the trend toward delivering more educational content in both traditional print and electronic formats; market acceptance of new technology products, including online or

 

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computer-based testing; an increase in the amount of materials given away in the K-12 markets as part of a bundled pack; the impact of the expected increase in turnover of K-12 teachers and instructors on the market acceptance of our products; customer consolidation in the retail and wholesale trade book market and the increased dependence on fewer but stronger customers; rising advances for popular authors and market pressures to maintain competitive retail pricing; a material increase in product returns or in certain costs such as paper; and overall uncertain economic issues that affect all markets.

We cannot predict with certainty the changes that may occur and the effect of those changes on the competitiveness of our businesses, and the acceleration of any of these developments may materially and adversely affect our profitability.

The means of delivering our products may be subject to rapid technological change. Although we have undertaken several initiatives and invested significant amounts of capital to adapt to and benefit from these changes, we cannot predict whether technological innovations will, in the future, make some of our products, particularly those printed in traditional formats, wholly or partially obsolete. If this were to occur, we might be required to invest significant resources to further adapt to the changing competitive environment. In addition, we cannot predict whether end customers will have sufficient funding to purchase the equipment needed to use our new technology products.

In order to maintain a competitive position, we must continue to invest in new offerings and new ways to deliver our products and services. These investments may not be profitable or may be less profitable than what we have experienced historically. We could experience threats to our existing businesses from the rise of new competitors due to the rapidly changing environment within which we operate.

Our ability to enforce our intellectual property and proprietary rights may be limited, which may harm our competitive position and materially and adversely affect our business and results of operations.

Our products are largely comprised of intellectual property content delivered through a variety of media, including books and digital and web-based media. We rely on copyright, trademark and other intellectual property laws to establish and protect our proprietary rights in these products. However, we cannot make assurances that our proprietary rights will not be challenged, invalidated or circumvented. We conduct business in other countries where the extent of effective legal protection for intellectual property rights is uncertain, and this uncertainty could affect future growth. Moreover, despite the existence of copyright and trademark protection under applicable laws, third parties may nonetheless violate our intellectual property rights, and our ability to remedy such violations, particularly in foreign countries, may be limited. In addition, the copying and distribution of content over the Internet creates additional challenges for us in protecting our proprietary rights. If we are unable to adequately protect and enforce our intellectual property and proprietary rights, our competitive position may be harmed and our business and financial results could be materially and adversely affected.

We operate in markets which are dependent on Information Technology (“IT”) systems and technological change.

Our business is dependent on information technology. We either provide software and/or internet based services to our customers or we use complex IT systems and products to support our business activities, particularly in infrastructure and as we move our products and services to an increasingly digital delivery platform.

We face several technological risks associated with software product development and service delivery in our educational businesses, information technology security (including virus and hacker attacks), e-commerce, enterprise resource planning, system implementations and upgrades. The failure to recruit and retain staff with relevant skills may constrain our ability to grow as we combine traditional publishing products with online service offerings.

 

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We rely on third-party software development as part of our digital platform.

Some of the technologies and software that compose our instruction and assessment technologies are developed by third parties. We rely on those third parties for the development of future components and modules. Thus, we face risks associated with software product development and the ability of those third parties to meet our needs and their obligations under our contracts with them.

A major data privacy breach or unanticipated IT system failure may cause reputational damage to our brands and financial loss.

Across our businesses we hold large volumes of personal data, including that of employees, customers and students. Failure to adequately protect such personal data could lead to penalties, significant remediation costs, reputational damage, potential cancellation of existing contracts and inability to compete for future business. We have policies, processes, internal controls and cybersecurity mechanisms in place to ensure the stability of our information technology, provide security from unauthorized access to our systems and maintain business continuity, but no mechanisms are entirely free from failure and we have no guarantee that our security mechanisms will be adequate to prevent all possible security threats. Our operating results may be adversely impacted by unanticipated system failures, data corruption or breaches in security.

We may not be able to complete, or achieve the expected benefits from, any future acquisitions, which could materially and adversely affect our growth.

We have at times used acquisitions as a means of expanding our business and expect that we will continue to do so. If we do not successfully integrate acquisitions, anticipated operating advantages and cost savings may not be realized. The acquisition and integration of companies involve a number of risks, including: use of available cash, new borrowings or borrowings under our revolving credit facility to consummate the acquisition; demands on management related to the increase in our size after an acquisition; diversion of management’s attention from existing operations to the integration of acquired companies; integration of companies existing systems into our systems; difficulties in the assimilation and retention of employees; and potential adverse effects on our operating results.

We may not be able to maintain the levels of operating efficiency that acquired companies achieved separately. Successful integration of acquired operations will depend upon our ability to manage those operations and to eliminate redundant and excess costs. We may not be able to achieve the cost savings and other benefits that we would hope to achieve from acquisitions, which could materially and adversely affect our business, financial condition and results of operations.

We may not be able to retain or attract the key management, creative, editorial and sales personnel that we need to remain competitive and grow.

Our success depends, in part, on our ability to continue to retain key management and other personnel. We operate in a number of highly visible industry segments where there is intense competition for experienced and highly effective individuals, including authors. Our successful operations in these segments may increase the market visibility of members of key management, creative and editorial teams and result in their recruitment by other businesses. There can be no assurance that we can continue to attract and retain the necessary talented employees, including executive officers and other key members of management and, if we fail to do so, it could adversely affect our business.

In addition, our sales personnel make up about approximately 24% of our employees, and our business results depend largely upon the experience, knowledge of local market dynamics and long-standing customer relationships of such personnel. Our inability to retain or hire effective sales people at economically reasonable compensation levels could materially and adversely affect our ability to operate profitably and grow our business.

 

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A significant increase in operating costs and expenses could have a material adverse effect on our profitability.

Our major expenses include employee compensation and printing, paper and distribution costs for product-related manufacturing. We offer competitive salary and benefit packages in order to attract and retain the quality employees required to grow and expand our businesses. Compensation costs are influenced by general economic factors, including those affecting the cost of health insurance and postretirement benefits, and any trends specific to the employee skill sets we require. We could experience changes in pension costs and funding requirements due to poor investment returns and/or changes in pension laws and regulations.

Paper is one of our principal raw materials and, for the year ended December 31, 2012, our paper purchases totaled approximately $47 million while our manufacturing costs totaled approximately $234 million. As a result, our business may be negatively impacted by an increase in paper prices. Paper prices fluctuate based on the worldwide demand and supply for paper in general and for the specific types of paper used by us. The price of paper may fluctuate significantly in the future, and changes in the market supply of or demand for paper could affect delivery times and prices. Paper suppliers may consolidate and as a result, there may be future shortfalls in supplies necessary to meet the demands of the entire marketplace. We may need to find alternative sources for paper from time to time. Our books and workbooks are printed by third parties and we typically have multi-year contracts for the production of books and workbooks. Increases in any of our operating costs and expenses could materially and adversely affect our profitability and our business, financial condition and results of operations.

We make significant investments in information technology data centers and other technology initiatives as well as significant investments in the development of programs for the K-12 marketplace. Although we believe we are prudent in our investment strategies and execution of our implementation plans, there is no assurance as to the ultimate recoverability of these investments.

We also have other significant operating costs, and unanticipated increases in these costs could adversely affect our operating margins. Higher energy costs and other factors affecting the cost of publishing, transporting and distributing our products could adversely affect our financial results. Our inability to absorb the impact of increases in paper costs and other costs or any strategic determination not to pass on all or a portion of these increases to customers could adversely affect our business, financial condition and results of operations.

Exposure to litigation could have a material effect on our financial position and results of operations.

We are involved in legal actions and claims arising from our business practices and face the risk that additional actions and claims will be filed in the future. Litigation alleging infringement of copyrights and other intellectual property rights has become extensive in the educational publishing industry. At present, there are various suits pending or threatened which claim that we exceeded the print run limitation or other restrictions in licenses granted to us to reproduce photographs in our instructional materials. A number of similar claims against us have already been settled. While management does not expect any of these matters to have a material adverse effect on our results of operations, financial position or cash flows, due to the inherent uncertainty of the litigation process, the resolution of any particular legal proceeding or change in applicable legal standards could have a material effect on our financial position and results of operations.

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 coverage will be sufficient to fully cover all potential liabilities.

Operational disruption to our business caused by a major disaster and/or external threats could restrict our ability to supply products and services to our customers.

Across all our businesses, we manage complex operational and logistical arrangements including distribution centers, data centers and large office facilities as well as relationships with third party print vendors.

 

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We have also outsourced some support functions, including application maintenance support, to third party providers. Failure to recover from a major disaster (such as fire, flood or other natural disaster) at a key facility or the disruption of supply from a key third party vendor or partner (e.g., due to bankruptcy) could restrict our ability to service our customers. External threats, such as terrorist attacks, strikes, weather and political upheaval, could affect our business and employees, disrupting our daily business activities.

We are subject to contingent liabilities that may affect liquidity and our ability to meet our obligations.

In the ordinary course of business, we issue performance-related surety bonds and letters of credit posted as security for our operating activities, some of which obligate us to make payments if we fail to perform under certain contracts in connection with the sale of instructional materials and assessment tests. The surety bonds are partially backstopped by letters of credit. As of June 30, 2013, our contingent liability for all letters of credit was approximately $25.9 million, of which $6.4 million were issued to backstop $12.1 million of surety bonds. The letters of credit reduce the borrowing availability on our revolving credit facility, which could affect liquidity and, therefore, our ability to meet our obligations. We may increase the number and amount of contracts that require the use of letters of credit, which may further restrict liquidity and, therefore, our ability to meet our obligations in the future.

We may be adversely affected by significant changes in interest rates.

Our financing indebtedness, including borrowings under our revolving credit facility, bears interest at variable rates. As of June 30, 2013, we had $246.9 million 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 $2.5 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. 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.

If market interest rates increase, variable-rate debt will create higher debt service requirements, which could adversely affect our cash flow. If we enter into agreements limiting exposure to higher interest rates in the future, these agreements may not offer complete protection from this risk.

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments or to refinance our debt obligations and to fund planned capital expenditures and other growth initiatives depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flow from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness or to fund our other liquidity needs.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations. Our term loan facility and revolving credit facility restrict our ability to use the proceeds from asset sales. We may not be able to consummate those asset sales to raise capital or sell assets at prices that we believe are fair and proceeds that we do receive may not be adequate to meet any debt service obligations then due.

 

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Despite our current leverage, we may still be able to incur substantially more debt. This could further exacerbate the risks that we and our subsidiaries face.

We and our subsidiaries may be able to incur substantial additional indebtedness, including additional secured indebtedness, in the future. The terms of the credit agreements do and the agreements governing our existing and future indebtedness may restrict, but will not completely prohibit, us from doing so. As of June 30, 2013, we had approximately $212.8 million of borrowing base availability under our revolving credit facility. This may have the effect of reducing the amount of proceeds paid to you in the event of a liquidation. If new debt or other liabilities are added to our current debt levels, the related risks that we and our subsidiaries now face could intensify.

We may record future goodwill or indefinite-lived intangibles impairment charges related to one or more of our reporting units, which could materially adversely impact our results of operations.

We test our goodwill and indefinite-lived intangibles asset balances for impairment during the fourth quarter of each year, or more frequently if indicators are present or changes in circumstances suggest that impairment may exist. We assess goodwill for impairment at the reporting unit level and, in evaluating the potential for impairment of goodwill, we make assumptions regarding estimated revenue projections, growth rates, cash flows and discount rates. Although we use consistent methodologies in developing the assumptions and estimates underlying the fair value calculations used in our impairment tests, these estimates are uncertain by nature and can vary from actual results. Declines in the future performance and cash flows of the reporting unit or small changes in other key assumptions may result future goodwill impairment charges, which could materially adversely impact our results of operations. We have goodwill and indefinite-lived intangible assets of approximately $520.1 million and $440.5 million, $520.1 million and $440.8 million as of December 31, 2012 and 2011, respectively. There was no goodwill impairment charge for the year ended December 31, 2012. For the year ended December 31, 2011, goodwill impairment charges were $1,442.5 million. For the years ended December 31, 2012 and 2011, impairment charges for indefinite-lived intangible assets were $5.0 million and $161.0 million, respectively.

Risks Related to this Offering and Our Common Stock

There can be no assurance that a viable public market for our common stock will develop.

Prior to this offering, there has been a limited public market for our common stock. The initial public offering price for our common stock will be determined through negotiations between us, the selling stockholders and the representatives of the underwriters and may not be indicative of the market price of our common stock after this offering. If you purchase our common stock, you may not be able to resell those shares at or above the initial public offering price. We cannot predict the extent to which investor interest in our common stock will lead to the development of an active trading market on a national securities exchange or otherwise or how liquid that market might become. If an active public market for our common stock does not develop, or is not sustained, it may be difficult for you to sell your shares at a price that is attractive to you or at all.

Our stock price may be volatile or may decline regardless of our operating performance, and you may not be able to resell your shares at or above the initial public offering price.

After this offering, the market price for our common stock is likely to be volatile and may fluctuate significantly in response to a number of factors, most of which we cannot control, including, among others:

 

   

changes in economic trends or the continuation of current economic conditions;

 

   

changes in state and local education funding and/or related programs, legislation and procurement processes;

 

   

changes in schools’ curriculum programs in various states;

 

   

changes in consumer demand for, and acceptance of, our publications;

 

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industry cycles and trends;

 

   

changes in laws or regulations governing our business and operations;

 

   

changes in technology and the digitalization of content;

 

   

the development and sustainability of an active trading market for our common stock; and

 

   

future sales of our common stock by our stockholders.

These and other factors may lower the market price of our common stock, regardless of our actual operating performance. As a result, our common stock may trade at prices significantly below the public offering price.

In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies, including other publishing companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, we could incur substantial costs and our resources and the attention of management could be diverted from our business.

Future sales of our common stock, or the perception in the public markets that these sales may occur, may depress the price of our common stock.

Additional sales of a substantial number of our shares of common stock in the public market after this offering, or the perception that such sales may occur, could have a material adverse effect on the price of our common stock and could materially impair our ability to raise capital through the sale of additional shares. Upon completion of this offering, we will have              shares of common stock issued and outstanding. The shares of common stock offered in this offering will be freely tradable without restriction under the Securities Act of 1933, as amended (the “Securities Act”), except for any shares that may be held or acquired by our directors, executive officers and other affiliates (as that term is defined in the Securities Act), which will be restricted securities under the Securities Act. Restricted securities may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available. The issuance of our common stock in the 2012 reorganization was exempt from the registration requirements of the Securities Act pursuant to Section 1145 of the Bankruptcy Code. As a result, the 69,958,989 shares of our outstanding common stock (excluding 41,011 shares held by us in treasury) that were issued in the reorganization are freely tradable, except for shares that are held by our directors, executive officers and other affiliates. The shares of common stock that are freely tradable represent approximately     % of our outstanding shares of common stock, and the sale of such shares in the public market, or the perception that these sales may occur, could cause the market price of our common stock to decrease significantly.

Pursuant to the investor rights agreement described under the heading “Certain Relationships and Related Party Transactions—Investor Rights Agreement,” our current stockholders have certain demand and piggyback rights that may require us to file registration statements registering their common stock or to include sales of such common stock in registration statements that we may file for ourselves or other stockholders. Any shares of common stock sold under these registration statements will be freely tradable in the public market. In the event such registration rights are exercised and a large number of common stock is sold in the public market, such sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital. Additionally, we will bear all expenses in connection with any such registrations, except that the selling stockholders may be responsible for their pro rata shares of underwriters’ fees, commissions and discounts (except for this offering and the first underwritten demand registration or shelf takedown by stockholders after this offering), stock transfer taxes and certain legal expenses. See “Certain Relationships and Related Party Transactions—Investor Rights Agreement.”

We and each of our executive officers and directors, all of the selling stockholders and certain of our other existing stockholders have agreed with the underwriters that for a period of 180 days after the date of this prospectus, subject to extension under certain circumstances, we and they will not offer, sell, assign, transfer, pledge, contract to sell or otherwise dispose of or hedge any of our common stock, or any options or warrants to

 

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purchase any of our common stock or any securities convertible into or exchangeable for our common stock, subject to specified exceptions. Goldman, Sachs & Co. and Morgan Stanley & Co. LLC may, in their discretion, at any time without prior notice, release all or any portion of the common stock from the restrictions in any such agreement. See “Shares Eligible for Future Sale” for more information. All of our common stock outstanding as of the date of this prospectus may be sold in the public market by existing stockholders 180 days after the date of this prospectus, subject to applicable volume and other limitations imposed under United States securities laws. See “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling our common stock after this offering. Sales by our existing stockholders of a substantial number of shares in the public market, or the perception that these sales might occur, could cause the market price of our common stock to decrease significantly.

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about us or our business, our share price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If no securities or industry analysts commence or continue coverage of our company, the trading price for our common stock would be negatively impacted. If we obtain securities or industry analyst coverage and if one or more of the analysts who cover us downgrades our common stock or publishes inaccurate or unfavorable research about us or our business, our share price would likely decline. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, demand for our common stock could decrease, which could cause our share price and trading volume to decline.

We do not expect to pay any cash dividends for the foreseeable future.

We currently expect to retain all our future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends on our common stock for the foreseeable future following the completion of this offering. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our board of directors and will depend upon many factors, including our financial condition, earnings, legal requirements, restrictions in our debt agreements, including the credit agreements governing our term loan facility and revolving credit facility, and other factors deemed relevant by our board of directors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for more information on the restrictions the credit agreements impose on our ability to declare and pay cash dividends. As a holding company, our ability to pay dividends depends on our receipt of cash dividends from our operating subsidiaries, which may further restrict our ability to pay dividends as a result of the laws of their respective jurisdictions of organization, agreements of our subsidiaries or covenants under future indebtedness that we or they may incur. In addition, Delaware law may impose requirements that may restrict our ability to pay dividends to holders of our common stock. Investors seeking cash dividends in the foreseeable future should not purchase our common stock.

Transformation into a public company may increase our costs and disrupt the regular operations of our business.

We have historically operated as a privately owned company, and we expect to incur significant additional legal, accounting, reporting and other expenses as a result of having publicly traded common stock, including, but not limited to, increased costs related to auditor fees, legal fees, directors’ fees, directors and officers insurance, investor relations and various other costs. We also anticipate that we will incur costs associated with corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), as well as rules implemented by the Securities and Exchange Commission (the “SEC”) and the national securities exchange on which our common stock will be listed. Moreover, the additional demands associated with being a public company may disrupt regular operations of our business by diverting the attention of some of our senior management team away from revenue producing activities.

 

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Failure to maintain adequate financial and management processes and controls could lead to errors in our financial reporting, which could harm our business and cause a decline in the price of our common stock.

Maintaining effective internal control over financial reporting is necessary for us to produce reliable financial reports and is important in helping to prevent financial fraud. If we are unable to maintain adequate internal controls, our business and operating results could be harmed. The requirements of Section 404 of Sarbanes-Oxley and the related rules of the SEC require, among other things, our management to assess annually the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm may be required to issue a report on our internal control over financial reporting beginning with our Annual Report on Form 10-K for the year ending December 31, 2014. In the future, we may identify deficiencies that we may be unable to remedy before the requisite deadline for those reports. Also, our auditors have not yet conducted an audit of our internal control over financial reporting. Any failure to remediate material weaknesses noted by us or our independent registered public accounting firm or to implement required new or improved controls or difficulties encountered in their implementation could cause us to fail to meet our reporting obligation or result in material misstatements in our financial statements. If our management or our independent registered public accounting firm were to conclude in their reports that our internal control over financial reporting was not effective, investors could lose confidence in our reported financial information, and the trading price of our common stock could decrease significantly. Failure to comply with Section 404 of Sarbanes-Oxley could potentially subject us to sanctions or investigations by the SEC, the Financial Industry Regulatory Authority, Inc. (“FINRA”) or other regulatory authorities. The accompanying loss of public confidence could harm our business and cause a decline in the price of our common stock.

As a holding company, our only material assets will be our equity interests in our operating subsidiaries, and our principal source of revenue and cash flow will be distributions from such subsidiaries, which may be limited by law and/or contract in making such distributions.

As a holding company, our principal source of revenue and cash flow will be distributions from our subsidiaries. Therefore, our ability to carry out our business plan, to fund and conduct our business, service our debt and pay dividends (if any) in the future will depend on the ability of our subsidiaries to generate sufficient net income and cash flows to make upstream cash distributions to us. Our subsidiaries are separate legal entities, and although they may be wholly owned or controlled by us, they have no obligation to make any funds available to us, whether in the form of loans, dividends or otherwise. The ability of our subsidiaries to distribute cash to us may also be subject to, among other things, future restrictions that are contained in our subsidiaries’ agreements (as entered into from time to time), availability of sufficient funds in such subsidiaries and applicable laws and regulatory restrictions. Claims of creditors of our subsidiaries generally will have priority as to the assets of such subsidiaries over our claims and claims of our creditors and stockholders. To the extent the ability of our subsidiaries to distribute dividends or other payments to us could be limited in any way, this could materially limit our ability to fund and conduct our business, service our debt and pay dividends (if any).

Provisions in our organizational documents may delay or prevent our acquisition by a third party.

Our amended and restated certificate of incorporation and our amended and restated by-laws to be in effect at the time of consummation of this offering will contain several provisions that may make it more difficult or expensive for a third party to acquire control of us without the approval of our board of directors. These provisions also may delay, prevent or deter a merger, acquisition, tender offer, proxy contest or other transaction that might otherwise result in our stockholders receiving a premium over the market price for their common stock. These provisions include, among others:

 

   

our board of directors’ ability to issue, from time to time, one or more classes of preferred stock and, with respect to each such class, to fix the terms thereof by resolution;

 

   

provisions relating to the appointment of directors upon an increase in the number of directors or vacancy on our board of directors;

 

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provisions requiring stockholders to hold at least 50.1% of our outstanding common stock in the aggregate to request special meetings and restricting the ability of stockholders to bring proposals before meetings;

 

   

elimination of the right of our stockholders to act by written consent;

 

   

provisions that provide that the doctrine of “corporate opportunity” will not apply with respect to the Company, to any of our stockholders or directors, other than any stockholder or director that is an employee, consultant or officer of ours; and

 

   

provisions that set forth advance notice procedures for stockholders’ nominations of directors and proposals for consideration at meetings of stockholders.

These provisions of our certificate of incorporation and by-laws could discourage potential takeover attempts and reduce the price that investors might be willing to pay for our common stock in the future, which could reduce the market price of our common stock. For more information, see “Description of Capital Stock.”

This offering may cause or contribute to an “ownership change” of the Company for U.S. federal income tax purposes, which may result in limitations on the Company’s use of certain tax attributes.

The sale of shares of our common stock in this offering may cause or contribute to an “ownership change” of the Company for U.S. federal income tax purposes. If the Company undergoes an ownership change, the Company may be limited in its ability to use certain tax attributes, including its net operating losses, under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). The Company has certain significant tax attributes (other than net operating losses) and expects that these tax attributes will not be subject to any limitation as a result of any potential ownership change.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus includes 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” or “should,” “forecast,” “intend,” “plan,” “potential,” “project,” “target” or, in each case, their negative, or other variations or comparable terminology. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this prospectus and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies, the industry in which we operate 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. While we believe that our assumptions are reasonable, 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 prospectus.

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 our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate may differ materially from those made in or suggested by the forward-looking statements contained in this prospectus. In addition, even if our results of operations, financial condition and liquidity and the development of the industry in which we operate are consistent with the forward looking statements contained in this prospectus, those results or developments may not be indicative of results or developments in subsequent periods. Important factors that could cause our 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;

 

   

adverse or worsening economic trends or the continuation of current economic conditions;

 

   

changes in consumer demand for, and acceptance of, our products;

 

   

changes in competitive factors;

 

   

industry cycles and trends;

 

   

conditions and/or changes in the publishing industry;

 

   

restrictions under the credit agreements governing our term loan facility and revolving credit facility;

 

   

changes in laws or regulations governing our business and operations;

 

   

changes or failures in the information technology systems we use;

 

   

demographic trends;

 

   

uncertainty surrounding our ability to enforce our intellectual property rights;

 

   

inability to retain management or hire employees;

 

   

impact of potential impairment of goodwill and other intangibles in a challenging economy;

 

   

stock price may be volatile or may decline regardless of our operating performance;

 

   

transformation into a public company may increase our costs and disrupt the regular operations of our business.

 

   

provisions in our organizational documents may delay or prevent our acquisition by a third party; and

 

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this offering may cause or contribute to an “ownership change” of the Company for U.S. federal income tax purposes, which may result in limitations on the Company’s use of certain tax attributes.

We caution you that the foregoing list of important factors may not contain all of the material factors that are important to you. We urge you to read this entire prospectus carefully, including the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” for a more complete discussion of the factors that could affect our future performance and the industry in which we operate. In light of these risks, uncertainties and assumptions, the forward-looking events described in this prospectus 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 referred to above and contained elsewhere in this prospectus.

 

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USE OF PROCEEDS

We will not receive any proceeds from the sale of common stock in this offering. The selling stockholders will receive all of the proceeds from the sale of the shares of common stock offered under this prospectus. We have agreed to pay all underwriting discounts and commissions applicable to the sale of common stock and certain expenses of the selling stockholders incurred in connection with the sale as well as the other offering expenses payable by us.

 

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DIVIDEND POLICY

We have not paid any dividends since our incorporation in 2010. For the foreseeable future, we intend to retain any earnings to finance our business and we do not anticipate paying any cash dividends on our common stock. Any future determination to pay dividends will be at the discretion of our board of directors in accordance with applicable law and will be dependent upon then-existing conditions, including our financial condition and results of operations, capital requirements, contractual restrictions (including restrictions contained in our credit agreements), business prospects and other factors that our board of directors considers relevant.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of June 30, 2013. We have agreed to pay all underwriting discounts and commissions applicable to the sale of common stock and certain expenses of the selling stockholders incurred in connection with the sale as well as the other offering expenses payable by us. The selling stockholders will receive all of the proceeds from the sale of the shares of common stock offered under this prospectus. We will not receive any proceeds from the sale of common stock in this offering.

You should read the information set forth below in conjunction with our audited consolidated financial statements and unaudited consolidated interim financial statements and the notes thereto and the sections of this prospectus entitled “Selected Historical Financial and Operating Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

(dollars in thousands)    As of June 30, 2013
(Unaudited)
 

Cash, cash equivalents and short-term investments

   $ 212,579   
  

 

 

 

Current portion of long-term debt

   $ 2,500   

Long-term debt (1)

     244,375   
  

 

 

 

Total debt

     246,875   

Preferred stock, $0.01 par value: 10,000,000 shares authorized; no shares issued and outstanding as of June 30, 2013

     —     

Common stock, $0.01 par value: 190,000,000 shares authorized; 69,970,989 shares issued and outstanding as of June 30, 2013

     700   

Treasury stock, 41,011 shares as of June 30, 2013

     —     

Capital in excess of par value

     4,745,040   

Accumulated deficit

     (2,928,883

Accumulated other comprehensive income (loss)

     (22,018
  

 

 

 

Total stockholders’ equity

     1,794,839   
  

 

 

 

Total capitalization

   $ 2,041,714   
  

 

 

 

 

(1) Represents borrowings under our term loan facility as of June 30, 2013. Under our revolving credit facility, we also have up to $250.0 million of borrowing availability, subject to borrowing base availability, which as of June 30, 2013, was approximately $212.8 million. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information regarding our term loan facility and revolving credit facility.

 

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SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

The following table summarizes the consolidated historical financial data of HMH Holdings (Delaware), Inc. (Successor) and HMH Publishing Company (Predecessor) for the periods presented. We derived the consolidated historical financial data as of December 31, 2012 and 2011, for the years ended December 31, 2012 and 2011 (Successor) and for the periods March 10, 2010 to December 31, 2010 (Successor) and January 1, 2010 to March 9, 2010 (Predecessor) from the audited consolidated financial statements included elsewhere in this prospectus. We derived the consolidated historical financial statement data as of December 31, 2010 (Successor), as of December 31, 2009 and 2008 (Predecessor) and for the years ended December 31, 2009 and 2008 (Predecessor) from our audited consolidated financial statements for such years, which are not included in this prospectus. We derived the consolidated historical financial data as of June 30, 2013 and for the six months ended June 30, 2013 and 2012 from our unaudited consolidated interim financial statements included elsewhere in this prospectus. We derived the consolidated historical financial data as of June 30, 2012 from our unaudited consolidated interim financial statements not included in this prospectus. We have prepared our unaudited consolidated interim financial statements on the same basis as our audited consolidated financial statements and, in our opinion, have included all adjustments necessary to state fairly in all material respects our financial position and results of operations. Historical results for any prior period are not necessarily indicative of results to be expected in any future period, and results for any interim period are not necessarily indicative of results for a full fiscal year.

The data set forth in the following table should be read together with the sections of this prospectus entitled “Capitalization” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes thereto included elsewhere in this prospectus.

 

    Successor         Predecessor  
(in thousands, except share and
per share data)
  Six Months
Ended
June 30, 2013
    Six Months
Ended
June 30, 2012
    Year Ended December 31,     March 10,
2010 to
December 31,
2010
        January 1,
2010 to
March 9,
2010
    Year Ended December 31,  
      2012     2011           2009     2008  

Operating Data:

                 

Net sales

  $ 529,545      $ 509,433      $ 1,285,641      $ 1,295,295      $ 1,397,142        $ 109,905      $ 1,562,415      $ 2,049,254   
 

Cost and expenses:

                 

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

    245,816        214,272        515,948        512,612        559,593          45,270        586,159        760,973   

Publishing rights amortization (1)

    72,587        92,677        177,747        230,624        235,977          48,336        334,022        398,536   

Pre-publication amortization (2)

    56,653        66,433        137,729        176,829        181,521          37,923        242,045        249,670   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Cost of sales

    375,056        373,382        831,424        920,065        977,091          131,529        1,162,226        1,409,179   

Selling and administrative

    263,703        280,452        533,462        638,023        597,628          119,039        734,131        850,056   

Other intangible asset amortization

    13,433        26,372        54,815        67,372        57,601          2,006        28,857        38,664   

Impairment charge for goodwill, intangible assets, pre-publication costs and fixed assets

    8,500        —          8,003        1,674,164        103,933          4,028        953,587        824,009   

Severance and other charges (3)

    3,481        3,473        9,375        32,801        (11,243       —          75,882        30,132   

Gain on bargain purchase

    —          —          (30,751     —          —            —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Operating loss

    (134,628     (174,246     (120,687     (2,037,130     (327,868       (146,697     (1,392,268     (1,102,786
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

 

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Table of Contents
    Successor         Predecessor  
(in thousands, except share and
per share data)
 

 

Six Months
Ended
June 30, 2013

   

 

Six Months
Ended
June 30, 2012

   

 

Year Ended December 31,

    March 10,
2010 to
December 31,
2010
        January 1,
2010 to
March 9,
2010
   

 

Year Ended December 31,

 
      2012     2011           2009     2008  

Other Income (expense)

                 

Interest expense

    (11,585     (109,833     (123,197     (244,582     (258,174       (157,947     (860,042     (672,825

Other (loss) income, net

    —          —          —          —          (6       9        (631     (591

Loss on extinguishment of debt

    (598     —          —          —          —            —          —          (27,567

Change in fair value of derivative instruments

    (479     812        1,688        (811     90,250          (7,361     46,401        (54,955
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Loss before reorganization items and taxes

    (147,290     (283,267     (242,196     (2,282,523     (495,798       (311,996     (2,206,540     (1,858,724

Reorganization items, net (4)

    —          (156,894     (149,114     —          —            —          —          —     

Income tax expense

    4,357        (6,500     (5,943     (100,153     11,929          (220     (61,393     (396,434
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Net loss from continuing operations

    (151,647     (119,873     (87,139     (2,182,370     (507,727       (311,776     (2,145,147     (1,462,290
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Loss from discontinued operations, net of tax

    —          —          —          —          —            —          —          (36,806

Gain on sale of discontinued operations, net of tax

    —          —          —          —          —            —          —          35,254   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Net loss

  $ (151,647   $ (119,873   $ (87,139   $ (2,182,370   $ (507,727     $ (311,776   $ (2,145,147   $ (1,463,842
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Net loss per share from continuing operations—basic and diluted

  $ (2.17   $ (0.44   $ (0.51   $ (7.69   $ (1.79     $ (100,572.90   $ (691,982.90   $ (471,706.45
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common stockholders—basic and diluted

  $ (2.17   $ (0.44   $ (0.51   $ (7.69   $ (1.79     $ (100,572.90   $ (691,982.90   $ (472,207.10
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Weighted average number of common shares used in net loss per share attributable to common stockholders—basic and diluted

    69,959,522        272,624,886        170,459,064        283,636,235        283,636,235          3,100        3,100        3,100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

Balance Sheet Data (as of period end):

                 

Cash, cash equivalents and short-term investments

  $ 212,579      $ 266,083      $ 475,119      $ 413,610      $ 397,740          $ 94,002      $ 153,408   

Working capital

    508,262        443,129        599,085        440,844        380,678            (547,333     274,643   

Total assets

    2,879,275        3,023,152        3,029,584        3,263,903        5,257,155            5,295,149        7,013,611   

Debt (short-term and long-term)

    246,875        250,000        248,125        3,011,588        2,861,594            6,953,629        6,257,316   

Stockholders’ equity (deficit)

    1,794,839        1,861,514        1,943,701        (674,552     1,517,828            (2,614,736     (856,060
 

Statement of Cash Flows Data:

                 

Net cash provided by (used in):

                 

Operating activities

    (152,768     (218,219     104,802        132,796        182,966        $ (41,296     (207,385     98,951   

Investing activities

    (69,858     (53,479     (295,998     (195,300     (232,122       (25,616     (155,099     472,484   

Financing activities

    (1,250     124,171        106,664        96,041        402,289          (150     303,078        (487,368
 

Other Data:

                 

Capital expenditures:

                 

Pre-publication capital expenditures (5)

    74,808        59,408        114,522        122,592        96,613          22,057        138,440        219,384   

Other capital expenditures

    31,213        20,566        50,943        71,817        64,139          3,559        30,659        64,681   

Depreciation and amortization

    172,898        212,484        428,422        532,996        523,651          99,260        680,622        763,604   

 

(1) Publishing rights are intangible assets that allow us to publish and republish existing and future works as well as create new works based on previously published materials and are amortized on an accelerated basis over periods estimated to represent the useful life of the content.
(2) We capitalize the art, prepress, manuscript and other costs incurred in the creation of the master copy of a book or other media and amortize such costs from the year of sale over five years on an accelerated basis.
(3) Represents severance and real estate charges. The credit balance in 2010 relates to the reversal of certain charges recorded in prior periods due to a change in estimate.
(4) Represents net gain associated with our Chapter 11 reorganization in 2012.
(5) Represents capital expenditures for the art, prepress, manuscript and other costs incurred in the creation of the master copy of a book or other media.

 

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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 our consolidated financial statements and the accompanying notes included elsewhere in this prospectus. The following discussion and analysis of our financial condition and results of operations contains forward-looking statements about our business, operations and industry that involve risks and uncertainties, such as statements regarding our plans, objectives, expectations and intentions. Actual results and the timing of events may differ materially from those expressed or implied in such forward-looking statements due to a number of factors, including those set forth under “Risk Factors” and elsewhere in this prospectus. See “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Overview

We are a leading global provider of education solutions, delivering content, technology, services and media to over 60 million students in over 150 countries worldwide. We deliver our offerings to both educational institutions and consumers around the world. In the United States, we are the leading provider of K-12 educational content by market share and our instructional materials are used in every school district within the United States. Furthermore, since 1832, we have published trade and reference materials, including award-winning adult and children’s fiction and non-fiction books. Our long-standing, global reputation and well-known and trusted brands enable us to capitalize on the consumerization and digitalization of the education market through our existing and developing channels.

Corporate History

HMH Holdings (Delaware), Inc. (“Successor”) was incorporated as a Delaware corporation on March 5, 2010, and was established as the holding company of the current operating group. Houghton Mifflin Harcourt was formed in December 2007 with the acquisition of Harcourt Education Group, then the second-largest K-12 U.S. publisher, by Houghton Mifflin Group. Houghton Mifflin Group was previously formed in December 2006 by the acquisition of Houghton Mifflin Publishers Inc. by Riverdeep Group plc. We are headquartered in Boston, Massachusetts.

Key Aspects and Trends of Our Operations

Business Segments

We are organized along two business segments: Education and Trade Publishing. Our Education segment is our largest segment and represented approximately 88%, 90% and 92% of our total net sales for the years ended December 31, 2012, 2011 and 2010, respectively. Our Trade Publishing segment represented approximately 12%, 10% and 8% of our total net sales for the years ended December 31, 2012, 2011 and 2010, 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 textbooks and instructional materials, trade books, reference materials, multimedia instructional programs, license fees for book rights, content, software and services, test scoring, 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, usually due to future deliverable products or functions and a provision for product returns.

Basal programs, which 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

 

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student materials required to conduct the class throughout the school year. Products and services in basal programs include print and digital offerings for students and a variety of supporting materials such as teacher’s editions, formative assessments, whole group instruction materials, practice aids, educational games and services. The process through which materials and curricula are selected and procured for classroom use varies throughout the United States. Twenty states, known as adoption states, approve and procure new basal programs usually every five to seven years on a state-wide basis, before individual schools or school districts are permitted to schedule the purchase of materials. In all remaining states, known as open states or open territories, each individual school or school district can procure materials at any time, though usually according to a five to nine year cycle. The student population in adoption states represents over 50% of the U.S. elementary and secondary school-age population. Many adoption states provide “categorical funding” for instructional materials, which means that state funds cannot be used for any other purpose.

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. 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 basal programs.

We also derive our Education segment net sales from the sale of summative, formative or in-classroom and diagnostic assessments to districts and schools in all 50 states. Summative assessments are concluding or “final” exams that measure students’ proficiency in a particular academic subject or group of subjects on an aggregate level or against state standards. Additionally, our offerings include supplemental products that target struggling learners through comprehensive intervention solutions along with products targeted at assisting English language learners.

In international markets, our Education segment predominantly exports and sells 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 and the Caribbean. Our international sales team utilizes a global network of international partners and alliances, including distributors in local markets around the world.

Our Trade Publishing segment sells works of fiction and non-fiction for adults and children, dictionaries and other reference works through physical and online retail outlets and book distributors, as well as through our e-commerce platform.

Factors affecting our net sales include:

Education

 

   

state or district per student funding levels;

 

   

the cyclicality of the purchasing schedule for adoption states;

 

   

student enrollments;

 

   

adoption of new education standards; and

 

   

technological advancement and the introduction of new content and products that meet the needs of students, teachers and consumers, including through strategic partnerships pertaining to content and distribution.

Trade Publishing

 

   

consumer spending levels as influenced by various factors, including the U.S. economy and consumer confidence;

 

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the transition to e-books and any resulting impact on market growth;

 

   

the publishing of bestsellers along with obtaining recognized authors; and

 

   

movie tie-ins to our titles that spur sales of current and backlist titles.

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. Recently, total educational materials expenditures by institutions in the United States is rebounding in the wake of the economic recovery. Globally, education expenditures are projected to grow at 7% through 2018, according to GSV Asset Management.

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 Texas, California and Florida, are or are not scheduled to make significant purchases. Texas, California, Florida and Georgia—states where we have historically captured meaningful market share—have announced that they will have significant educational materials expenditures between 2013 and 2016.

Longer-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. According to NCES, student enrollments are expected to increase from 54.7 million in 2010, to over 58.0 million by the 2020 school year. Outside the United States, the global education market continues to demonstrate strong macroeconomic growth characteristics. Population growth is a leading indicator for pre-primary school enrollments, which have a subsequent impact on secondary and higher education enrollments. Globally, according to UNESCO, rapid population growth in the past 5 years has caused pre-primary enrollments to grow by 16% worldwide. The global population is expected to be 9.2 billion by 2050, as countries develop and improvements in medical conditions increase the birth rate.

The digitalization of education content and delivery is also driving a substantial shift in the education market. As the K-12 educational market transitions to purchasing more digital solutions, our ability to offer embedded assessments, adaptive learning, real-time interaction and student specific personalization in addition to our core educational content in a platform- and device-agnostic manner will provide new opportunities for growth.

Our Trade Publishing 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 and are at their highest level since 2008.

While print remains the primary format in which trade books are produced and distributed, the market for trade titles in digital format, primarily e-books, has developed rapidly over the past several years, as the industry evolves 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 growing consumer demand for these products.

In the Trade Publishing segment, annual results can be driven by bestselling trade titles. Furthermore, backlist titles can experience resurgence in sales when made into films. Over the past several years, a number of our backlist titles such as The Hobbit, The Lord of the Rings, Life of Pi, Extremely Loud and Incredibly Close and The Time Traveler’s Wife have benefited in popularity due to movie releases and have subsequently resulted in increased trade sales. The second and third parts of The Hobbit trilogy are scheduled to be released in December 2013 and July 2014, respectively.

 

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Cost of sales, excluding pre-publication and publishing rights

Cost of sales, excluding pre-publication and publishing rights, include expenses directly attributable to the production of our products and services, including the non-capitalizable costs associated with our content operations department. 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 operations department. We also include depreciation expense associated with our platforms. Certain products such as trade books and those 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 gratis expense. A change in the sales mix of these products can impact consolidated profitability. As a percentage of net sales, cost of sales, excluding pre-publication amortization and publishing rights amortization, has remained relatively constant over the past several years, which is due to the largely variable nature of these costs. However, we expect cost of sales, excluding pre-publication and publishing rights, and our gross margins to be favorably impacted by increased digital sales as a percentage of overall net sales, which do not have any paper, printing and binding costs and are not impacted by inventory obsolescence.

Pre-publication amortization and publishing rights amortization

A publishing right is an acquired right which 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. See Note 1 to our consolidated financial statements included elsewhere in this prospectus. Our publishing rights amortization is expected to decline from the 2012 amount of $177.7 million, to approximately $139.6 million, $105.6 million and $81.0 million in 2013, 2014 and 2015, respectively.

We capitalize the art, prepress, manuscript and other costs incurred in the creation of the master copy of a book or other media, 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. We utilize this policy for all pre-publication costs, except with respect to our Trade Publishing consumer books, for which we expense such costs as incurred, and our assessment products, for which we use the straight-line 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 costs are variable costs such as commission expense, outbound transportation costs, sampling and depository fees, which are fees paid to state mandated depositories which fulfill centralized ordering and warehousing functions for specific states. Additionally, significant fixed and discretionary costs include facilities, telecommunications, professional fees, promotions and advertising. We have significantly reduced our selling and administrative expenses by $183.2 million from fiscal 2010 through fiscal 2012, largely through workforce reductions, facility closures and cost containment and efficiency measures. Although we expect our selling and administrative costs in dollars to increase as we invest in new growth initiatives and become a public company, our selling and administrative costs as a percentage of revenue should gradually decline.

Other intangible asset amortization

Our other intangible asset amortization expense primarily includes the amortization of acquired intangible assets consisting of customer relationships, content rights and licenses. Our customer relationships, which constituted the largest component of the amortization expense over the past two years, pertained to our assessment

 

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customers and was fully amortized as of March 31, 2013. The existing software, content rights and licenses will be amortized over varying periods of 6 to 25 years. We expect our expense for the year ending December 31, 2013 to be $18.7 million, and $10.4 million and $10.6 million in 2014 and 2015, respectively.

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 and the amortization of any deferred financing fees and loan discounts. Based on our outstanding indebtedness as of June 30, 2013 and the interest rates applicable to our indebtedness based on LIBOR as of June 30, 2013, we expect our full year interest expense to be approximately $20.0 million annually.

Reorganization items, net

Our reorganization items, net represents expense and income amounts that were recorded to the statement of operations as a result of the bankruptcy proceedings. The amount is primarily attributed to cancellation of debt income net of related expenses and the elimination of deferred costs related to the cancelled debt. Reorganization items were incurred starting with the date of the bankruptcy filing through the date of bankruptcy emergence.

Financial Presentation

The historical financial information has been derived from the financial statements and accounting records of HMH Holdings (Delaware), Inc. (“Successor”) for periods on and after March 10, 2010, and from the financial statements and accounting records of HMH Publishing Company (“Predecessor”) for the period from January 1, 2010 through March 9, 2010. For purposes of presenting a comparison of our 2011 results to 2010, we have presented our 2010 results as the mathematical addition of the Predecessor and Successor periods. We believe that this presentation provides meaningful information about our results of operations. This approach is not consistent with U.S. GAAP, may yield results that are not strictly comparable on a period-to-period basis and may not reflect the actual results we would have achieved. The table showing the combined 2010 results follows:

 

           Successor                     Predecessor             Combined      
(in thousands)    For the Period
March 10, –
December 31,
2010
          For the Period
January 1, –
March 9,
2010
    For the Period
January 1, –
December 31,
2010
 

Net sales

   $ 1,397,142           $ 109,905      $ 1,507,047   
 

Costs and expenses:

           

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

     559,593             45,270        604,863   

Publishing rights amortization

     235,977             48,336        284,313   

Pre-publication amortization

     181,521             37,923        219,444   
  

 

 

        

 

 

   

 

 

 

Cost of sales

     977,091             131,529        1,108,620   

Selling and administrative

     597,628             119,039        716,667   

Other intangible asset amortization

     57,601             2,006        59,607   

Impairment charge for goodwill, intangible assets, pre-publication costs and fixed assets

     103,933             4,028        107,961   

Severance and other charges

     (11,243          —          (11,243
  

 

 

        

 

 

   

 

 

 

Operating loss

     (327,868          (146,697     (474,565
  

 

 

        

 

 

   

 

 

 

Other income (expense):

           

Interest expense

     (258,174          (157,947     (416,121

Other (loss) income, net

     (6          9        3   

Change in fair value of derivative instruments

     90,250             (7,361     82,889   
  

 

 

        

 

 

   

 

 

 

Loss before taxes

     (495,798          (311,996     (807,794

Income tax expense (benefit)

     11,929             (220     11,709   
  

 

 

        

 

 

   

 

 

 

Net loss

   $ (507,727        $ (311,776   $ (819,503
  

 

 

        

 

 

   

 

 

 

 

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Chapter 11 Reorganization

On May 10, 2012, we entered into a Restructuring Support Agreement (the “Plan Support Agreement”) with consenting creditors holding greater than 74% of the principal amount of the then-outstanding senior secured indebtedness of the Company and with equity owners holding approximately 64% of the Company’s then-outstanding common stock. The consenting creditors agreed to support the Company’s Pre-Packaged Chapter 11 Plan of Reorganization (“Plan”).

On May 21, 2012 (the “Petition Date”), the U.S.-based entities that borrowed or guaranteed the debt of the Company (collectively the “Debtors”), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code (“Chapter 11”) in the United States Bankruptcy Court for the Southern District of New York (“Court”). The Debtors also concurrently filed the Plan, the Disclosure Statement in support of the Plan and filed various motions seeking relief to continue operations. Following the Petition Date, the Debtors operated their business as “debtors in possession” (“DIP”) under the jurisdiction of the Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Court.

On June 22, 2012, the Company successfully emerged from bankruptcy as a reorganized company pursuant to the Plan. The financial restructuring realized by the confirmation of the Plan was accomplished through a debt-for-equity exchange. The Plan deleveraged the Company’s balance sheet by eliminating the Company’s secured indebtedness in exchange for new equity in the Company. Existing stockholders, in their capacity as stockholders, received warrants for the new equity in the Company in exchange for the existing equity.

Subsequent to the Petition Date, the provisions in U.S. GAAP guidance for reorganizations applied to the Company’s financial statements while it operated under the provisions of Chapter 11. The accounting guidance did not change the application of generally accepted accounting principles in the preparation of financial statements. However, it does require that the financial statements, for periods including and subsequent to the filing of the Chapter 11 petition, distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Accordingly, all transactions (including, but not limited to, all professional fees, realized gains and losses and provisions for losses) directly associated with the reorganization and restructuring of our businesses are reported separately in our financial statements. All such expense or income amounts are reported in reorganization items in our consolidated statements of operations for the year ended December 31, 2012. The Company was not required to apply fresh-start accounting based on U.S. GAAP guidance for reorganizations due to the fact that the pre-petition holders who owned more than 50% of the Company’s outstanding common stock immediately before confirmation of the Plan received more than 50% of the Company’s outstanding common stock upon emergence. Accordingly, a new reporting entity was not created for accounting purposes.

Below is a summary of the significant transactions affecting the Company’s capital structure as a result of the effectiveness of the Plan.

Equity Transactions

On June 22, 2012, pursuant to the Plan, all of the issued and outstanding shares of common stock of the Company, including all options, warrants or any other agreements to acquire shares of common stock of the Company that existed prior to the Petition Date, were cancelled and in exchange, holders of such interests received distributions pursuant to the terms of the Plan. Following the emergence on June 22, 2012, the authorized capital stock of the Company consisted of (i) 190,000,000 shares of common stock, of which 69,970,989 shares of common stock were issued and outstanding at June 30, 2013, 3,684,211 shares of common stock were reserved for issuance upon exercise of warrants at June 30, 2013 and 8,175,135 shares of common stock were reserved for issuance upon exercise of certain other warrants and awards at June 30, 2013 under the MIP and (ii) 10,000,000 shares of preferred stock, $0.01 par value per share, of which no shares were issued and outstanding at June 30, 2013.

On June 22, 2012, the Company issued an aggregate of 70,000,000 post-emergence shares of new common stock pursuant to the final Plan, of which 41,011 are treasury shares as of June 30, 2013, on a pro rata basis to the holders of the then-existing first lien term loan (the “Term Loan”), the then-existing first lien revolving loan facility

 

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(the “Revolving Loan”) and the 10.5% Senior Secured Notes due 2019 (the “10.5% Senior Notes”) as of the Petition Date. The Company issued the new common stock pursuant to Section 1145(a)(1) of the Bankruptcy Code.

Our new MIP became effective upon emergence. The MIP provides for grants of options and restricted stock at a strike price equal to or greater than the fair value per share of common stock as of the date of the grant and reserved for management and employees up to 10% of the new common stock of the Company. During 2012 and 2013, the Company granted to certain employees, including executive officers, stock options totaling 4,952,281 and 1,722,006 shares of the Company’s common stock, respectively. On June 22, 2012, in connection with our emergence from bankruptcy, we issued 4,625,731 stock options with an exercise price of $25.00. In November 2012, January 2013, February 2013, and March 2013, we issued a total of 842,357 stock options with an exercise price of $25.00 in each case. On July 25, 2013, we issued 1,206,199 stock options with an exercise price of $26.96. Each of the stock options granted have an exercise price equal to or greater than the fair value on the date of grant and generally vest over a three or four year period. During 2012 and 2013, we granted 22,200 and 45,905 restricted stock units, respectively, to independent directors and executive officers, which generally vest after one year. During the six months ended June 30, 2013, there were 491,228 stock options that were forfeited. As of June 30, 2013, there were 3,142,170 shares of common stock underlying awards reserved for future issuance under the MIP.

Valuation of Common Stock

We are required to estimate the fair value of our equity in connection with the issuance of equity awards to properly record stock compensation expense. For equity awards granted in connection with our emergence from bankruptcy, fair value was based on a third-party valuation of the invested capital of the Company at such time. Our subsequent grants of options in November 2012, January 2013, February 2013 and March 2013 utilized the June 2012 valuation as the exercise price of the options. During 2013, when it became apparent that private secondary market trading activity in our common stock was emerging, we began to determine fair value of our equity compensation awards based on market inputs. Our stock option grant on July 25, 2013, was based on private secondary market trading by market participants, which we believe to be fair value.

We issued restricted stock units in January 2013 and June 2013, as well as additional options in July 2013. In each case, fair value for the issuance was based on private secondary market trading by market participants.

Prior to this offering, our common stock has not been listed on a securities exchange. However, the common stock issued in connection with the 2012 reorganization was exempt from the registration requirements of the Securities Act pursuant to Section 1145 of the Bankruptcy Code. As a result, shares of our common stock are generally freely tradable, except for shares of our common stock that are held by our affiliates. There has been limited secondary market trading activity for our shares of common stock since our 2012 reorganization. We have obtained private secondary market trading data and have used that information as a basis for determining the fair value of our common stock for purposes of valuing employee equity based compensation.

We believe the current secondary market trading activity represents a reasonable basis from which to determine the fair value of our shares of common stock for the following reasons:

 

   

Availability of financial information—we publicly disclose comprehensive annual and interim financial information on a quarterly basis, hold publically accessible earnings calls and provide news affecting the company publicly on a timely basis. The information available to potential investors is not substantively different than that of a publicly traded company.

 

   

Although shares of our common stock do not always trade on a daily basis, ongoing transactions occur with increased volume activity among several market participants after information regarding the company is released.

 

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Additionally, changes to the private secondary market trading data has not fluctuated significantly over time, which further indicates the market’s relative consensus of the value of our common stock.

 

   

There is no evidence that any of the trading activity is not “orderly”, as that term is applied in FASB ASC 820 and Chapter 8 of the AICPA Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation (2013 edition) (the “Guide”). Under this guidance, to the extent a transaction is orderly, e.g., it is not a forced liquidation or a distress sale, an entity shall take into account that transaction price.

As noted in the Guide, if the evidence indicates that a transaction is orderly, the amount of weight placed upon the reliability of that transaction price is a function of the consideration of the volume of the transaction, the comparability of the transaction to the asset or liability being measured and the proximity of the transaction to the measurement date. We believe that the most recent secondary market trading data represents the best estimate of the fair value of our common shares for purposes of measuring our employee and director equity based compensation expense.

In accordance with the Plan, each existing common stockholder prior to bankruptcy received its pro rata share of warrants to purchase 5% of the common stock of the Company, subject to dilution for equity awards issued in connection with the MIP. The exercise price for the warrants was based upon a $3.1 billion enterprise valuation of the Company, and the warrants have a term of seven years. All of the then-existing common stock was extinguished on the effective date of the Plan. As of June 30, 2013, there were 3,684,211 shares of common stock reserved for issuance upon the exercise of such warrants at a weighted average exercise price of $42.27 per share.

Debt Transactions

On June 22, 2012, the Company’s creditors converted the Term Loan with an aggregate outstanding principal balance of $2.6 billion and the Revolving Loan with an aggregate outstanding principal balance of $235.8 million, and the outstanding $300.0 million principal amount of 10.5% Senior Notes to 100 percent pro rata ownership of the Company’s common stock, subject to dilution pursuant to the MIP and the exercise of the new warrants, and received $30.3 million in cash.

In connection with the Chapter 11 filing on May 22, 2012, the Company entered into a new $500.0 million senior secured credit facility, which converted into an exit facility on the effective date of the emergence from Chapter 11. This exit facility consists of a $250.0 million revolving credit facility, which is secured by the Company’s accounts receivable and inventory, and a $250.0 million term loan credit facility. The proceeds of the exit facility were used to fund the costs of the reorganization and are providing working capital to the Company since its emergence from Chapter 11.

A summary of the transactions affecting the Company’s debt balances is as follows (in thousands):

 

Debt balance prior to emergence from bankruptcy (including accrued interest)

   $ (3,142,234

Exchange of debt for new common shares

     1,750,000   

Elimination of debt discount and deferred financing fees

     98,352   

Adequate protection payments

     69,701   

Conversion fees

     30,299   

Professional fees

     21,726   
  

 

 

 

(Gain) loss on extinguishment of debt

   $ (1,172,156
  

 

 

 

 

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Results of Operations

Consolidated Operating Results for the Six Months Ended June 30, 2013 and 2012

 

(dollars in thousands)    Six Months
Ended
June 30,
2013
    Six Months
Ended
June 30,
2012
    Dollar
Increase
(Decrease)
    Percent
Change
 

Net sales

   $ 529,545      $ 509,433      $ 20,112        3.9

Costs and expenses

        

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

     245,816        214,272        31,544        14.7

Publishing rights amortization

     72,587        92,677        (20,090     (21.7 )% 

Pre-publication amortization

     56,653        66,433        (9,780     (14.7 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

     375,056        373,382        1,674        0.4

Selling and administrative

     263,703        280,452        (16,749     (6.0 )% 

Other intangible asset amortization

     13,433        26,372        (12,939     (49.1 )% 

Impairment charge for pre-publication costs and fixed assets

     8,500        —          8,500        NM   

Severance and other charges

     3,481        3,473        8        0.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (134,628     (174,246     (39,618     (22.7 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense)

        

Interest expense

     (11,585     (109,833     (98,248     (89.5 )% 

Change in fair value of derivative instruments

     (479     812        (1,291     NM   

Loss on debt extinguishment

     (598     —          (598     NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before reorganization items and taxes

     (147,290     (283,267     (135,977     (48.0 )% 

Reorganization items, net

     —          (156,894     (156,894     NM   

Income tax expense (benefit)

     4,357        (6,500     10,857        NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (151,647   $ (119,873   $ 31,774        26.5
  

 

 

   

 

 

   

 

 

   

 

 

 
NM = not meaningful         

Net sales for the six months ended June 30, 2013, increased $20.1 million, or 3.9%, from $509.4 million for the same period in 2012, to $529.5 million. The increase was largely driven by strong sales of intervention and professional development products, strong adoption sales in Florida and Tennessee and robust Trade Publishing sales from the culinary product line as well as young readers titles. The increase was partially offset by lower sales of learning management systems as we migrate to a new learning management system partner strategy.

Operating loss for the six months ended June 30, 2013, decreased $39.6 million, or 22.7%, from a loss of $174.2 million for the same period in 2012, to a loss of $134.6 million, due primarily to:

 

   

a $42.8 million reduction in amortization expense related to publishing rights, pre-publication and other intangible assets due to our use of accelerated amortization methods and lower pre-publication spending over the past several years as compared to previous years;

 

   

a $16.7 million decrease in selling and administrative expenses related primarily to a reduction in labor related costs of $8.3 million related to reduced head count, and a reduction of discretionary and fixed costs of $11.1 million, generally evenly spread across most expense groups; and lower depreciation of $4.0 million; offset by an increase in variable costs such as transportation, commissions and depository fees attributed to higher sales in the quarter; and

 

   

offsetting the savings in amortization and selling and administrative expense was a $8.5 million impairment charge in 2013 to write off platforms and programs that will not be utilized in the future, along with an increase in cost of sales resulting from increased sales coupled with an increase in

 

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production and royalty costs associated with our product mix, higher gratis costs due to increased sales to adoption states and higher depreciation on digital platforms.

Interest expense for the six months ended June 30, 2013 decreased $98.2 million, or 89.5%, to $11.6 million from $109.8 million for the same period in 2012, primarily as a result of our emergence from bankruptcy with substantially reduced debt.

Change in fair value of derivative instruments for the six months ended June 30, 2013 unfavorably changed by $1.3 million from income of $0.8 million to an expense of $0.5 million. The loss on change in fair value of derivative instruments was related to unfavorable foreign exchange forward contracts executed on the Euro.

Income tax expense for the six months ended June 30, 2013 increased by $10.9 million from a $6.5 million benefit for the same period in 2012, to a $4.4 million income tax expense for the six months ended June 30, 2013. The increase in income tax expense for the six months ended June 30, 2013 compared to the same period in 2012, was primarily due to a tax benefit allocated to continuing operations after considering the gain recorded in the second quarter of 2012 in additional paid-in capital as a result of the reorganization. Such gain outside continuing operations serves as a source of income that enables realization of the tax benefit of the current year’s loss in continuing operations. This tax benefit in continuing operations is offset by the deferred tax liabilities associated with tax amortization on indefinite-lived intangibles, as well as expected foreign, state and local taxes.

Consolidated Operating Results for the Years Ended December 31, 2012 and 2011

 

(dollars in thousands)    Year
Ended
December 31,
2012
    Year
Ended
December 31,
2011
    Dollar
Increase (Decrease)
    Percent
Change
 

Net sales

   $ 1,285,641      $ 1,295,295      $ (9,654     (0.7 )% 

Costs and expenses:

        

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

     515,948        512,612        3,336        0.7

Publishing rights amortization

     177,747        230,624        (52,877     (22.9 )% 

Pre-publication amortization

     137,729        176,829        (39,100     (22.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

     831,424        920,065        (88,641     (9.6 )% 

Selling and administrative

     533,462        638,023        (104,561     (16.4 )% 

Other intangible asset amortization

     54,815        67,372        (12,557     (18.6 )% 

Impairment charge for goodwill, intangible assets, pre-publication costs and fixed assets

     8,003        1,674,164        (1,666,161     (99.5 )% 

Severance and other charges

     9,375        32,801        (23,426     (71.4 )% 

Gain on bargain purchase

     (30,751     —          30,751        NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (120,687     (2,037,130     (1,916,443     (94.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense):

        

Interest expense

     (123,197     (244,582     (121,385     (49.6 )% 

Change in fair value of derivative instruments

     1,688        (811     2,499        NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before reorganization items and taxes

     (242,196     (2,282,523     (2,040,327     (89.4 )% 

Reorganization items, net

     (149,114     —          149,114        NM   

Income tax expense (benefit)

     (5,943     (100,153     (94,210     (94.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (87,139   $ (2,182,370   $ (2,098,231     (96.0 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 
NM = not meaningful         

 

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Net sales for the year ended December 31, 2012 decreased $9.7 million, or 0.7%, from $1,295.3 million for the same period in 2011, to $1,285.6 million. The decrease was due to a $47.0 million decline in domestic education sales from the prior year. New adoption and open territory sales in the markets in which we compete were reduced from the prior year primarily due to known lower adoptions in 2012, coupled with a continuing decline in the open territory market. We believe the overall addressable adoption market was down approximately 23% and the open territory market was down approximately 8% when compared to the prior year. Offsetting a portion of the decline was a $31.4 million increase in our Trade Publishing sales primarily due to increased sales of a number of our best-selling titles and an increase in e-book sales.

Operating loss for the year ended December 31, 2012 decreased $1,916.4 million, or 94.1%, from a loss of $2,037.1 million for the same period in 2011 to a loss of $120.7 million, primarily due to a goodwill impairment charge recognized in 2011 of $1,442.5 million. The goodwill impairment was due to the carrying value of the Education reporting unit exceeding the implied fair value. Further, the increased loss in 2011 was also due to tradename and other impairments of $231.6 million. Other significant components of the decrease in operating loss were as follows:

 

   

a $104.5 million decrease in amortization expense related to publishing rights, pre-publication and other intangible assets due to our use of accelerated amortization methods and lower pre-publication spending over the past several years as compared to previous years;

 

   

a $104.6 million decrease in selling and administrative expenses related primarily to a reduction in labor related costs of $32.3 million; a reduction in variable expenses such as commissions and depository fees of $10.6 million associated with lower revenue; lower travel and entertainment expenses of $11.0 million; with the remaining $50.7 million attributed to lower fixed and discretionary expenses such as rent, bad debt and professional fees;

 

   

a $23.4 million decrease in severance and other charges, as 2011 included a significant executive and workforce realignment; and

 

   

a $30.8 million gain on bargain purchase associated with the acquisition of certain asset product lines for our Trade Publishing segment.

Interest expense for the year ended December 31, 2012 decreased $121.4 million, or 49.6%, from $244.6 million for the same period in 2011, to $123.2 million, primarily as a result of our emergence from bankruptcy with substantially reduced debt.

Change in fair value of derivative instruments for the year ended December 31, 2012 increased $2.5 million from an unrealized loss of $0.8 million for the same period in 2011, to an unrealized gain of $1.7 million. The increase was due to favorable euro currency fluctuations on our foreign exchange forward contracts.

Reorganization items, net for the year ended December 31, 2012 was $149.1 million. The amount represents expense and income amounts that were recorded to the statement of operations as a result of the bankruptcy proceedings. Reorganization items were incurred starting with the date of the bankruptcy filing through the date of bankruptcy emergence.

Income tax benefit for the year ended December 31, 2012 decreased $94.2 million from a tax benefit of $100.2 million for the year ended December 31, 2011, to a tax benefit of $5.9 million. The full year effective tax rate for 2012 was 6.4% primarily due to a tax benefit allocated to continuing operations after considering the gain recorded in 2012 in equity as a result of the reorganization. Such gain serves as a source of income that enables realization of the tax benefit of the current year loss in continuing operations. This tax benefit in continuing operations is offset by the deferred tax liabilities associated with tax amortization on indefinite-lived intangibles as well as expected foreign, state and local taxes for 2012. The full year effective tax rate for 2011 was approximately 4.4% due to the deferred tax benefit resulting from the decrease in deferred tax liabilities associated with book impairments on indefinite-lived intangibles and goodwill.

 

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Consolidated Operating Results for the Years Ended December 31, 2011 and 2010

 

(dollars in thousands)    Year
Ended
December 31,
2011
    Combined
Year
Ended
December 31,
2010
    Dollar
Increase
(Decrease)
    Percent
Change
 

Net sales

   $ 1,295,295      $ 1,507,047      $ (211,752     (14.1 )% 

Costs and expenses

        

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

     512,612        604,863        (92,251     (15.3 )% 

Publishing rights amortization

     230,624        284,313        (53,689     (18.9 )% 

Pre-publication amortization

     176,829        219,444        (42,615     (19.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

     920,065        1,108,620        (188,555     (17.0 )% 

Selling and administrative

     638,023        716,667        (78,644     (11.0 )% 

Other intangible asset amortization

     67,372        59,607        7,765        13.0

Impairment charge for goodwill, intangible assets, pre-publication costs and fixed assets

     1,674,164        107,961        1,566,203        NM   

Severance and other charges

     32,801        (11,243     44,044        NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (2,037,130     (474,565     1,562,565        NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense)

        

Interest expense

     (244,582     (416,121     (171,539     (41.2 )% 

Other (loss) income, net

     —          3        (3     NM   

Change in fair value of derivative instruments

     (811     82,889        (83,700     NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before taxes

     (2,282,523     (807,794     1,474,729        NM   

Income tax expense (benefit)

     (100,153     11,709        (111,862     NM   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (2,182,370   $ (819,503   $ 1,362,867        NM   
  

 

 

   

 

 

   

 

 

   

 

 

 
NM = not meaningful         

Net sales for the year ended December 31, 2011, decreased $211.8 million, or 14.1%, from $1,507.0 million for the same period in 2010, to $1,295.3 million. The decline was largely driven by a reduction in the Texas adoption market by over $250 million from 2010, coupled with a decline in sales to open territories along with a decline in international sales. Net sales for Texas for the year ended December 31, 2011 was $72.0 million, approximately $119.0 million less than the same period in 2010. Additionally, sales to open territories were approximately $59.3 million lower for the year ended 2011, compared to the same period in 2010 due primarily to the contraction of spending throughout most states. International sales were $46.1 million lower in 2011 than 2010 due to a tightening of credit terms with our distribution partners in the Middle East. These declines were partially offset by sales of our professional development services.

Operating loss for the year ended December 31, 2011, increased $1,562.6 million, or 329.3%, from a loss of $474.6 million for the same period in 2010, to a loss of $2,037.1 million, primarily due to a goodwill impairment charge of $1,442.5 million. Further, the increased loss was also due to lower annual net sales, increased tradename and other impairments of $231.6 million and a $44.0 million increase in severance and other expenses, partially offset by:

 

   

a $88.5 million decrease in amortization expense related to publishing rights, pre-publication and other intangible assets due to our use of accelerated amortization methods and lower pre-publication spending over the past several years as compared to previous years;

 

   

a $78.6 million decrease in selling and administrative expenses related primarily to a reduction in variable expenses, such as commissions and depository fees associated with lower revenue; and

 

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a $92.3 million decrease in cost of sales (excluding pre-publication and publishing rights amortization) due to a reduction of the inventory step up amortization of $41.7 million, which was included in 2010, along with lower net sales.

Interest expense for the year ended December 31, 2011 decreased $171.5 million, or 41.2%, from $416.1 million for the same period in 2010, to $244.6 million, primarily a result of the expiration of legacy swap agreements with unfavorable fixed interest rates and the conversion of $4.0 billion of debt to equity in March 2010, as part of the restructuring. The components for the decline were:

 

   

in 2010, we paid $93.1 million related to the interest rate swap agreements in place at the time. The swap agreements, which were mandatory under our Credit Agreement, expired on December 31, 2010;

 

   

reduction of $67.0 million in interest related to our Mezzanine debt, which bore interest at 17.5% through March 9, 2010, that did not exist in 2011;

 

   

a reduction of $5.1 million of deferred financing costs as a substantial amount of deferred financing fees that existed at March 9, 2010 were written off; and

 

   

a reduction of $8.1 million related to the accounts receivable securitization facility, as we had $140.0 million outstanding on the securitization facility from February 2010 through August 3, 2010, and an average outstanding balance of $30.6 million for only two months during 2011.

Change in fair value of derivative instruments for the year ended December 31, 2011, decreased $83.7 million from a gain of $82.9 million for the same period in 2010, to an unrealized loss of $0.8 million. The decrease was due to interest rate swap payments made during 2010, which effectively reduced the unrealized liability established on the balance sheet. No interest rate swap agreements were in place during 2011. The $0.8 million unrealized loss on change in fair value of derivative instruments related to unfavorable foreign exchange forward contracts in place during 2011.

Income tax expense for the year ended December 31, 2011, decreased $111.9 million from an expense of $11.7 million for the year ended December 31, 2010, to a benefit of $100.2 million. The full year effective tax rate for 2011 was approximately 4.4% primarily due to a deferred income tax benefit recorded in the fourth quarter of 2011 as a result of book impairments to indefinite-lived intangibles and goodwill, which reduce deferred tax liabilities.

Adjusted EBITDA

To supplement our financial statements presented in accordance with GAAP, we have presented Adjusted EBITDA in addition to our GAAP results. 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, or levels of depreciation or amortization. Accordingly, our management believes that this measurement is useful for comparing general operating performance from period to period. Furthermore, the agreements governing our indebtedness contain covenants and other tests based on Adjusted EBITDA. In addition, targets and positive trends in Adjusted EBITDA are used as performance measures and to determine certain compensation of management. 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

 

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substitute for, net earnings in accordance with GAAP as a measure of performance. Adjusted EBITDA is not intended to be a measure of liquidity or free cash flow for discretionary use. You are cautioned not to place undue reliance on Adjusted EBITDA.

Below is a reconciliation of our net loss to Adjusted EBITDA for the six months ended June 30, 2013 and 2012 and for the years ended December 31, 2012, 2011 and 2010:

 

(in thousands)   Successor          Predecessor  
  Six Months Ended
June  30,
    Year Ended
December 31,
    For the Period
March 10, 2010
to December 31,
         For the Period
January 1, 2010
to March 9,
 
  2013     2012     2012     2011     2010          2010  

Net loss

  $ (151,647   $ (119,873   $ (87,139   $ (2,182,370   $ (507,727       $ (311,776

Interest expense

    11,585        109,833        123,197        244,582        258,174            157,947   

Provision (benefit) for income taxes

    4,357        (6,500     (5,943     (100,153     11,929            (220

Depreciation expense

    30,225        27,003        58,131        58,392        48,649            10,900   

Amortization expense

    142,673        185,482        370,291        474,825        475,099            88,265   

Non-cash charges—stock compensation

    3,275        347        4,227        8,558        4,274            925   

Non-cash charges—gain (loss) on foreign currency and interest hedge

    479        (812     (1,688     811        (90,250         7,361   

Non-cash charges—asset impairment charges

    8,500        —          8,003        1,674,164        103,933            4,028   

Purchase accounting adjustments (1)

    4,878        6,326        (16,511     22,732        113,182            —     

Fees. expenses or charges for equity offerings, debt or acquisitions

    1,764        267        267        3,839        1,513            —     

Debt restructuring (2)

    —          —          —          —          30,000            9,564   

Restructuring (3)

    1,539        1,788        6,716        —          —              —     

Severance separation costs and facility closures (4)

    6,481        3,762        9,375        32,818        23,975            992   

Reorganization items, net (5)

    —          (156,894     (149,114     —          —              —     

Debt extinguishment loss

    598        —          —          —          —              —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

Adjusted EBITDA

  $ 64,707      $ 50,729      $ 319,812      $ 238,198      $ 472,751          $ (32,014
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

(1) Represents certain non-cash accounting adjustments, most significantly relating to deferred revenue and inventory costs, that we were required to record as a direct result of the March 9, 2010 restructuring and the acquisitions for the years ended December 31, 2012 and 2011 and the periods March 10, 2010 to December 31, 2010 and January 1, 2010 to March 9, 2010.
(2) Represents fees paid and charged to operations relating to the March 9, 2010 debt restructuring.
(3) Represents restructuring costs (other than severance and real estate) such as consulting and realignment.
(4) Represents costs associated with restructuring. Included in such costs are severance, facility integration and vacancy of excess facilities. 2010 costs also include program integration and related inventory obsolescence and consulting costs.
(5) Represents net gain associated with our Chapter 11 reorganization in 2012.

 

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Segment Operating Results

Results of Operations—Comparing Six Months Ended June 30, 2013 and 2012

 

(dollars in thousands)    Six Months Ended June 30,     Dollar Change      Percentage Change  
           2013                     2012               

Net sales:

         

Education

   $ 450,560      $ 447,317      $ 3,243         0.7

Trade Publishing

     78,985        62,116        16,869         27.2
  

 

 

   

 

 

      

Total

   $ 529,545      $ 509,433        
  

 

 

   

 

 

      

Segment Adjusted EBITDA:

         

Education

   $ 73,447      $ 67,385      $ 6,062         9.0

Trade Publishing

     11,308        5,266        6,042         114.7

Corporate and Other

     (20,048     (21,922     1,874         8.5
  

 

 

   

 

 

      

Total

   $ 64,707      $ 50,729        
  

 

 

   

 

 

      

Net Sales

Education

Our Education segment net sales for the six months ended June 30, 2013, increased $3.2 million, or 0.7%, from $447.3 million for the same period in 2012, to $450.6 million. The increase was largely driven by strong sales of intervention and professional development products and strong adoption sales in Florida and Tennessee. The increases were partially offset by lower sales of learning management systems as we migrate to a new learning management system partner strategy.

Trade Publishing

Our Trade Publishing segment net sales for the six months ended June 30, 2013, increased $16.9 million, or 27.2%, from $62.1 million for the same period in 2012, to $79.0 million. The increase was attributed to additional net sales from the culinary product line as well as increases in the general interest and young readers products.

Segment Adjusted EBITDA

Education

Our Education segment Adjusted EBITDA for the six months ended June 30, 2013, increased $6.1 million, or 9.0%, from $67.4 million for the same period in 2012, to $73.4 million. The increase was attributed to increased sales and lower selling and administrative costs. Savings in selling and administrative expense reductions were partially offset by an increase in cost of sales as a result of higher production and royalty costs associated with our product mix along with higher gratis costs due to increased sales to adoption states.

Trade Publishing

Our Trade Publishing segment Adjusted EBITDA for the six months ended June 30, 2013, increased $6.0 million, or 114.7%, from $5.3 million for the same period in 2012, to $11.3 million, due to the flow through effect of the $16.9 million increase in net sales.

Corporate and Other

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. Adjusted EBITDA for the Corporate and Other category for the six months ended June 30, 2013, increased $1.9 million, or 8.5%, from a loss of $21.9 million for the same period in 2012, to a loss of $20.0 million.

 

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Results of Operations—Comparing Years Ended December 31, 2012 and 2011

 

(dollars in thousands)    Year Ended     Dollar Change     Percentage Change  
   2012     2011      

Net sales:

        

Education

   $ 1,128,591      $ 1,169,645      $ (41,054     (3.5 )% 

Trade Publishing

     157,050        125,650        31,400        25.0
  

 

 

   

 

 

     

Total

   $ 1,285,641      $ 1,295,295       
  

 

 

   

 

 

     

Segment Adjusted EBITDA:

        

Education

   $ 329,723      $ 278,930      $ 50,793        18.2

Trade Publishing

     28,774        12,888        15,886        123.3

Corporate and Other

     (38,685     (53,620     14,935        27.9
  

 

 

   

 

 

     

Total

   $ 319,812      $ 238,198       
  

 

 

   

 

 

     

Net Sales

Education

Our Education segment net sales for the year ended December 31, 2012, decreased $41.1 million, or 3.5%, from $1,169.6 million for the same period in 2011, to $1,128.6 million. The decrease was primarily due to a $47.0 million decline in domestic education sales from the prior year. This is a result of our addressable new adoption and open territory sales being down from the prior year largely due to known lower adoptions in 2012 coupled with a continuing decline in the open territory market as a result of funding. The overall addressable adoption market was down approximately 23% when compared to the prior year and the open territory market was down approximately 8% from the prior year. While our Singapore Math product continues to outperform, certain other supplemental product sales were down due to aging products. The decrease was partially offset by the strength of our professional development services and reading intervention sales, which increased $20.5 million.

Trade Publishing

Our Trade Publishing segment net sales for the year ended December 31, 2012, increased $31.4 million, or 25.0%, from $125.7 million for the same period in 2011, to $157.1 million. The increase is primarily related to the increased popularity of certain titles as attributed to the theatrical releases of The Hobbit, Life of Pi and Extremely Loud and Incredibly Close, which drove increased book sales. Further, there was a continued increase in e-book sales driven by an overall growth in digital devices.

Segment Adjusted EBITDA

Education

Our Education segment Adjusted EBITDA for the year ended December 31, 2012, increased $50.8 million, or 18.2%, from $278.9 million for the same period in 2011, to $329.7 million. The increase was attributed to a reduction in labor related costs due to the head count reduction associated with the restructuring activity and a reduction in travel expense and other fixed and discretionary costs realized as part of cost control measures. The increase was partially offset by the effect of the $41.1 million decrease in net sales for the year.

Trade Publishing

Our Trade Publishing segment Adjusted EBITDA for the year ended December 31, 2012, increased $15.9 million, or 123.3%, from $12.9 million for the same period in 2011, to $28.8 million. The increase was primarily attributed to the effect of the $31.4 million increase in net sales partially offset by slightly higher royalties.

 

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Corporate and Other

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. Additionally, 2011 included headcount associated with certain incubator initiatives which were terminated in the latter half of 2011, resulting in labor savings in 2012. Adjusted EBITDA for the Corporate and Other category for the year ended December 31, 2012, increased $14.9 million, from a loss of $53.6 million for the same period in 2011, to a loss of $38.7 million. The increase was due to lower headcount and administrative expenses associated with cost control measures.

Results of Operations—Comparing Years Ended December 31, 2011 and 2010

 

(dollars in thousands)    Year Ended     Dollar Change     Percentage Change  
   2011     2010      

Net sales:

        

Education

   $ 1,169,645      $ 1,383,147      $ (213,502     (15.4 )% 

Trade Publishing

     125,650        123,900        1,750        1.4
  

 

 

   

 

 

     

Total

   $ 1,295,295      $ 1,507,047       
  

 

 

   

 

 

     

Segment Adjusted EBITDA:

        

Education

   $ 278,930      $ 490,262      $ (211,332     (43.1 )% 

Trade Publishing

     12,888        12,730        158        1.2

Corporate and Other

     (53,620     (62,255     8,635        13.9
  

 

 

   

 

 

     

Total

   $ 238,198      $ 440,737       
  

 

 

   

 

 

     

Net Sales

Education

Our Education segment net sales for the year ended December 31, 2011, decreased $213.5 million, or 15.4%, from $1,383.1 million for the same period in 2010, to $1,169.6 million. The decline was largely driven by a reduction in the Texas adoption market by over $250 million from 2010 coupled with a decline in sales to open territories along with a decline in international sales. Net sales for Texas for the year ended December 31, 2011, was $72.0 million, approximately $119.0 million less than the same period in 2010. Additionally, sales to open territories were approximately $59.0 million lower for the year ended 2011, compared to the same period in 2010 due primarily to the contraction of spending throughout most states. International sales were $46.1 million lower in 2011 than 2010 due to a tightening of credit terms with our distribution partners in the Middle East.

Trade Publishing

Our Trade Publishing segment net sales for the year ended December 31, 2011, increased $1.8 million, or 1.4%, from $123.9 million for the same period in 2010, to $125.7 million. The increase was primarily attributed to favorable returns compared to the prior year due to a shift to e-book sales from print sales partially offset by a decline in income related to subsidiary rights.

Segment Adjusted EBITDA

Education

Our Education segment Adjusted EBITDA for the year ended December 31, 2011, decreased $211.3 million, or 43.1%, from $490.3 million for the same period in 2010, to $278.9 million. The decline was largely driven by a decline in net sales primarily attributed to markets in Texas and reduced expenditures in certain open territories. Additionally, our cost of sales rate as a percentage of net sales increased as we shifted to

 

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more development and consulting services from the more profitable print products. Additionally, we incurred higher bad debt expense and returns expense attributed to a tightening of credit terms with our distribution partners in the Middle East.

Trade Publishing

Our Trade Publishing segment Adjusted EBITDA for the year ended December 31, 2011, increased $0.2 million, or 1.2%, from $12.7 million for the same period in 2010, to $12.9 million. The increase was primarily attributed to tighter cost management.

Corporate and Other

The Corporate and Other category represents certain general overhead costs not fully allocated to the business segments along with incubator initiatives focusing on consumer and emerging markets and research and development. Adjusted EBITDA for the Corporate and Other category for the year ended December 31, 2011, increased $8.6 million, from a loss of $62.2 million for the same period in 2010, to a loss of $53.6 million. The increase was due to the elimination of our corporate office in Dublin, Ireland.

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.

In the K-12 market, we typically receive payments for products and services from individual school districts, and, to a lesser extent, individual schools and states. In the Trade Publishing markets, payment is received for products and services from book distributors and retail booksellers. In the case of testing and assessment products and services, payment is received from the individually contracted parties.

Approximately 88% of our net sales for the year ended December 31, 2012 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 years, approximately 69% 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. 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.

 

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Quarterly Results of Operations

 

(in thousands)   Third
Quarter
2011
    Fourth
Quarter
2011
    First
Quarter
2012
    Second
Quarter
2012
    Third
Quarter
2012
    Fourth
Quarter
2012
    First
Quarter
2013
    Second
Quarter
2013
 

Education segment

  $ 538,107      $ 203,641      $ 133,369      $ 313,948      $ 451,326      $ 229,948      $ 126,827      $ 323,733   

Trade Publishing segment

    36,402        36,075        31,860        30,256        42,687        52,247        39,767        39,218   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net sales

    574,509        239,716        165,229        344,204        494,013        282,195        166,594        362,951   

Costs and expenses:

               

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

    195,129        123,516        81,317        132,955        179,583        122,093        87,060        158,756   

Publishing rights amortization

    54,703        54,703        50,604        42,073        42,535        42,535        39,450        33,137   

Pre-publication amortization

    45,045        49,681        32,577        33,856        35,593        35,703        26,157        30,496   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

    294,877        227,900        164,498        208,884        257,711        200,331        152,667        222,389   

Selling and administrative

    157,685        164,793        138,849        141,603        139,410        113,600        130,236        133,467   

Other intangible asset amortization

    18,348        13,015        13,138        13,234        13,381        15,062        10,752        2,681   

Impairment charge for goodwill, intangible assets, pre-publication costs and fixed assets

    36,757        1,637,407        —          —          —          8,003        —          8,500   

Severance and other charges

    2,254        29,878        1,093        2,380        2,019        3,883        1,928        1,553   

Gain on bargain purchase

    —          —          —          —          —          (30,751     —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    64,588        (1,833,277     (152,349     (21,897     81,492        (27,933     (128,989     (5,639
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense)

               

Interest expense

    (64,025     (66,654     (66,800     (43,033     (6,900     (6,464     (5,907     (5,678

Change in fair value of derivative instruments

    (1,560     (286     1,006        (194     812        64        (530     51   

Loss on extinguishment of debt

    —          —          —          —          —          —          —          (598
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before reorganization items and taxes

    (997     (1,900,217     (218,143     (65,124     75,404        (34,333     (135,426     (11,864

Reorganization items, net

    —          —          —          (156,894     —          7,780        —          —     

Income tax expense (benefit)

    (21,639     (109,973     7,204        (13,704     8,466        (7,909     1,955        2,402   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 20,642      $ (1,790,244   $ (225,347   $ 105,474      $ 66,938      $ (34,204   $ (137,381   $ (14,266
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

A gain on bargain purchase of $30.8 million was recorded in the fourth quarter of 2012. In addition, reorganization items of $156.9 million associated with our Chapter 11 reorganization were recorded in the second quarter of 2012.

Liquidity and Capital Resources

 

     Six Months
Ended
June 30,

2013
    Year Ended December 31,  
(in thousands)      2012      2011      2010  

Cash and cash equivalents

   $ 105,202      $ 329,078       $ 413,610       $ 380,073   

Short-term investments

     107,377        146,041         —           17,667   

Current portion of long-term debt

     2,500        2,500         43,500         193,064   

Long-term debt

     244,375        245,625         2,968,088         2,668,530   

Net cash provided by (used in) operating activities

     (152,768     104,802         132,796         141,670   

 

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On June 22, 2012, our creditors converted the First Lien Credit Agreement consisting of the Term Loan with an aggregate outstanding principal balance of $2.6 billion and the Revolving Loan with an aggregate outstanding principal balance of $235.8 million and the outstanding $300.0 million principal amount of 10.5% Senior Notes to 100 percent pro rata ownership of our common stock.

On May 22, 2012, we entered into a new $500.0 million senior secured credit facility, which was converted into an exit facility on the effective date of the emergence from Chapter 11. As a result, our existing senior secured credit facilities consist of a $250.0 million asset-based revolving credit facility and a $250.0 million term loan facility. The proceeds from the initial borrowings under the senior secured credit facilities were used to fund the costs of the reorganization and provide post-closing working capital to the Company.

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 (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 and HMH Intermediate Holdings (Delaware), LLC) (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.

Borrowings under the term loan facility are payable in equal quarterly amounts totaling 1.0% per annum of the original term loan facility amount prior to the maturity date of the term loan facility, with the remaining unpaid balance due and payable at maturity. No amortization payments are required with respect to the revolving credit facility.

The revolving credit facility is available based on a borrowing base comprised of eligible inventory and eligible receivables. Up to $40.0 million of the revolving credit facility is available for issuances of letters of credit. The amount of any outstanding letters of credit reduce availability under the revolving credit facility on a dollar for dollar basis.

The revolving credit facility has a term of five years and the interest rate for borrowings under the revolving credit facility is based on, at the Borrowers’ election, LIBOR or an alternate base rate, plus in each case a margin that is determined based on average daily availability. The term loan facility has a term of six years and the interest rate for borrowings under the term loan facility is based on, at the Borrowers’ election, LIBOR plus 4.25% per annum or the alternate base rate plus 3.25%. The LIBOR rate under the term loan facility is subject to a minimum “floor” of 1.00%. As of June 30, 2013, the interest rate of the term loan facility was 5.25%. As of June 30, 2013, we had approximately $246.9 million outstanding under our term loan facility and no amounts outstanding under our revolving credit facility. We had approximately $212.8 million of borrowing availability under our revolving credit facility and approximately $25.9 million of outstanding letters of credit as of June 30, 2013.

The term loan facility contains financial covenants based on EBITDA requiring the Company, on a consolidated basis, to maintain a certain minimum interest coverage ratio and a certain maximum leverage ratio. The interest coverage ratio is 8.0 to 1.0 for fiscal quarters ending during 2013, and 9.0 to 1.0 for fiscal quarters

 

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ending thereafter. The maximum leverage ratio is 2.25 to 1.0 for fiscal quarters ending through September 30, 2013, and 2.0 to 1.0 for fiscal quarters ending December 31, 2013 and thereafter. The revolving credit facility contains a minimum fixed charge coverage ratio which is tested if availability is less than the greater of $31.25 million and 15% 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. We were in compliance with each of these covenants in the term loan facility as of June 30, 2013, and the minimum fixed charge coverage ratio was not applicable under the revolving credit facility. The senior secured credit facilities also contain customary restrictive covenants, including limitations on incurrence of indebtedness, incurrence of liens, transactions with affiliates, mergers, dividends and other distributions, asset dispositions and investments.

Our senior secured credit facilities contain customary events of default, subject to applicable grace periods, including for nonpayment of principal, interest or other amounts, violation of covenants, incorrectness of representations or warranties in any material respect, cross default to material indebtedness, material monetary judgments, ERISA defaults, insolvency, actual or asserted invalidity of loan documents or material security and change of control.

We had $105.2 million of cash and cash equivalents and $107.4 million of short-term investments at June 30, 2013. We had $329.1 million of cash and cash equivalents and $146.0 million of short-term investments at December 31, 2012.

We expect our net cash provided by operations combined with our cash and cash equivalents and borrowings 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.

Operating activities

Net cash used in operating activities was $152.8 million for the six months ended June 30, 2013, a $65.5 million decrease from the $218.2 million used in operating activities for the six months ended June 30, 2012. The decrease in cash used in operating activities for the first six months of 2013 from 2012 was primarily driven by lower interest, a direct result of the substantial reduction in debt related to our Chapter 11 reorganization, slightly offset by unfavorable changes in working capital as a result of lower accounts receivable due to timing and higher inventory related to anticipated third quarter sales from the prior year.

Net cash provided by operating activities was $104.8 million for the year ended December 31, 2012, a $28.0 million decrease from the $132.8 million provided by operating activities for the year ended December 31, 2011. The decrease in cash provided by operating activities from 2011 to 2012 was primarily due to decreases in working capital, primarily consisting of lower deferred revenue and a decrease in accounts payable partially offset by stronger operating performance and a decrease in accounts receivable and inventory.

Net cash provided by operating activities was $132.8 million for the year ended December 31, 2011, a $8.9 million decrease from the $141.7 million provided by operating activities for the year ended December 31, 2010. The decrease in cash provided by operating activities from 2010 to 2011 was driven by an unfavorable change in accounts receivable as a substantial amount of prior year adoption sales were collected by the end of the fourth quarter of 2010, along with lower inventory levels and decreased interest payable. These changes were partially offset by favorable changes in accounts payable and severance and other charges.

Investing activities

Net cash used in investing activities was $69.9 million for the six months ended June 30, 2013, an increase of $16.4 million from the $53.5 million used in investing activities for the six months ended June 30, 2012. The increase in cash investing expenditures is attributed to a $26.0 million increase in additions to pre-publication costs and property, plant and equipment, primarily platforms. Although a portion of the increase is attributed to

 

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timing, there is a portion of the increase due to incremental spending as we prepare programs for an increase in upcoming adoptions over the next couple of years. Partially offsetting the net cash used in investing activities is an increase in net proceeds from short-term investment activity.

Net cash used in investing activities was $296.0 million for the year ended December 31, 2012, an increase of $100.7 million from the $195.3 million used in investing activities for the year ended December 31, 2011. The increase in cash expenditures for 2012 is primarily attributable to purchases of $165.6 million of short-term investments offset by reductions in capital expenditures of $28.9 million for property, plant, and equipment and pre-publication costs, and reductions in cash outlays over the prior year for acquisitions of $24.6 million.

Net cash used in investing activities was $195.3 million for the year ended December 31, 2011, a decrease of $62.4 million from the $257.7 million used in investing activities for the year ended December 31, 2010. The decrease reflects $17.8 million in proceeds from the sale of short term investments and $16.8 million in proceeds from restricted cash accounts related to cash collateralized letter of credit which were released in 2011. In the year ended December 31, 2010, $18.0 million had been used for the purchase of short term investments and $42.7 million had been deposited to restricted cash accounts. Partially offsetting the source of cash from investing activities was $30.0 million of additional capital expenditure over the prior period for an acquisition of an intangible asset.

Financing activities

Net cash used in financing activities was $1.3 million for the six months ended June 30, 2013, a decrease of $125.4 million from the $124.2 million net cash provided by financing activities for the six months ended June 30, 2012. We paid $1.3 million of principal payments in 2013 for our outstanding indebtedness under the term loan facility during the first six months of 2013. During the six months ended June 30, 2012, we received proceeds of $250.0 million in connection with the initial borrowings under our term loan facility. This amount was partially offset by our Chapter 11 reorganization costs and principal payments of long term debt of $10.9 million.

Net cash provided by financing activities was $106.7 million for the year ended December 31, 2012, an increase of $10.7 million from the $96.0 million net cash provided by financing activities for the year ended December 31, 2011. During 2012, in connection with our emergence from bankruptcy, we issued new term debt with proceeds of $250.0 million and we paid $104.0 million in restructuring costs and $26.6 million in deferred financing fees relating to the bankruptcy and new term debt. We also paid $10.9 million of principal payments on the debt existing prior to bankruptcy and three quarters of principal payments related to the new term debt totaling $1.9 million. During 2011, we issued secured notes with proceeds of $300.0 million and we paid $150.0 million to retire the 7.2% secured notes that matured on March 15, 2011. We also made principal payments on our long term debt totaling $43.5 million and paid approximately $10.5 million of fees in connection with the issuance of the $300.0 million principal amount of 10.5% Senior Notes.

Net cash provided by financing activities was $96.0 million for the year ended December 31, 2011, a decrease of $306.1 million from the $402.1 million net cash provided by financing activities for the year ended December 31, 2010. During 2011, we received $300.0 million through a 10.5% Senior Notes offering and paid $8.9 million for fees associated with that offering. We also paid $1.6 million of deferred financing fees related to the amendments to our accounts receivable securitization facility. We paid $150.0 million to retire the 7.2% secured notes that matured on March 15, 2011. During the year ended December 31, 2010, we raised $649.6 million, net of fees, from our rights offering. Offsetting this inflow was a payment of $43.7 million of related restructuring costs.

Critical Accounting Policies

The preparation of financial statements in conformity with U.S. GAAP requires the use of estimates, assumptions and judgments by management that affect the reported amounts of assets, liabilities, net sales, expenses and related disclosure of contingent assets and liabilities in the amounts reported in the financial statements and accompanying notes. On an on-going basis, we evaluate our estimates and assumptions,

 

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including, but not limited to, book returns, allowance for bad debts, recoverability of advances to authors, valuation of inventory, financial instruments, depreciation and amortization periods, recoverability of long-term assets such as property, plant and equipment, capitalized pre-publication costs, other identified intangibles, goodwill, deferred revenue, income taxes, pensions and other postretirement benefits, contingencies, litigation and purchase accounting. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates.

Revenue Recognition

We derive revenue primarily from the sale of print and digital textbooks and instructional materials, trade books, reference materials, assessment materials and multimedia instructional programs; license fees for book rights, content and software; and services that include test development, test delivery, test scoring, professional development, consulting and training as well as access to hosted content. Revenue is recognized only once persuasive evidence of an arrangement with the customer exists, the sales price is fixed or determinable, delivery of products or services has occurred, title and risk of loss with respect to products have transferred to the customer, all significant obligations, if any, have been performed, and collection is probable.

We enter into certain contractual arrangements that have multiple elements, one or more of which may be delivered subsequent to the delivery of other elements. These multiple-deliverable arrangements may include print and digital media, professional development services, training, software licenses, access to hosted content, and various services related to the software including but not limited to hosting, maintenance and support, and implementation. For these multiple-element arrangements, we allocate revenue to each deliverable of the arrangement based on the relative selling prices of the deliverables. In such circumstances, we first determine the selling price of each deliverable based on (i) vendor-specific objective evidence of fair value (“VSOE”) if that exists, (ii) third-party evidence of selling price (“TPE”) when VSOE does not exist, or (iii) our best estimate of the selling price when neither VSOE nor TPE exists. Revenue is then allocated to the non-software deliverables as a group and to the software deliverables as a group using the relative selling prices of each of the deliverables in the arrangement, based on the selling price hierarchy. Non-software deliverables include print and digital textbooks and instructional materials, trade books, reference materials, assessment materials and multimedia instructional programs; licenses to book rights and content; access to hosted content; and services including test development, test delivery, test scoring, professional development, consulting and training when those services do not relate to software deliverables. Software deliverables include software licenses, software maintenance and support services, professional services and training when those services relate to software deliverables.

For the non-software deliverables, we determine the revenue for each deliverable based on its relative selling price in the arrangement and we recognize revenue upon delivery of the product or service, assuming all other revenue recognition criteria have been met. Revenue for test delivery, test scoring and training is recognized when the service has been completed. Revenue for test development, professional development, consulting and training is recognized as the service is provided. Revenue for access to hosted content is recognized ratably over the term of the arrangement.

For the software deliverables as a group, we recognize revenue in accordance with the authoritative guidance for software revenue recognition. As our software licenses are typically sold with maintenance and support, professional services or training, we use the residual method to determine the amount of software license revenue to be recognized.

Under the residual method, arrangement consideration of the software deliverables as a group is allocated to the undelivered elements based upon VSOE of those elements, with the residual amount of the arrangement fee allocated to and recognized as license revenue upon delivery, assuming all other revenue recognition criteria have been met. If VSOE of one or more of the undelivered services or other elements does not exist, all revenues

 

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of the software-deliverables arrangement are deferred until delivery of all of those services or other elements has occurred, or until VSOE of each of those services or other elements can be established.

As products are shipped with right of return, a provision for estimated returns on these sales is made at the time of sale based on historical experience.

Deferred revenues represent amounts billed to customers or payments received from customers for which revenue has not been recognized. Deferred revenues primarily consist of gratis items, digital and on-line learning components. As our business model shifts to more digital and on-line learning components, our deferred revenue balance could increase.

Accounts Receivable

Accounts receivable are recorded net of allowances for doubtful accounts and reserves for book returns. In the normal course of business, we extend credit to customers that satisfy predefined criteria. We estimate the collectability of our receivables. Allowances for doubtful accounts are established through the evaluation of accounts receivable aging and prior collection experience to estimate the ultimate collectability of these receivables. Reserves for book returns are based on historical return rates and sales patterns.

Inventories

Inventories are stated at the lower of weighted average cost or net realizable value. The level of obsolete and excess inventory is estimated on a program or title level-basis by comparing the number of units in stock with the expected future demand. The expected future demand of a program or title is determined by the copyright year, the previous years’ sales history, the subsequent year’s sales forecast, known forward-looking trends including our development cycle to replace the title or program and competing titles or programs.

Pre-publication Costs

We capitalize 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. We utilize this policy for all pre-publication costs, except with respect to our Trade Publishing consumer books, for which we expense such costs as incurred, and our assessment products, for which we use the straight-line 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.

Amortization expense related to pre-publication costs for the years ended December 31, 2012 and 2011 were $137.7 million and $176.8 million, respectively. For the period January 1, 2010 to March 9, 2010 amortization expense related to pre-publication costs was $37.9 million and for the period March 10, 2010 to December 31, 2010 amortization expense related to pre-publication costs was $181.5 million.

For the years ended December 31, 2012 and 2011, the period January 1, 2010 to March 9, 2010, and the period March 10, 2010 to December 31, 2010, pre-publication costs of $0.4 million, $33.5 million, $0 and $16.9 million, respectively, were deemed to be impaired. The impairment was included as a charge to the statement of operations in the impairment charge for goodwill, intangible assets, pre-publication costs and fixed assets caption.

Goodwill and Indefinite-Lived Intangible Assets

Goodwill is the excess of the purchase price paid over the fair value of the net assets of the business acquired. Other intangible assets principally consist of branded trademarks and trade names, acquired publishing rights and customer relationships. Goodwill and indefinite-lived intangible assets (certain trade names) are not

 

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amortized but are reviewed at least annually for impairment or earlier, if an indication of impairment exists. Recoverability of goodwill and indefinite lived intangibles is evaluated using a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the fair value of a reporting unit exceeds the carrying value of the net assets assigned to a reporting unit, goodwill is considered not impaired and no further testing is required. If the carrying value of the net assets assigned to a reporting unit exceeds the fair value of a reporting unit, the second step of the impairment test is performed in order to determine the implied fair value of a reporting unit’s goodwill. Determining the implied fair value of goodwill requires valuation of a reporting unit’s tangible and intangible assets and liabilities in a manner similar to the allocation of purchase price in a business combination. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, goodwill is deemed impaired and is written down to the extent of the difference. We estimate total fair value of each reporting unit using discounted cash flow analysis, and make assumptions regarding future revenue, gross margins, working capital levels, investments in new products, capital spending, tax, cash flows and the terminal value of the reporting unit. With regard to other intangibles with indefinite lives, we determine the fair value by asset, which is then compared to its carrying value to determine if the assets are impaired.

Goodwill is allocated entirely to our Education reporting unit. Determining the fair value of a reporting unit is judgmental in nature, and involves the use of significant estimates and assumptions. These estimates and assumptions may include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions, the determination of appropriate market comparables as well as the fair value of individual assets and liabilities. Consistent with prior years, we used an income approach to establish the fair value of the reporting unit as of October 1, 2012. As in prior years, we used the most recent five year strategic plan as the initial basis of our analysis.

We completed our annual goodwill and indefinite-lived intangible asset impairment tests as of October 1, 2012, 2011, and 2010 and recorded a noncash impairment charge of $5.0 million for the year ended December 31, 2012, $1,635.1 million for the year ended December 31, 2011, and $87.0 million for the period March 10, 2010 to December 31, 2010. There was no impairment for the period January 1, 2010 to March 9, 2010. The impairments principally related to one specific tradename within the Education segment in 2012, goodwill and tradenames within the Education segment in 2011, and related to tradenames within the Education segment and Trade Publishing segment in 2010. The impairment charges resulted primarily from a decline in revenue from previously projected amounts as a result of the economic downturn and reduced educational spending by states and school districts. All impairment charges are included in operating income.

Publishing Rights

A publishing right is an acquired right which allows us to publish and republish existing and future works as well as create new works based on previously published materials. We determine the fair market value of the publishing rights arising from business combinations by discounting the after-tax cash flows projected to be derived from the publishing rights and titles to their net present value using a rate of return that accounts for the time value of money and the appropriate degree of risk. The useful life of the publishing rights is based on the lives of the various copyrights involved. Acquired publication rights, as well as customer-related intangibles with definitive lives, are primarily amortized on an accelerated basis over periods ranging from three to 20 years.

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. Advances are evaluated periodically to determine if they are expected to be recovered. Any portion of a royalty advance that is not expected to be recovered is fully reserved.

 

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Stock-Based Compensation

Accounting guidance requires employee stock-based payments to be accounted for under the fair value method. Under this method, we are required to record compensation cost based on the fair value estimated for stock-based awards granted over the requisite service periods for the individual awards, which generally equal the vesting periods. We use the straight-line amortization method for recognizing stock-based compensation expense.

The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model, which requires the use of highly subjective estimates and assumptions. Historically, as a private company, we lacked company-specific historical and implied volatility information. Therefore, we estimate our expected volatility based on the historical volatility of our publicly traded peer companies and expect to continue to do so until such time as we have adequate historical data regarding the volatility of our traded stock price. The expected life assumption is based on the simplified method for estimating expected term for awards. This option has been elected as we do not have sufficient stock option exercise experience to support a reasonable estimate of the expected term. The risk-free interest rate is the yield currently available on U.S. Treasury zero-coupon issues with a remaining term approximating the expected term of the option. We recognize compensation expense for only the portion of options that are expected to vest. Accordingly, we have estimated expected forfeitures of stock options based on our historical forfeiture rate and used these rates in developing a future forfeiture rate. If our actual forfeiture rate varies from our historical rates and estimates, additional adjustments to compensation expense may be required in future periods.

Impact of Inflation and Changing Prices

Although inflation is currently well below levels in prior years and has, therefore, benefited recent results, particularly in the area of manufacturing costs, there are offsetting costs. 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. Prices for paper moderated during the last three years.

The most significant investments affected by inflation include pre-publication, other property, plant and equipment and inventories. We use the weighted average cost method to value substantially all inventory. We have negotiated favorable pricing through contractual agreements with our two top print and sourcing vendors, and from our other major vendors, which has helped to stabilize our unit costs, and therefore our cost of inventories sold. Our publishing business requires a high level of investment in pre-publication for our educational and reference works, and in other property, plant and equipment. We expect to continue to commit funds to the publishing areas through both internal growth and acquisitions. We believe that by continuing to emphasize cost controls, technological improvements and quality control, we can continue to moderate the impact of inflation on our operating results and financial position.

Covenant Compliance

As of June 30, 2013, we were in compliance with all of our debt covenants.

We are currently required to meet certain restrictive financial covenants as defined under our term loan facility and revolving credit facility. We have financial covenants primarily pertaining to interest coverage and maximum leverage ratios. 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

 

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indebtedness, our assets may not be sufficient to repay in full the indebtedness and any other indebtedness that would become due as a result of any acceleration. Further, in such an event, the lenders would not be required to make further loans to us, and assuming similar facilities were not established and we are unable to obtain replacement financing, it would materially affect our liquidity and results of operations.

Contractual Obligations

The following table provides information with respect to our estimated commitments and obligations as of December 31, 2012:

 

 

Contractual Obligations

   Total      Less than 1
year
     1-3 years      3-5 years      More than 5
years
 
     (in thousands)  

Term loan facility due May 2018 (1)

   $ 248,125       $ 2,500       $ 5,000       $ 5,000       $ 235,625   

Interest Payable on term loan facility due
May 2018 (2)

     69,365         13,157         25,915         25,418         4,875   

Capital Leases

     5,925         1,689         4,236         —           —     

Operating leases (3)

     192,930         43,818         82,642         48,388         18,082   

Purchase obligations (4)

     407,535         187,628         210,329         9,513         65   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total cash contractual obligations

   $ 923,880       $ 248,792       $ 328,122       $ 88,319       $ 258,647   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The term loan facility amortizes at a rate of 1% per annum of the original $250.0 million amount.
(2) As of June 30, 2013, the interest rate was 5.25%.
(3) Represents minimum lease payments under non-cancelable operating leases.
(4) Purchase obligations are agreements to purchase goods or services that are enforceable and legally binding. These goods and services consist primarily of author advances, subcontractor expenses, information technology licenses, and outsourcing arrangements.

In addition to the payments described above, we have employee benefit obligations that require future payments. For example, we have made $19.8 million in cash contributions to our pension and postretirement benefit plans in 2012 and expect to make another $13.5 million of contributions in 2013 relating to our pension and postretirement benefit plans although we are not obligated to do so. We expect to periodically draw and repay borrowings under the revolving credit facility. We believe that we will be able to meet our cash interest obligations on our outstanding debt when they are due and payable.

Off-Balance Sheet Arrangement

We have no off-balance sheet arrangements.

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

 

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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 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 credit risk through the continuous monitoring of exposures to such counterparties.

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 June 30, 2013, we have $246.9 million 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 $2.5 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. We have no borrowings outstanding under the revolving credit facility at June 30, 2013. 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.

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 forward exchange contracts, when deemed appropriate, which were not significant as of December 31, 2012 and June 30, 2013. We do not enter into derivative transactions or use other financial instruments for trading or speculative purposes.

 

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BUSINESS

Company Overview

Our mission is to change people’s lives by fostering passionate, curious learners. We believe that by combining world-class educational content, products and services with cutting edge technology, digital innovation and research, we can make learning and teaching more effective and engaging.

We are a leading global provider of education solutions, delivering content, technology, services and media to over 60 million students in over 150 countries worldwide. We deliver our offerings to both educational institutions and consumers around the world. In the United States, we are the leading provider of K-12 educational content by market share and our instructional materials are used in every school district within the United States. We believe that nearly every K-12 current student in the United States has utilized our content during the course of his or her education. As a result, we have an established reputation with these students that is difficult for others to replicate and strongly positions us to continue to provide our broader content and services to serve their lifelong learning needs. Our long-standing, global reputation and well-known and trusted brands enable us to capitalize on the consumerization and digitalization of the education market through our existing and developing channels. Furthermore, since 1832, we have published trade and reference materials, including award-winning adult and children’s fiction and non-fiction books.

According to GSV Asset Management, the market for education content, media and services related expenditures is around $4.6 trillion globally. Our long-standing leadership position provides us with strong competitive advantages in this market. We have established trusted relationships with educators, institutions, parents, students and life-long learners around the world. This position of trust is founded on our consistent delivery of best-in-class content and services that meet the evolving needs of our customers. Our portfolio of intellectual property spans educational, general interest, children’s and reference works, and has been developed by award-winning authors—including 8 Nobel Prize winners, 47 Pulitzer Prize winners and 13 National Book Award winners—and industry-leading editors with deep expertise in learning and pedagogy. Our content includes globally recognized characters and titles such as Curious George, Carmen Sandiego, The Oregon Trail, The Little Prince, The Lord of the Rings, Life of Pi, Webster’s New World Dictionary and Cliffs Notes. Through our network of over 300 highly productive and experienced sales professionals, we are able to successfully serve our growing list of institutional customers. We believe that our unique combination of trusted relationships, best-in-class content portfolio, and our committed, effective sales team creates a competitive position that is difficult to replicate.

We monetize our proprietary content portfolio across multiple platforms and distribution channels and are expanding our addressable market beyond institutions, with an increasing focus on individual consumers who comprise a significant target audience of life-long learners. Leveraging our iconic and timeless children’s brands and titles such as Where in the World is Carmen Sandiego? and our Curious George-based Curious About series of mobile apps, we create rich interactive digital content and educational games, build engaging websites and provide effective, technology-based educational solutions. Our recent acquisition of Tribal Nova, a children’s educational gaming company that operates online learning services such as PBS KIDS PLAY!, Kids’ CBC Wonderworld and Bayam, accelerates our consumer e-commerce expansion strategy by further enriching our existing content with enhanced digital capabilities. Based on the strength of our content portfolio and its adaptability across multiple distribution channels, we believe that we are also well positioned to expand into the adjacent early childhood development and global English language learning markets without significant additional costs associated with content development.

We believe we are leading the transformation of the traditional educational content and services landscape. Our complete digital portfolio, combined with our development partnerships with recognized technology leaders such as Apple, Samsung, Knewton and Kno, enables us to bring our next-generation learning solutions and media content to all learners across substantially all platforms and devices. We are recognized as an Apple iTunes Top Publisher with one of the most robust digital learning catalogs of any educational content company, including a

 

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growing suite of interactive textbooks, mobile applications and educational games. Additionally, our technology and development capabilities allow us to enhance content engagement and effectiveness with embedded assessment, interactivity, personalization and adaptivity. For example, our award-winning HMH Fuse curriculum incorporates embedded video tutorials, step-by-step examples and other integrated features to provide a personalized math learning experience for students in a device-agnostic mobile environment.

Adding to our comprehensive instructional materials, we provide testing and assessment solutions through our Riverside products. We also provide school improvement and professional development services, through our Heinemann products and The Leadership and Learning Center, that help teachers and administrators meet their academic objectives and regulatory mandates. We believe that our research-based, proven education solutions are mission-critical for school systems and educators as they provide a comprehensive set of curriculum and instructional strategy solutions designed to deliver outcomes-based learning and teaching results both in the classroom and at home.

For the six months ended June 30, 2013 and for the years ended December 31, 2012, 2011 and 2010, our total net sales were $529.5 million, $1,285.6 million, $1,295.3 and $1,507.0 million, respectively. For the six months ended June 30, 2013 and for the years ended December 31, 2012, 2011 and 2010, our net loss was $151.6 million, $87.1 million, $2,182.4 million and $819.5 million, respectively, and our Adjusted EBITDA, a non-GAAP measure, was $64.7 million, $319.8 million, $238.2 million and $440.7 million, respectively. For a reconciliation of Adjusted EBITDA to net loss, see “Summary—Summary Historical Consolidated Financial and Other Information.”

Market Opportunity

Rising Global Demand for Education

As a leading provider in the global learning and educational content market, we are well positioned to take advantage of the continued growth expected to result as more countries transition to knowledge-based economies, global markets integrate, and consumption, especially in emerging markets, rises. The global education sector is experiencing rising enrollments and increasing government and consumer spending driven by the close connection between levels of educational attainment, evolving standards, personal career prospects and economic growth.

U.S. K-12 Market is Large and Growing

In the United States, which is our primary market today, the K-12 education sector represents one of the largest industry segments accounting for over $638 billion of expenditures, or about 4.4% of the 2011 U.S. gross domestic product as measured by the U.S. Department of Education’s National Center for Education Statistics (“NCES”) for the 2010-2011 school year. The instructional supplies and services component of this market was estimated to be approximately $30 billion in 2011 and is expected to continue growing as a result of several secular and cyclical factors.

In addition to its size, the U.S. K-12 education market is highly decentralized and is characterized by complex content adoption processes. The sector is comprised of approximately 16,000 school districts across the 50 states, and 132,000 elementary and secondary schools. This market structure underscores the importance of scale and industry relationships and the need for broad, diverse coverage across states, districts and schools. Even while certain initiatives in the education sector such as the Common Core State Standards, a set of shared math and literacy standards benchmarked to international standards, have increased standardization in K-12 education content, significant state standard specific customization still exists, ensuring an ongoing need for companies in the sector to maintain deep relationships with individual state and district policymakers and expertise in state-varying academic standards.

Growth in the U.S. K-12 market for educational content and services will be driven by several factors. In the near term, total spend by institutions, which is largely dependent upon state and local funding, is rebounding in the wake of the U.S. economic recovery. While the market has historically grown above the pace of inflation, averaging 7.2% growth annually since 1969, the difficult operating environment stemming from the recession

 

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has caused many states and school districts to defer spending on educational materials. Following the recovery, and as tax revenues collected through income, sales and property taxes continue to rebound, institutional customers benefit from improved funding cycles. States such as Texas, California, Florida and Georgia—areas where we have historically captured meaningful market share – are all slated for significant educational materials expenditures between 2013 and 2016.

Longer-term growth in the U.S. K-12 market is positively correlated with student enrollments. Compared to 55.0 million students in 2010, enrollments are expected to increase to over 58.0 million by the 2021 school year, according to NCES. Accordingly, NCES forecasts that the current expenditures in U.S. K-12 are expected to grow to approximately $665 billion by 2022.

In addition, increased investment in areas of government policy focus is expected to further drive market growth. For example, President Obama has identified early childhood development as an important education initiative of his administration, and has developed a Preschool for All program with a $75 billion budget over the next 10 years to increase access to high quality early childhood education. Multi-state initiatives to establish a common set of educational standards are also expanding the market for teacher professional development and school improvement services.

Increasing Focus on Accountability and Student Outcomes

U.S. K-12 education has come under significant political scrutiny in recent years, due to a recognition of its importance to the U.S. society at large and concern over the perceived decline in U.S. student competitiveness relative to their international peers. An independent task force report published in March of 2012 by the Council on Foreign Relations, a non-partisan membership organization and