Houghton Mifflin Harcourt (HMHC) 10-Q 2019 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2019

OR

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

For the transition period from                     to                     

Commission file number 001-36166

Houghton Mifflin Harcourt Company

(Exact name of registrant as specified in its charter)

Delaware	27-1566372
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

125 High Street

Boston, MA 02110

(617) 351-5000

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

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.01 par value	HMHC	The Nasdaq Stock Market LLC

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

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

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

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

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

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

The number of shares of common stock, par value $0.01 per share, outstanding as of October 28, 2019 was 124,330,921.

Table of Contents

		Page (s)
Special Note Regarding Forward-Looking Statements			3
PART I.	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (Unaudited):		4
	Consolidated Balance Sheets		4
	Consolidated Statements of Operations		5
	Consolidated Statements of Comprehensive Income (Loss)		6
	Consolidated Statements of Cash Flows		7
	Consolidated Statements of Stockholders’ Equity		8
	Notes to Consolidated Financial Statements		9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		47
Item 4.	Controls and Procedures		47
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings		48
Item 1A.	Risk Factors		48
Item 6.	Exhibits		49
SIGNATURES			50

2

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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

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

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

3

PART 1 – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Houghton Mifflin Harcourt Company

Consolidated Balance Sheets

(in thousands of dollars, except share information)	September 30, 2019 (Unaudited)			December 31, 2018
Assets
Current assets
Cash and cash equivalents	$	308,676		$	253,365
Short-term investments		—			49,833
Accounts receivable, net of allowances for bad debts and book returns of    $25.2 million and $20.7 million, respectively		434,903			203,574
Inventories		211,744			184,209
Prepaid expenses and other assets		18,728			15,297
Total current assets		974,051			706,278
Property, plant, and equipment, net		104,718			125,925
Pre-publication costs, net		290,356			323,641
Royalty advances to authors, net		48,124			47,993
Goodwill		716,977			716,073
Other intangible assets, net		486,356			520,892
Operating lease assets		135,298			—
Deferred income taxes		3,259			3,259
Deferred commissions		33,953			22,635
Other assets		31,698			28,428
Total assets	$	2,824,790		$	2,495,124
Liabilities and Stockholders’ Equity
Current liabilities
Current portion of long-term debt	$	8,000		$	8,000
Accounts payable		88,091			76,313
Royalties payable		68,189			66,893
Salaries, wages, and commissions payable		69,638			50,225
Deferred revenue		314,083			251,944
Interest payable		147			136
Severance and other charges		1,312			6,020
Accrued postretirement benefits		1,512			1,512
Operating lease liabilities		11,135			—
Other liabilities		34,473			26,649
Total current liabilities		596,580			487,692
Long-term debt, net of discount and issuance costs		752,241			755,649
Operating lease liabilities		137,375			—
Long-term deferred revenue		574,641			395,500
Accrued pension benefits		27,624			29,320
Accrued postretirement benefits		13,235			14,300
Deferred income taxes		29,655			27,075
Other liabilities		6,746			17,118
Total liabilities		2,138,097			1,726,654
Commitments and contingencies (Note 15)
Stockholders’ equity
Preferred stock, $0.01 par value: 20,000,000 shares authorized; 0 shares    issued and outstanding at September 30, 2019 and December 31, 2018		—			—
Common stock, $0.01 par value: 380,000,000 shares authorized;    148,907,955 and 148,164,854 shares issued at September 30, 2019 and    December 31, 2018, respectively; 124,330,921 and 123,587,820 shares    outstanding at September 30, 2019 and December 31, 2018, respectively		1,489			1,481
Treasury stock, 24,577,034 shares as of September 30, 2019 and December 31,    2018, respectively, at cost		(518,030	)		(518,030	)
Capital in excess of par value		4,903,422			4,893,174
Accumulated deficit		(3,650,874	)		(3,562,971	)
Accumulated other comprehensive loss		(49,314	)		(45,184	)
Total stockholders’ equity		686,693			768,470
Total liabilities and stockholders’ equity	$	2,824,790		$	2,495,124

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

4

Houghton Mifflin Harcourt Company

Consolidated Statements of Operations (Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands of dollars, except share and per share information)	2019			2018			2019			2018
Net sales	$	565,668		$	516,255		$	1,149,199		$	1,073,379
Costs and expenses
Cost of sales, excluding publishing rights and pre-publication    amortization		246,527			201,748			533,413			461,539
Publishing rights amortization		6,341			8,238			20,217			26,476
Pre-publication amortization		39,319			28,094			108,140			80,047
Cost of sales		292,187			238,080			661,770			568,062
Selling and administrative		188,957			176,202			516,206			491,052
Other intangible asset amortization		6,383			6,696			19,519			20,238
Restructuring		—			3,077			—			3,077
Severance and other charges		270			362			5,921			6,380
Loss on sale of assets		—			—			—			384
Operating income (loss)		77,871			91,838			(54,217	)		(15,814	)
Other income (expense)
Retirement benefits non-service income		41			320			125			960
Interest expense		(11,597	)		(11,627	)		(35,142	)		(34,035	)
Interest income		509			277			1,698			900
Change in fair value of derivative instruments		(737	)		(249	)		(1,171	)		(974	)
Income from transition services agreement		571			—			4,248			—
Income (loss) from continuing operations before taxes		66,658			80,559			(84,459	)		(48,963	)
Income tax (benefit) expense for continuing operations		(2,602	)		(3,349	)		4,256			2,104
Income (loss) from continuing operations		69,260			83,908			(88,715	)		(51,067	)
Income from discontinued operations, net of tax		—			2,441			—			12,833
Net income (loss)	$	69,260		$	86,349		$	(88,715	)	$	(38,234	)
Net income (loss) per share attributable to common stockholders
Basic:
Continuing operations	$	0.56		$	0.68		$	(0.71	)	$	(0.41	)
Discontinued operations		—			0.02			—			0.10
Net income (loss)	$	0.56		$	0.70		$	(0.71	)	$	(0.31	)
Diluted:
Continuing operations	$	0.55		$	0.68		$	(0.71	)	$	(0.41	)
Discontinued operations		—			0.02			—			0.10
Net income (loss)	$	0.55		$	0.70		$	(0.71	)	$	(0.31	)
Weighted average shares outstanding
Basic		124,315,491			123,553,116			124,089,257			123,401,005
Diluted		124,807,488			123,870,380			124,089,257			123,401,005

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

5

Houghton Mifflin Harcourt Company

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands of dollars, except share and per share information)	2019			2018			2019			2018
Net income (loss)	$	69,260		$	86,349		$	(88,715	)	$	(38,234	)
Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustments, net of tax		(351	)		(97	)		(478	)		(13	)
Unrealized (loss) gain on short-term investments, net of tax		—			(13	)		9			5
Net change in unrealized (loss) gain on derivative    financial instruments, net of tax		(257	)		686			(3,661	)		5,794
Other comprehensive income (loss), net of taxes		(608	)		576			(4,130	)		5,786
Comprehensive income (loss)	$	68,652		$	86,925		$	(92,845	)	$	(32,448	)

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

6

Houghton Mifflin Harcourt Company

Consolidated Statements of Cash Flows (Unaudited)

	Nine Months Ended September 30,
(in thousands of dollars)	2019			2018
Cash flows from operating activities
Net loss	$	(88,715	)	$	(38,234	)
Adjustments to reconcile net loss to net cash provided by operating activities
Income from discontinued operations, net of tax		—			(12,833	)
Loss on sale of assets		—			384
Depreciation and amortization expense		201,593			183,218
Amortization and impairments of operating lease assets		12,898			—
Amortization of debt discount and deferred financing costs		3,136			3,136
Deferred income taxes		2,580			2,597
Stock-based compensation expense		11,094			9,363
Change in fair value of derivative instruments		1,171			974
Changes in operating assets and liabilities, net of acquisitions
Accounts receivable		(231,296	)		(160,506	)
Inventories		(27,535	)		(19,317	)
Other assets		(23,649	)		(716	)
Accounts payable and accrued expenses		37,488			15,471
Royalties payable and author advances, net		1,165			(5,165	)
Deferred revenue		241,091			34,362
Interest payable		11			41
Severance and other charges		(464	)		(481	)
Accrued pension and postretirement benefits		(2,761	)		(2,462	)
Operating lease liabilities		(12,450	)		—
Other liabilities		2,015			16,274
Net cash provided by operating activities – continuing operations		127,372			26,106
Net cash provided by operating activities – discontinued operations		—			17,361
Net cash provided by operating activities		127,372			43,467
Cash flows from investing activities
Proceeds from sales and maturities of short-term investments		50,000			86,539
Purchases of short-term investments		—			(29,708	)
Additions to pre-publication costs		(81,532	)		(92,202	)
Additions to property, plant, and equipment		(27,350	)		(41,488	)
Proceeds from sale of assets		—			500
Acquisition of business, net of cash acquired		(5,447	)		—
Investment in preferred stock		(750	)		—
Net cash used in investing activities – continuing operations		(65,079	)		(76,359	)
Net cash used in investing activities – discontinued operations		—			(5,933	)
Net cash used in investing activities		(65,079	)		(82,292	)
Cash flows from financing activities
Proceeds under revolving credit facility		60,000			50,000
Payments of revolving credit facility		(60,000	)		(50,000	)
Payments of long-term debt		(6,000	)		(6,000	)
Payments of deferred financing fees		(311	)		—
Tax withholding payments related to net share settlements of restricted stock    units and awards		(1,963	)		(1,113	)
Issuance of common stock under employee stock purchase plan		1,027			1,263
Net collections under transition services agreement		265			—
Net cash used in financing activities – continuing operations		(6,982	)		(5,850	)
Net increase (decrease) in cash and cash equivalents		55,311			(44,675	)
Cash and cash equivalents at the beginning of the period		253,365			148,979
Cash and cash equivalents at the end of the period	$	308,676		$	104,304
Supplemental disclosure of cash flow information
Interest paid	$	32,264		$	30,865
Income taxes paid		469			545
Non-cash investing activities
Pre-publication costs included in accounts payable and accruals	$	7,299		$	16,733
Property, plant, and equipment included in accounts payable and accruals		2,317			13,943
Property, plant, and equipment acquired under finance leases		366			515

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

7

Houghton Mifflin Harcourt Company

Consolidated Statements of Stockholders’ Equity (Unaudited)

	Common Stock
(in thousands of dollars, except share information)	Shares Issued			Par Value			Treasury Stock			Capital in excess of Par Value			Accumulated Deficit			Accumulated Other Comprehensive Loss			Total
Balance at December 31, 2017		147,911,466		$	1,479		$	(518,030	)	$	4,879,793		$	(3,521,527	)	$	(46,522	)	$	795,193
Net loss		—			—			—			—			(101,311	)		—			(101,311	)
Other comprehensive income, net of tax		—			—			—			—			—			3,721			3,721
Effects of adoption of new revenue accounting standard		—			—			—			—			52,711			—			52,711
Issuance of common stock for employee purchase plan		85,542			1			—			864			—			—			865
Issuance of common stock for vesting of restricted    stock units		245,572			2			—			(2	)		—			—			—
Stock withheld to cover tax withholdings    requirements upon vesting of restricted stock units		—			—			—			(1,073	)		—			—			(1,073	)
Restricted stock forfeitures and cancellations		(268,295	)		(3	)		—			3			—			—			—
Stock-based compensation expense		—			—			—			2,873			—			—			2,873
Balance at March 31, 2018		147,974,285		$	1,479		$	(518,030	)	$	4,882,458		$	(3,570,127	)	$	(42,801	)	$	752,979
Net loss		—			—			—			—			(23,272	)		—			(23,272	)
Other comprehensive income, net of tax		—			—			—			—			—			1,489			1,489
Issuance of common stock for employee purchase plan		—			—			—			1			—			—			1
Issuance of common stock for vesting of restricted    stock units		66,653			1			—			(1	)		—			—			—
Stock withheld to cover tax withholdings    requirements upon vesting of restricted stock units		—			—			—			(20	)		—			—			(20	)
Stock-based compensation expense		—			—			—			3,082			—			—			3,082
Balance at June 30, 2018		148,040,938		$	1,480		$	(518,030	)	$	4,885,520		$	(3,593,399	)	$	(41,312	)	$	734,259
Net income		—			—			—			—			86,349			—			86,349
Other comprehensive income, net of tax		—			—			—			—			—			576			576
Issuance of common stock for employee purchase plan		89,886			1			—			746			—			—			747
Issuance of common stock for vesting of restricted    stock units		7,472			—			—			—			—			—			—
Stock withheld to cover tax withholdings    requirements upon vesting of restricted stock units		—			—			—			(20	)		—			—			(20	)
Stock-based compensation expense		—			—			—			3,200			—			—			3,200
Balance at September 30, 2018		148,138,296		$	1,481		$	(518,030	)	$	4,889,446		$	(3,507,050	)	$	(40,736	)	$	825,111
Balance at December 31, 2018		148,164,854		$	1,481		$	(518,030	)	$	4,893,174		$	(3,562,971	)	$	(45,184	)	$	768,470
Net loss		—			—			—			—			(117,362	)		—			(117,362	)
Other comprehensive loss, net of tax		—			—			—			—			—			(1,550	)		(1,550	)
Effects of adoption of new lease accounting standard		—			—			—			—			725			—			725
Issuance of common stock for employee purchase plan		78,105			1			—			701			—			—			702
Issuance of common stock for vesting of restricted    stock units		444,622			5			—			(5	)		—			—			—
Stock withheld to cover tax withholdings    requirements upon vesting of restricted stock units		—			—			—			(1,756	)		—			—			(1,756	)
Stock-based compensation expense		—			—			—			3,442			—			—			3,442
Balance at March 31, 2019		148,687,581		$	1,487		$	(518,030	)	$	4,895,556		$	(3,679,608	)	$	(46,734	)	$	652,671
Net loss		—			—			—			—			(40,613	)		—			(40,613	)
Other comprehensive loss, net of tax		—			—			—			—			—			(1,972	)		(1,972	)
Effects of adoption of new lease accounting standard		—			—			—			—			87			—			87
Issuance of common stock for employee    purchase plan		—			—			—			1			—			—			1
Issuance of common stock for vesting of restricted    stock units		97,845			—			—			—			—			—			—
Stock withheld to cover tax withholdings    requirements upon vesting of restricted stock units		—			—			—			(173	)		—			—			(173	)
Stock-based compensation expense		—			—			—			3,604			—			—			3,604
Balance at June 30, 2019		148,785,426		$	1,487		$	(518,030	)	$	4,898,988		$	(3,720,134	)	$	(48,706	)	$	613,605
Net income		—			—			—			—			69,260			—			69,260
Other comprehensive loss, net of tax		—			—			—			—			—			(608	)		(608	)
Issuance of common stock for employee purchase plan		108,009			1			—			734			—			—			735
Issuance of common stock for vesting of restricted    stock units		14,520			1			—			(1	)		—			—			—
Stock withheld to cover tax withholdings    requirements upon vesting of restricted stock units		—			—			—			(34	)		—			—			(34	)
Stock-based compensation expense		—			—			—			3,735			—			—			3,735
Balance at September 30, 2019		148,907,955		$	1,489		$	(518,030	)	$	4,903,422		$	(3,650,874	)	$	(49,314	)	$	686,693

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

8

 Houghton Mifflin Harcourt Company

Notes to Consolidated Financial Statements (Unaudited)

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

1. Basis of Presentation

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

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

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

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

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

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

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

We expect our net cash provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund our current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months.

The ability of the Company to fund planned operations is based on assumptions which involve significant judgment and estimates of future revenues, capital spend and other operating costs. If necessary, management will take steps intended to improve the Company’s financial position and liquidity if actual results differ from such assumptions.

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Seasonality and Comparability

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

Approximately 85% of our net sales for the year ended December 31, 2018 were derived from our Education segment, which is a markedly seasonal business. Schools conduct the majority of their purchases in the second and third quarters of the calendar year in preparation for the beginning of the school year. Thus, for the last three completed fiscal years, approximately 67% of our consolidated net sales were realized in the second and third quarters. Sales of K-12 instructional materials are also cyclical with some years offering more sales opportunities than others based on the state adoption calendar. The amount of funding available at the state level for educational materials also has a significant effect on year-to-year net sales. Although the loss of a single customer would not have a material adverse effect on our business, schedules of school adoptions and market acceptance of our products can materially affect year-to-year net sales performance.

2. Significant Accounting Policies and Estimates

Our financial results are affected by the selection and application of accounting policies and methods. Except for the adoption of the new lease accounting standard discussed below, there were no material changes during the three and nine months ended September 30, 2019 due to the application of significant accounting policies and estimates as described in our audited consolidated financial statements, which were included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Adoption of New Lease Accounting Standard

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

Prior comparative periods were not adjusted under this method. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which allowed us to not reassess whether any expired or existing contracts are or contain leases, carry forward the historical lease classification and to not reassess initial direct costs for any existing leases. We did not elect the hindsight practical expedient to determine the lease term for existing leases. Upon implementation of the new guidance, we have elected the practical expedients to combine lease and non-lease components, and to not recognize right of use assets and lease liabilities for short-term leases. The adoption of this guidance impacted our consolidated balance sheets due to the recognition of the lease rights and obligations related to our office space, automobile fleet and office equipment leases as assets and liabilities of approximately $148.0 million and $161.0 million, respectively. The adjustment to accumulated deficit of approximately $0.8 million related to a previously recorded deferred gain on the sale leaseback of a warehouse. The impact on our results of operations and cash flows was not material.

3. Recent Accounting Standards

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

Recently Issued Accounting Standards

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

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

Recently Adopted Accounting Standards

In February 2016, the FASB issued guidance that primarily requires lessees to recognize most leases on their balance sheets but record expenses on their income statements in a manner similar to current accounting. We adopted the guidance on January 1, 2019 using the modified retrospective method and did not adjust comparative periods or modify disclosures in those comparative periods (see Note 2).

In May 2014, the FASB issued new guidance related to revenue recognition. This new accounting standard replaced most current U.S. GAAP guidance on this topic and eliminated most industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Entities had the choice of adopting the new standard either retrospectively to all periods presented in the financial statements (the full retrospective method) or as a cumulative-effect adjustment as of the date of adoption (modified retrospective method) in the year of adoption without applying to comparative periods financial statements. We adopted the guidance on January 1, 2018 applying the modified retrospective method.

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

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

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

4. Acquisitions

On January 14, 2019, we completed the acquisition of certain assets of PV Waggle LLC, which comprised a web-based adaptive learning solution providing Math and English Language Arts (“ELA”) instruction for students in grades 2-8 for a total purchase price of approximately $5.4 million. The transaction was accounted for under the acquisition method of accounting. Goodwill, other intangible assets and other liabilities recorded as part of the acquisition totaled approximately $0.9 million, $5.2 million and $0.7 million, respectively. The other intangible assets represent developed technology and were valued using a replacement cost approach. Measurement period adjustments were not material.

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5. Discontinued Operations

On October 1, 2018, we completed the sale of all the assets, including intellectual property, used primarily in our Riverside clinical and standardized testing business (“Riverside Business”) for cash consideration received of $140.0 million and the purchaser’s assumption of all liabilities relating to the Riverside Business subject to specified exceptions. Net proceeds from the sale after the payment of transaction costs were approximately $135.0 million with a post-tax book gain on sale of approximately $30.5 million. The gain was recorded in the fourth quarter of 2018 as the transaction closed on October 1, 2018. The tax gain on the sale was offset by 2018 losses. The results of the Riverside Business were previously reported in our Education segment. In connection with the sale of the Riverside Business, we entered into a Transition Services Agreement (“TSA”) with the purchaser whereby we performed certain support functions through September 30, 2019.

Upon the signing of the asset purchase agreement on September 12, 2018, the Riverside Business qualified as a discontinued operation, and goodwill originally included in the Education reportable segment was transferred to the Riverside Business. The amount of transferred goodwill was $67.0 million and was determined using the relative fair value method. The relative fair value was determined based on the purchase price of the Riverside Business compared to the Education reportable segment fair value. The Education reportable segment fair value was based primarily on the market value of the overall Company at the date that the Riverside Business qualified as a discontinued operation. The allocation also required the assessment for impairment for each of the Riverside Business and Education reportable segment’s goodwill and indefinite-lived intangible assets carrying values. NaN impairment was deemed to exist.

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

	Three Months Ended			Nine Months Ended
	September 30,			September 30,
	2018			2018
Net sales	$	18,337		$	56,562
Costs		14,428			37,714
Amortization		1,842			4,954
Income from discontinued operations before taxes	$	2,067		$	13,894
Income tax (benefit) expense		(374	)		1,061
Income from discontinued operations, net of tax	$	2,441		$	12,833

6. Inventories

Inventories consisted of the following:

	September 30, 2019		December 31, 2018
Finished goods	$	202,326	$	162,890
Raw materials		9,418		21,319
Inventories	$	211,744	$	184,209

7. Contract Assets, Contract Liabilities and Deferred Commissions

Contract assets consist of unbilled amounts at the reporting date and are transferred to accounts receivable when the rights become unconditional. Contract assets are included in prepaid expenses and other assets on our consolidated balance sheets. Contract liabilities consist of deferred revenue (current and long-term). The following table presents changes in contract assets and contract liabilities during the nine months ended September 30, 2019:

	September 30, 2019		December 31, 2018		$ Change		% Change
Contract assets	$	228	$	74	$	154	NM
Contract liabilities (deferred revenue)	$	888,724	$	647,444	$	241,280		37.27	%

NM = not meaningful

The $241.1 million increase in our net contract liabilities from December 31, 2018 to September 30, 2019 was primarily due to higher billings in the period attributed to the seasonal and cyclical nature of our business exceeding the satisfaction of performance obligations related to physical and digital products, and services during the period.

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During the three and nine months ended September 30, 2019 and 2018, we recognized the following net sales as a result of changes in the contract assets and contract liabilities balances:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
Net sales recognized in the period from:
Amounts included in contract liabilities at the beginning    of the period	$	70,686	$	68,063	$	194,509	$	187,277

As of September 30, 2019, the aggregate amount of the transaction price allocated to the remaining performance obligations, which includes deferred revenue and open orders, was $948.0 million, and we will recognize approximately 72% to net sales over the next 1 to 3 years.

Prior to the adoption of the new revenue standard, we expensed incremental commissions paid to sales representatives for obtaining product sales as well as service contracts. We expect that the costs are recoverable, and under the new standard, we capitalize these incremental costs of obtaining customer contracts unless the capitalization and amortization of such costs are not expected to have a material impact on the financial statements. Applying the practical expedient, we recognize sales commission expense when incurred if the amortization period of the assets that we otherwise would have recognized is one year or less. We had deferred commissions in the amount of $34.0 million at September 30, 2019 and amortized $11.0 million and $7.8 million during the nine months ended September 30, 2019 and 2018, respectively. The amortization is included in selling and administrative expenses.

8. Goodwill and Other Intangible Assets

Goodwill and other intangible assets consisted of the following:

	September 30, 2019							December 31, 2018
	Cost		Accumulated Amortization			Total		Cost		Accumulated Amortization			Total
Goodwill	$	716,977	$	—		$	716,977	$	716,073	$	—		$	716,073
Trademarks and tradenames: indefinite-lived	$	161,000	$	—		$	161,000	$	161,000	$	—		$	161,000
Trademarks and tradenames: definite-lived		164,130		(36,238	)		127,892		164,130		(28,087	)		136,043
Publishing rights		1,180,000		(1,133,086	)		46,914		1,180,000		(1,112,869	)		67,131
Customer related and other		449,840		(299,290	)		150,550		444,640		(287,922	)		156,718
Other intangible assets, net	$	1,954,970	$	(1,468,614	)	$	486,356	$	1,949,770	$	(1,428,878	)	$	520,892

The change in the carrying amount of goodwill for the nine months ended September 30, 2019 is as follows:

Balance at December 31, 2018	$	716,073
Acquisitions		904
Balance at September 30, 2019	$	716,977

Amortization expense for definite-lived trademarks and tradenames, publishing rights and customer related and other intangibles were $39.7 million and $46.7 million for the nine months ended September 30, 2019 and 2018, respectively.

9. Debt

Our debt consisted of the following:

	September 30, 2019		December 31, 2018
$800,000 term loan due May 29, 2021, interest payable    quarterly (net of discount and issuance costs)	$	760,241	$	763,649
Less: Current portion of long-term debt		8,000		8,000
Total long-term debt, net of discount and issuance costs	$	752,241	$	755,649
Revolving credit facility	$	—	$	—

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Term Loan Facility

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

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

The term loan facility was issued at a discount equal to 0.5% of the outstanding borrowing commitment. As of September 30, 2019, the interest rate on the term loan facility was 5.0%.

The term loan facility does not require us to comply with financial maintenance covenants. We are currently required to meet certain incurrence based financial covenants as defined under our term loan facility. The term loan facility is subject to customary conditions, representations, warranties and covenants, including restrictions on additional indebtedness, liens, investments, mergers, acquisitions, asset dispositions, dividends to stockholders, repurchase or redemption of our stock, transactions with affiliates and other matters. The term loan facility is subject to customary events of default. If an event of default occurs and is continuing, the administrative agent may, or at the request of certain required lenders shall, accelerate the obligations outstanding under the term loan facility.

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

Interest Rate Hedging

On August 17, 2015, we entered into interest rate derivative contracts with various financial institutions having an aggregate notional amount of $400.0 million to convert floating rate debt into fixed rate debt and had $400.0 million outstanding as of September 30, 2019. We assessed at inception, and re-assess on an ongoing basis, whether the interest rate derivative contracts are highly effective in offsetting changes in the fair value of the hedged variable rate debt.

These interest rate swaps were designated as cash flow hedges and qualify for hedge accounting under the accounting guidance related to derivatives and hedging. Accordingly, we recorded an unrealized loss of $3.7 million and an unrealized gain of $5.8 million in our statements of comprehensive income (loss) to account for the changes in fair value of these derivatives during the nine months ended September 30, 2019 and 2018, respectively. The corresponding $1.3 million hedge liability and $2.4 million hedge asset are included within short-term other liabilities and long-term other assets in our consolidated balance sheet as of September 30, 2019 and December 31, 2018, respectively. The interest rate derivative contracts mature on July 22, 2020.

Revolving Credit Facility

On July 22, 2015, we entered into an amended and restated revolving credit facility (the “revolving credit facility”). The revolving credit facility provides borrowing availability in an amount equal to the lesser of either $250.0 million or a borrowing base that is computed monthly or weekly and comprised of the Borrowers’ and the Guarantors’ (as such terms are defined below) eligible inventory and receivables. The revolving credit facility includes a letter of credit subfacility of $50.0 million, a swingline subfacility of $20.0 million and the option to expand the facility by up to $100.0 million in the aggregate under certain specified conditions. The revolving credit facility may be prepaid, in whole or in part, at any time, without premium.

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The revolving credit facility requires the Company to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 on a trailing four-quarter basis only during certain periods commencing when excess availability under the revolving credit facility is less than certain limits prescribed by the terms of the revolving credit facility. The revolving credit facility is subject to usual and customary conditions, representations, warranties and covenants, including restrictions on additional indebtedness, liens, investments, mergers, acquisitions, asset dispositions, dividends to stockholders, repurchase or redemption of our stock, transactions with affiliates and other matters. The revolving credit facility is subject to customary events of default. As of September 30, 2019, 0 amounts are outstanding on the revolving credit facility.

As of September 30, 2019, the minimum fixed charge coverage ratio covenant under our revolving credit facility was not applicable, due to our level of borrowing availability. The minimum fixed charge coverage ratio, which is only tested in limited situations, is 1.0 to 1.0 through the end of the facility.

On June 28, 2019, we entered into an amendment to the revolving credit facility extending the maturity date to the earlier of (i) July 22, 2021 or (ii) February 28, 2021 if our term loan facility is not refinanced by such date. The amendment became effective on July 1, 2019. The transaction was accounted for under the accounting guidance for modifications to or exchanges of revolving debt arrangements. We incurred approximately $0.3 million of creditor and third-party fees which were capitalized as deferred financing fees.

Guarantees

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

The obligations under the revolving credit facility and the term loan facility are guaranteed by the Company and each of its direct and indirect for-profit domestic subsidiaries (other than the Borrowers) (collectively, the “Guarantors”) and are secured by all capital stock and other equity interests of the Borrowers and the Guarantors and substantially all of the other tangible and intangible assets of the Borrowers and the Guarantors, including, without limitation, receivables, inventory, equipment, contract rights, securities, patents, trademarks, other intellectual property, cash, bank accounts and securities accounts and owned real estate. The revolving credit facility is secured by first priority liens on receivables, inventory, deposit accounts, securities accounts, instruments, chattel paper and other assets related to the foregoing (the “Revolving First Lien Collateral”), and second priority liens on the collateral which secures the term loan facility on a first priority basis. The term loan facility is secured by first priority liens on the capital stock and other equity interests of the Borrowers and the Guarantors, equipment, owned real estate, trademarks and other intellectual property, general intangibles that are not Revolving First Lien Collateral and other assets related to the foregoing, and second priority liens on the Revolving First Lien Collateral.

10. Leases

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

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

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Lease Position as of September 30, 2019

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

Leases	Classification	September 30, 2019
Assets
Operating lease assets	Operating lease assets	$	135,298
Total leased assets		$	135,298
Liabilities
Current
Operating	Operating lease liabilities	$	11,135
Noncurrent
Operating	Operating lease liabilities		137,375
Total lease liabilities		$	148,510
Weighted average remaining lease term Operating leases		9.6 Years
Weighted average discount rate Operating leases (1)			12.44	%

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

Lease costs

Operating lease cost and sublease income totaled $8.2 million and $0.7 million, and $31.0 million and $2.1 million, respectively, for the three and nine months ended September 30, 2019. The net lease cost of $7.5 million and $28.9 million for the three and nine months ended September 30, 2019, respectively, is included in the selling and administrative line item in our consolidated statements of operations. Operating lease cost includes short term leases and variable lease costs, which are not material.

Undiscounted Cash Flows

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

Maturity of Lease Liabilities	Operating Leases
2019		7,079
2020		27,039
2021		25,838
2022		23,426
2023		25,230
Thereafter		161,790
Total lease payments	$	270,402
Less: interest		121,892
Present value of lease liabilities	$	148,510

During the third quarter of 2019, we executed a lease agreement on new office space in Portsmouth, New Hampshire. We plan to relocate our employees from the existing location in Portsmouth, New Hampshire to this new office space upon the substantial completion of the building. The lease term specified in the agreement is 10 years with an option to renew for an additional 5 years.  Our estimated fixed lease payments over the 10 year initial lease term is $9.8 million.  We currently expect to relocate to the space in the first quarter of 2021, but this timing as well as when we are required to begin making payments and recognize rental and other expenses under the new lease, is dependent on when the space is available for use.

Other Information

The table below presents supplemental cash flow information related to leases during the nine months ended September 30, 2019.

Cash paid for amounts included in the measurement of lease    liabilities
Operating cash flows for operating leases	$	24,661

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

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

	Operating Leases
2019	$	32,694
2020		26,889
2021		26,118
2022		24,549
2023		27,469
Thereafter		171,203
Total lease payments	$	308,922

11. Restructuring, Severance and Other Charges

2017 Restructuring Plan

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

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

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

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

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

Severance and Other Charges

2019

Exclusive of the 2017 Restructuring Plan, during the nine months ended September 30, 2019, $2.6 million of severance payments were made to employees whose employment ended in 2019 and prior years. Further, we recorded an expense in the amount of $2.5 million to reflect costs for severance, which we expect to be paid over the next twelve months. We also recorded an expense in the amount of $3.4 million for real estate consolidation costs, which is reflected as a reduction in operating lease assets in our consolidated balance sheet as of September 30, 2019.

2018

Exclusive of the 2017 Restructuring Plan, during the nine months ended September 30, 2018, $2.8 million of severance payments were made to employees whose employment ended in 2018 and prior years and $0.1 million of net payments were made for office space no longer utilized by the Company as a result of prior savings initiatives. Further, we recorded an expense in the amount of $6.4 million to reflect costs for severance, which have been fully paid.

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

	2019
	Severance/ other accruals at December 31, 2018			Severance/ other expense		Cash payments			Severance/ other accruals at September 30, 2019
Severance costs	$	1,420		$	2,534	$	(2,642	)	$	1,312
Other accruals		270	(1)		—		—			—
	$	1,690		$	2,534	$	(2,642	)	$	1,312

	2018
	Severance/ other accruals at December 31, 2017		Severance/ other expense		Cash payments			Severance/ other accruals at September 30, 2018
Severance costs	$	341	$	6,380	$	(2,771	)	$	3,950
Other accruals		1,299		—		(85	)		1,214
	$	1,640	$	6,380	$	(2,856	)	$	5,164

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

The current portion of the severance and other charges was $1.3 million and $6.0 million (inclusive of the 2017 Restructuring Plan) as of September 30, 2019 and December 31, 2018, respectively.

12. Income Taxes

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

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

For the three months ended September 30, 2019 and 2018, we recorded an income tax benefit of approximately $2.6 million and $3.3 million, respectively, and for the nine months ended September 30, 2019 and 2018, we recorded income tax expense of approximately $4.3 million and $2.1 million, respectively. For all periods, the income tax expense was impacted by certain discrete tax items, including the accrual of potential interest and penalties on uncertain tax positions. Including the tax effects of these discrete tax items, the effective rate was (3.9)% and (4.2)% for the three months ended September 30, 2019 and 2018, respectively and (5.0)% and (4.3)% for the nine months ended September 30, 2019 and 2018, respectively.

Reserves for unrecognized tax benefits, excluding accrued interest and penalties, were $15.7 million at both September 30, 2019 and December 31, 2018.

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13. Retirement and Postretirement Benefit Plans

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

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

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

	Pension Plans
	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Interest cost	$	1,511		$	1,325		$	4,533		$	3,975
Expected return on plan assets		(1,918	)		(1,994	)		(5,755	)		(5,987	)
Amortization of net loss		251			354			752			1,065
Net periodic benefit credit	$	(156	)	$	(315	)	$	(470	)	$	(947	)

	Other Post Retirement Plans
	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Service cost	$	15		$	33		$	44		$	96
Interest cost		145			167			436			504
Amortization of prior service cost		10			(172	)		32			(517	)
Amortization of net loss		(40	)		—			(123	)		—
Net periodic benefit cost	$	130		$	28		$	389		$	83

We made $1.2 million of contributions to the pension plans during the nine months ended September 30, 2019. There were 0 contributions to the pension plans during 2018.

14. Fair Value Measurements

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

Level 1 Observable input such as quoted prices in active markets for identical assets or liabilities;

Level 2 Observable inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3 Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

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

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

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

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

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

Financial Assets and Liabilities

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

	September 30, 2019		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Valuation Technique
Financial assets
Money market funds	$	290,772	$	290,772	$	—	(a)
	$	290,772	$	290,772	$	—
Financial liabilities
Interest rate derivatives	$	1,263	$	—	$	1,263	(a)
Foreign exchange derivatives		653		—		653	(a)
	$	1,916	$	—	$	1,916	(a)

	December 31, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Valuation Technique
Financial assets
Money market funds	$	228,587	$	228,587	$	—	(a)
U.S. treasury securities		24,939		24,939		—	(a)
U.S. agency securities		24,894		—		24,894	(a)
Interest rate derivatives		2,382		—		2,382	(a)
	$	280,802	$	253,526	$	27,276
Financial liabilities
Foreign exchange derivatives	$	534	$	—	$	534	(a)
	$	534	$	—	$	534

Our money market funds and U.S. treasury securities are classified within Level 1 of the fair value hierarchy because they are valued using quoted prices in active markets for identical instruments. Our U.S. agency securities are classified within Level 2 of the fair value hierarchy because they are valued using other than quoted prices in active markets. In addition to $290.8 million and $228.6 million invested in money market funds as of September 30, 2019 and December 31, 2018, respectively, we had $17.9 million and $24.8 million of cash invested in bank accounts as of September 30, 2019 and December 31, 2018, respectively.

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Our foreign exchange derivatives consist of forward contracts and are classified within Level 2 of the fair value hierarchy because they are valued based on observable inputs and are available for substantially the full term of our derivative instruments. We use foreign exchange forward contracts to fix the functional currency value of forecasted commitments, payments and receipts. The aggregate notional amount of the outstanding foreign exchange forward contracts was $15.3 million and $15.7 million at September 30, 2019 and December 31, 2018, respectively. Our foreign exchange forward contracts contain netting provisions to mitigate credit risk in the event of counterparty default, including payment default and cross default. At September 30, 2019 and December 31, 2018, the fair value of our counterparty default exposure was less than $1.0 million and spread across several highly rated counterparties.

Our interest rate derivatives are classified within Level 2 of the fair value hierarchy because they are valued based on observable inputs and are available for substantially the full term of our derivative instruments. Our interest rate risk relates primarily to U.S. dollar borrowings, partially offset by U.S. dollar cash investments. We have historically used interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates by converting floating-rate debt into fixed-rate debt. The aggregate notional amount of the outstanding interest rate derivative instruments was $400.0 million as of September 30, 2019. We designate these derivative instruments either as fair value or cash flow hedges under the accounting guidance related to derivatives and hedging. We record changes in the value of fair value hedges in interest expense, which is generally offset by changes in the fair value of the hedged debt obligation. Interest payments made or received related to our interest rate derivative instruments are included in interest expense. We record the effective portion of any change in the fair value of derivative instruments designated as cash flow hedges as unrealized gains or losses in other comprehensive income (loss), net of tax, until the hedged cash flow occurs, at which point the effective portion of any gain or loss is reclassified to earnings. In the event the hedged cash flow does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash flow hedge to interest expense at that time.

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

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

Non-Financial Assets and Liabilities

Our non-financial assets, which include goodwill, other intangible assets, property, plant, and equipment, and pre-publication costs, are not required to be measured at fair value on a recurring basis. However, if certain trigger events occur, or if an annual impairment test is required, we evaluate the non-financial assets for impairment. If an impairment did occur, the asset is required to be recorded at the estimated fair value. An impairment analysis was not performed for the preparation of this report, as there were no triggering events for the nine months ended September 30, 2019. There were no non-financial liabilities that were required to be measured at fair value on a nonrecurring basis during the nine months ended September 30, 2019 and 2018.

Fair Value of Debt

The following table presents the carrying amounts and estimated fair market values of our debt at September 30, 2019 and December 31, 2018. The fair value of debt is deemed to be the amount at which the instrument could be exchanged in an orderly transaction between market participants at the measurement date.

	September 30, 2019				December 31, 2018
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Debt
Term Loan	$	760,241	$	735,533	$	763,649	$	691,102

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The fair market values of our debt were estimated based on quoted market prices on a private exchange for those instruments that are traded and are classified as Level 2 within the fair value hierarchy at September 30, 2019 and December 31, 2018. The fair market values require varying degrees of management judgment. The factors used to estimate these values may not be valid on any subsequent date. Accordingly, the fair market values of the debt presented may not be indicative of their future values.

15. Commitments and Contingencies

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

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

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

In September 2019, we were notified of an unasserted claim by Riverside Assessments LLC (“Riverside”) with regard to purported breaches of the Asset Purchase Agreement between the Company and Riverside dated September 12, 2018 (“APA”) and the Transition Services Agreement between the Company and Riverside dated October 1, 2018 (“TSA”). Management believes, based on discussions with its legal counsel, that we have meritorious defenses against such unasserted claim. With regard to the alleged breaches of the APA, the APA provides that the Company may be liable only for that portion of Riverside’s damages that exceeds $1.4 million, and in an amount that shall not exceed $1.4 million, which we believe would be the maximum exposure. For damages above $2.8 million, Riverside obtained a representation and warranty insurance policy as required by the APA. The Company will vigorously defend this matter if such claim is asserted.

In connection with an agreement with a development content provider, we agreed to act as guarantor to that party’s loan to finance such development. Such guarantee is expected to remain until 2020. Under the guarantee, we believe the maximum future payments to approximate $22.0 million. In the unlikely event that we are required to make payments on behalf of the development content provider, we would have recourse against the development content provider.

We were contingently liable for $0.8 million and $4.4 million of performance-related surety bonds for our operating activities as of September 30, 2019 and December 31, 2018, respectively. An aggregate of $24.2 million and $24.3 million of letters of credit existed as of September 30, 2019 and December 31, 2018, respectively, of which $0.2 million and $0.1 million backed the aforementioned performance-related surety bonds as of September 30, 2019 and December 31, 2018, respectively.

We routinely enter into standard indemnification provisions as part of license agreements involving use of our intellectual property. These provisions typically require us to indemnify and hold harmless licensees in connection with any infringement claim by a third party relating to the intellectual property covered by the license agreement. Although the term of these provisions and the maximum potential amounts of future payments we could be required to make is not limited, we have never incurred any costs to defend or settle claims related to these types of indemnification provisions. We therefore believe the estimated fair value of these provisions is inconsequential, and have 0 liabilities recorded for them as of September 30, 2019 or December 31, 2018.

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16. Net Income (Loss) Per Share

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019			2018
Numerator
Income (loss) from continuing operations	$	69,260	$	83,908	$	(88,715	)	$	(51,067	)
Income from discontinued operations, net of tax		—		2,441		—			12,833
Net income (loss) attributable to common stockholders	$	69,260	$	86,349	$	(88,715	)	$	(38,234	)
Denominator
Weighted average shares outstanding
Basic		124,315,491		123,553,116		124,089,257			123,401,005
Diluted		124,807,488		123,870,380		124,089,257			123,401,005
Net income (loss) per share attributable to common    stockholders
Basic:
Continuing operations	$	0.56	$	0.68	$	(0.71	)	$	(0.41	)
Discontinued operations		—		0.02		—			0.10
Net income (loss)	$	0.56	$	0.70	$	(0.71	)	$	(0.31	)
Diluted:
Continuing operations	$	0.55	$	0.68	$	(0.71	)	$	(0.41	)
Discontinued operations		—		0.02		—			0.10
Net income (loss)	$	0.55	$	0.70	$	(0.71	)	$	(0.31	)

As we incurred a net loss in the nine month periods ended September 30, 2019 and 2018, presented above, all outstanding stock options and restricted stock units for those periods have an anti-dilutive effect and therefore are excluded from the computation of diluted weighted average shares outstanding. Accordingly, basic and diluted weighted average shares outstanding are equal for such periods.

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Stock options		3,115,013		3,501,165		3,108,926		3,416,323
Restricted stock units		1,820,356		610,790		3,622,096		2,747,006

17. Segment Reporting

As of September 30, 2019, we had 2 reportable segments, Education and HMH Books & Media (formerly referred to as Trade Publishing; the composition of this segment has not changed). Our Education segment provides educational products, technology platforms and services to meet the diverse needs of today’s classrooms. These products and services include print and digital content in the form of textbooks, digital courseware, instructional aids, educational assessment and intervention solutions, which are aimed at improving achievement and supporting learning for students who are not keeping pace with peers, professional development and school reform services. Our HMH Books & Media segment primarily develops, markets and sells consumer books in print and digital formats, licenses book rights to other publishers and electronic businesses in the United States and abroad, and licenses brands across media platforms. The principal distribution channels for HMH Books & Media products are retail stores, both physical and online, and wholesalers.

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

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

	Three Months Ended September 30,
(in thousands)	Education		HMH Books & Media		Corporate/ Other
2019
Net sales	$	517,614	$	48,054	$	—
Segment Adjusted EBITDA		153,415		8,302		(13,002	)
2018
Net sales	$	449,636	$	66,619	$	—
Segment Adjusted EBITDA		154,904		15,486		(10,612	)

	Nine Months Ended September 30,
(in thousands)	Education		HMH Books & Media		Corporate/ Other
2019
Net sales	$	1,021,259	$	127,940	$	—
Segment Adjusted EBITDA		188,906		12,260		(31,671	)
2018
Net sales	$	933,935	$	139,444	$	—
Segment Adjusted EBITDA		208,051		14,725		(32,952	)

The following table disaggregates our net sales by major source:

	Three Months Ended September 30, 2019
(in thousands)	Education		HMH Books & Media		Consolidated
Core solutions (1)	$	273,262	$	—	$	273,262
Extensions (2)		244,352		—		244,352
HMH Books & Media products		—		48,054		48,054
Net sales	$	517,614	$	48,054	$	565,668

	Nine Months Ended September 30, 2019
(in thousands)	Education		HMH Books & Media		Consolidated
Core solutions (1)	$	493,273	$	—	$	493,273
Extensions (2)		527,986		—		527,986
HMH Books & Media products		—		127,940		127,940
Net sales	$	1,021,259	$	127,940	$	1,149,199

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	Three Months Ended September 30, 2018
(in thousands)	Education		HMH Books & Media		Consolidated
Core solutions (1)	$	243,130	$	—	$	243,130
Extensions (2)		206,506		—		206,506
HMH Books & Media products		—		66,619		66,619
Net sales	$	449,636	$	66,619	$	516,255

	Nine Months Ended September 30, 2018
(in thousands)	Education		HMH Books & Media		Consolidated
Core solutions (1)	$	456,335	$	—	$	456,335
Extensions (2)		477,600		—		477,600
HMH Books & Media products		—		139,444		139,444
Net sales	$	933,935	$	139,444	$	1,073,379

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

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

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

	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2019			2018			2019			2018
Total Adjusted EBITDA	$	148,715		$	159,778		$	169,495		$	189,824
Interest expense		(11,597	)		(11,627	)		(35,142	)		(34,035	)
Interest income		509			277			1,698			900
Depreciation expense		(13,901	)		(17,701	)		(46,945	)		(56,457	)
Amortization expense – film asset		—			—			(6,772	)		—
Amortization expense		(52,043	)		(43,028	)		(147,876	)		(126,761	)
Non-cash charges – stock-compensation		(3,835	)		(3,302	)		(11,094	)		(9,363	)
Non-cash charges – loss on derivative instruments		(737	)		(249	)		(1,171	)		(974	)
Fees, expenses or charges for equity offerings, debt or    acquisitions/dispositions		(183	)		(150	)		(731	)		(2,256	)
2017 Restructuring Plan		—			(3,077	)		—			(3,077	)
Severance, separation costs and facility closures		(270	)		(362	)		(5,921	)		(6,380	)
Loss on sale of assets		—			—			—			(384	)
Income (loss) before taxes		66,658			80,559			(84,459	)		(48,963	)
Provision (benefit) for income taxes		(2,602	)		(3,349	)		4,256			2,104
Income (loss) from continuing operations	$	69,260		$	83,908		$	(88,715	)	$	(51,067	)

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18. Subsequent Events

On October 15, 2019, our Board of Directors determined that we will make changes connected with our ongoing strategic transformation to simplify our business model and accelerate growth. This includes new product development and go-to-market capabilities, as well as the streamlining of operations company-wide for greater efficiency. These actions are expected to result in the elimination of 8% of our workforce, after taking into account new strategy-aligned positions that are expected to be added, and additional operating and capitalized cost reductions, including an approximately 20% reduction in previously planned content development expenditures over the next three years. These steps are intended to further simplify our business model while delivering increased value to customers, teachers and students. The workforce reductions are expected to be substantially completed by the end of 2019 and certain real estate actions are targeted for completion no later than 2020.

We currently estimate that implementation of the planned actions will result in total charges of approximately $12.0 million to $16.0 million, all of which are expected to result in cash expenditures. With respect to each major type of cost associated with such activities, we now estimate: (a) charges of approximately $11.0 million to $13.0 million in connection with severance and other termination benefit costs and (b) charges of approximately $1.0 million to $3.0 million in connection with office space related activities for space consolidation of non-cancelable leases not offset by subletting activities.

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

The following discussion and analysis is intended to facilitate an understanding of our results of operations and financial condition and should be read in conjunction with the interim unaudited consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and the related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, which was filed with the Securities Exchange Commission (the “SEC”) on February 28, 2019. This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. See “Special Note Regarding Forward-Looking Statements” included elsewhere in this Quarterly Report on Form 10-Q.

Overview

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

Recent Developments

Strategic Transformation Plan

On October 15, 2019, our Board of Directors determined that we will make changes connected with our ongoing strategic transformation to simplify our business model and accelerate growth. This includes new product development and go-to-market capabilities, as well as the streamlining of operations company-wide for greater efficiency. These actions are expected to result in the elimination of 8% of our workforce, after taking into account new strategy-aligned positions that are expected to be added, and additional operating and capitalized cost reductions, including an approximately 20% reduction in previously planned content development expenditures over the next three years. These steps are intended to further simplify our business model while delivering increased value to customers, teachers and students. The workforce reductions are expected to be substantially completed by the end of 2019 and certain real estate actions are targeted for completion no later than 2020.

We currently estimate that implementation of the planned actions will result in total charges of approximately $12.0 million to $16.0 million, all of which are expected to result in cash expenditures. With respect to each major type of cost associated with such activities, we now estimate: (a) charges of approximately $11.0 million to $13.0 million in connection with severance and other termination benefit costs and (b) charges of approximately $1.0 million to $3.0 million in connection with office space related activities for space consolidation of non-cancelable leases not offset by subletting activities.  

Key Aspects and Trends of Our Operations

Business Segments

We are organized along two business segments: Education and HMH Books & Media (formerly referred to as Trade Publishing). Our Education segment is our largest segment and represented approximately 85%, 86% and 87% of our total net sales for the years ended December 31, 2018, 2017 and 2016, respectively. Our HMH Books & Media segment represented approximately 15%, 14% and 13% of our total net sales for the years ended December 31, 2018, 2017 and 2016, respectively. The Corporate and Other category represents certain general overhead costs not fully allocated to the business segments, such as legal, accounting, treasury, human resources and executive functions.

Net Sales

We derive revenue primarily from the sale of print and digital content and instructional materials, trade books, multimedia instructional programs, license fees for book rights, content, software and services, consulting and training. We primarily sell to customers in the United States. Our net sales are driven primarily as a function of volume and, to a certain extent, changes in price. Our net sales consist of our billings for products and services, less revenue that will be deferred until future recognition along with the transaction price allocation adjusted to reflect the estimated returns for the arrangement. Deferred revenues primarily derive from online interactive digital content, digital and online learning components along with undelivered work-texts, workbooks and services. The work-texts, workbooks and services are deferred until control is transferred to the customer, which often extends over the life of the contract, and our hosted online and digital content is typically recognized ratably over the life of the contract. The digitalization of

27

education content and delivery is driving a shift in the education market. As the K-12 educational market transitions to purchasing more digital, personalized education solutions, we believe our ability now or in the future to offer embedded assessments, adaptive learning, real-time interaction and student specific personalization of educational content in a platform- and device-agnostic manner will provide new opportunities for growth. An increasing number of schools are utilizing digital content in their classrooms and implementing online or blended learning environments, which is altering the historical mix of print and digital educational materials in the classroom. As a result, our business model includes integrated solutions comprised of both print and digital offerings/products to address the needs of the education marketplace. The level of revenues being deferred can fluctuate depending upon the mix of product offering between digital and non-digital products, the length of programs and the mix of product delivered immediately or over time.

Core curriculum programs, which typically represent the most significant portion of our Education segment net sales, cover curriculum standards in a particular K-12 academic subject and include a comprehensive offering of teacher and student materials required to conduct the class throughout the school year. Products and services in these programs include print and digital offerings for students and a variety of supporting materials such as teacher’s editions, formative assessments, supplemental materials, whole group instruction materials, practice aids, educational games and professional services. The process through which materials and curricula are selected and procured for classroom use varies throughout the United States. Currently, nineteen states, known as adoption states, review and approve new programs usually every six to eight years on a state-wide basis. School districts in those states typically select and purchase materials from the state-approved list. The remaining states are known as open states or open territories. In those states, materials are not reviewed at the state level, and each individual school or school district is free to procure materials at any time, although most follow a five-to-ten year replacement cycle. The student population in adoption states represents approximately 48% of the U.S. elementary and secondary school-age population. Some adoption states provide “categorical funding” for instructional materials, which means that those state funds cannot be used for any other purpose. Our core curriculum programs typically have higher deferred sales than other parts of the business. The higher deferred sales are primarily due to the length of time that our programs are being delivered, along with greater component and digital product offerings. A significant portion of our Education segment net sales is dependent upon our ability to maintain residual sales, which are subsequent sales after the year of the original adoption, and our ability to continue to generate new business by developing new programs that meet our customers’ evolving needs. In addition, our market is affected by changes in state curriculum standards, which drive instruction, assessment and accountability in each state. Changes in state curriculum standards require that instructional materials be revised or replaced to align to the new standards, which historically has driven demand for core curriculum programs.

We also derive our Education segment net sales from supplemental products that target struggling learners through comprehensive intervention solutions aimed at raising student achievement by providing solutions that combine technology, content and other educational products, as well as consulting and professional development services. We also offer products targeted at assisting English language learners.

In international markets, we predominantly export and sell K-12 books to premium private schools that utilize the U.S. curriculum, which are located primarily in Asia, the Pacific, the Middle East, Latin America, the Caribbean and Africa. Our international sales team utilizes a global network of distributors in local markets around the world.

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

Factors affecting our net sales include:

Education

• state or district per student funding levels;

• federal funding levels;

• the cyclicality of the purchasing schedule for adoption states;

• student enrollments;

• adoption of new education standards;

• state acceptance of submitted programs and participation rates for accepted programs;

• technological advancement and the introduction of new content and products that meet the needs of students, teachers and consumers, including through strategic agreements pertaining to content development and distribution; and

• the amount of net sales subject to deferrals which is impacted by the mix of product offering between digital and non-digital products, the length of programs and the mix of product delivered immediately or over time.

28

HMH Books & Media

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

• the publishing of bestsellers along with obtaining recognized authors;

• film and series tie-ins to our titles that spur sales of current and backlist titles, which are titles that have been on sale for more than a year; and

• market growth or contraction.

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

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

Long-term growth in the U.S. K-12 market is positively correlated with student enrollments, which is a driver of growth in the educational publishing industry. Although economic cycles may affect short-term buying patterns, school enrollments are highly predictable and are expected to trend upward over the longer term. From 2018 to 2028, total public school enrollment, a major long-term driver of growth in the K-12 Education market, is projected to increase by 1.4% to 51.4 million students, according to the National Center for Education Statistics.

As the K-12 educational market purchases more digital solutions, we believe our ability to offer embedded assessments, adaptive learning, real-time interaction and student specific personalized learning and educational content in a platform- and device-agnostic manner will provide new opportunities for growth.

Our HMH Books & Media segment is heavily influenced by the U.S. and broader global economy, consumer confidence and consumer spending. As the economy continues to grow, both consumer confidence and consumer spending have increased.

While print remains the primary format in which trade books are produced and distributed, the market for trade titles in digital format, primarily ebooks, has developed in the recent decade, as the industry evolved to embrace new technologies for developing, producing, marketing and distributing trade works. We continue to focus on the development of innovative new digital products which capitalize on our strong content, our digital expertise and the consumer demand for these products.

In the HMH Books & Media segment, annual results can be driven by bestselling trade titles. Furthermore, backlist titles can experience resurgence in sales when made into films or series. In past years, a number of our backlist titles such as The Hobbit, The Lord of the Rings, Life of Pi, The Handmaid’s Tale, The Polar Express, The Giver and The Time Traveler’s Wife have benefited in popularity due to movie or series releases and have subsequently resulted in increased trade sales.

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

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

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

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

29

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

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

Publishing rights and Pre-publication amortization

A publishing right is an acquired right that allows us to publish and republish existing and future works as well as create new works based on previously published materials. As part of our March 9, 2010 restructuring, we recorded an intangible asset for publishing rights and amortize such asset on an accelerated basis over the useful lives of the various copyrights involved. This amortization will continue to decrease approximately 25% annually through March of 2023.

We capitalize the art, prepress, manuscript and other costs incurred in the creation of the master copy of our content, known as the pre-publication costs. Pre-publication costs are primarily amortized from the year of sale over five years using the sum-of-the-years-digits method, which is an accelerated method for calculating an asset’s amortization. Under this method, the amortization expense recorded for a pre-publication cost asset is approximately 33% (year 1), 27% (year 2), 20% (year 3), 13% (year 4) and 7% (year 5). We utilize this policy for all pre-publication costs, except with respect to our HMH Books & Media segment’s consumer books, for which we generally expense such costs as incurred and the acquired content of certain intervention products acquired in 2015, which we amortize over 7 years using an accelerated amortization method. The amortization methods and periods chosen best reflect the pattern of expected sales generated from individual titles or programs. We periodically evaluate the remaining lives and recoverability of capitalized pre-publication costs, which are often dependent upon program acceptance by state adoption authorities.

Selling and administrative expenses

Our selling and administrative expenses include the salaries, benefits and related costs of employees engaged in sales and marketing, fulfillment and administrative functions. Also included within selling and administrative expenses are variable costs such as commission expense, outbound transportation costs (approximately $29.9 million for the nine months ended September 30, 2019) and depository fees, which are fees paid to state-mandated depositories that fulfill centralized ordering and warehousing functions for specific states. Additionally, significant fixed and discretionary costs include facilities, telecommunications, professional fees, promotions, sampling and advertising, along with depreciation.

Other intangible asset amortization

Our other intangible asset amortization expense primarily includes the amortization of acquired intangible assets consisting of tradenames, customer relationships, content rights and licenses. The tradenames, customer relationships, content rights and licenses are amortized over varying periods of 6 to 25 years. The expense for the nine months ended September 30, 2019 was $19.5 million.

Interest expense

Our interest expense includes interest accrued on our $800.0 million term loan credit facility (the “term loan facility”) along with, to a lesser extent, our revolving credit facility, capital leases, the amortization of any deferred financing fees and loan discounts, and payments in connection with interest rate hedging agreements. Our interest expense for the nine months ended September 30, 2019 was $35.1 million.

30

Results of Operations

Consolidated Operating Results for the Three Months Ended September 30, 2019 and 2018

	Three Months Ended September 30,						Dollar Change			Percent Change
(dollars in thousands)	2019			2018			2019			2018
Net sales	$	565,668		$	516,255		$	49,413			9.6	%
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		246,527			201,748			44,779			22.2	%
Publishing rights amortization		6,341			8,238			(1,897	)		(23.0	)%
Pre-publication amortization		39,319			28,094			11,225			40.0	%
Cost of sales		292,187			238,080			54,107			22.7	%
Selling and administrative		188,957			176,202			12,755			7.2	%
Other intangible assets amortization		6,383			6,696			(313	)		(4.7	)%
Restructuring		—			3,077			(3,077	)	NM
Severance and other charges		270			362			(92	)		(25.4	)%
Operating income		77,871			91,838			(13,967	)		(15.2	)%
Other income (expense):
Retirement benefits non-service income		41			320			(279	)		(87.2	)%
Interest expense		(11,597	)		(11,627	)		30			0.3	%
Interest income		509			277			232			83.8	%
Change in fair value of derivative instruments		(737	)		(249	)		(488	)	NM
Income from transition services agreement		571			—			571		NM
Income from continuing operations before taxes		66,658			80,559			(13,901	)		(17.3	)%
Income tax benefit		(2,602	)		(3,349	)		747			22.3	%
Income from continuing operations	$	69,260		$	83,908		$	(14,648	)		(17.5	)%
Income from discontinued operations, net tax		—			2,441			(2,441	)	NM
Net Income	$	69,260		$	86,349		$	(17,089	)		(19.8	)%

NM = not meaningful

Net sales for the three months ended September 30, 2019 increased $49.4 million, or 9.6%, from $516.3 million for the same period in 2018 to $565.7 million. The net sales increase was driven by a $68.0 million increase in our Education segment, offset by a $18.6 million decrease in our HMH Books & Media segment. Within our Education segment, the increase was due to higher net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, which increased by $38.0 million from $207.0 million in 2018 to $244.0 million. Within Extensions, Heinemann net sales continued to grow primarily driven by sales of the Fountas & Pinnell Classroom and Calkins products. Extensions net sales were partially offset by lower intervention and supplemental product sales. Further, our net sales from Core Solutions increased by $30.0 million from $243.0 million in 2018 to $273.0 million. The primary driver of the increase in Core Solutions were net sales of Texas and national versions of the Into Reading and Into Literature programs. Our billings associated with Core Solutions increased $138.0 million in the third quarter of 2019 from the same period last year; however, due to the digital and print subscription nature of our offerings, a substantial portion of such billings were deferred and will be recognized in the future. Within our HMH Books & Media segment, the decrease in net sales was primarily due to 2018 licensing income of $16.0 million, pertaining to our classic backlist titles 1984 and Animal Farm, which did not repeat this year.

31

Operating income for the three months ended September 30, 2019 changed unfavorably from $91.8 million for the same period in 2018 to $77.9 million, due primarily to the following:

• A $44.8 million increase in our cost of sales, excluding publishing rights and pre-publication amortization, from $201.7 million for the same period in 2018 to $246.5 million, primarily due to product mix and higher royalty costs associated with our higher billings. Our billings increased $175.0 million in the quarter from the same quarter last year, however, our net sales which were deferred also increased $126.0 million. Since our costs of sales are primarily driven by billings, our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of sales, increased to 43.6% from 39.1% due to the increase in billings volume,

• A $12.8 million increase in selling and administrative expenses, primarily due to higher labor costs of $15.0 million, mainly attributable to support the increased billings, which increased $175.0 million from the same period last year. Further, there was an increase of $4.2 million of variable expenses such as transportation and commissions due to higher billings. Partially offsetting the increase in selling and administrative expenses was lower depreciation expense of $3.6 million, along with lower discretionary costs,

• A $9.0 million increase in net amortization expense related to publishing rights, pre-publication and other intangible assets, primarily due to an increase in pre-publication amortization attributed to the timing of 2019 major product releases slightly offset by our use of accelerated amortization methods for publishing rights amortization,

• Offsetting the aforementioned was an increase in net sales of $49.4 million, and

• A $3.1 million decrease in costs associated with our 2017 Restructuring Plan due to real estate consolidation costs in the third quarter of 2018 that did not repeat.

Retirement benefits non-service income for the three months ended September 30, 2019 changed unfavorably by $0.3 million due to the lowering of the expected return on plan assets assumption and greater interest costs in the calculation of net periodic benefit cost in 2019.

Interest expense for the three months ended September 30, 2019 slightly decreased from the same period in 2018, primarily due to a reduction of net settlement payments on our interest rate derivative instruments, offset by an increase in variable interest rates, during the current period.

Interest income for the three months ended September 30, 2019 increased $0.2 million due to higher cash balances invested in money market funds in 2019.

Change in fair value of derivative instruments for the three months ended September 30, 2019, unfavorably changed by $0.5 million from a loss of $0.2 million in the same period in 2018 to a loss of $0.7 million. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the strengthening of the U.S. dollar against the Euro.

Income from transition services agreement for the three months ended September 30, 2019 was $0.6 million and was related to transition service fees under the transition services agreement with the purchaser of the Riverside Business pursuant to which we performed certain support functions through September 30, 2019.

Income tax benefit for the three months ended September 30, 2019 decreased $0.7 million, from $3.3 million for the same period in 2018, to $2.6 million. For 2019, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (3.9)%. For 2018, our effective annual tax rate exclusive of discrete items was (3.8)%. For both periods income tax expense was primarily attributed to movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes, as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions.

32

Consolidated Operating Results for the Nine Months Ended September 30, 2019 and 2018

	Nine Months Ended September 30,						Dollar Change			Percent Change
(dollars in thousands)	2019			2018			2019			2018
Net sales	$	1,149,199		$	1,073,379		$	75,820			7.1	%
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		533,413			461,539			71,874			15.6	%
Publishing rights amortization		20,217			26,476			(6,259	)		(23.6	)%
Pre-publication amortization		108,140			80,047			28,093			35.1	%
Cost of sales		661,770			568,062			93,708			16.5	%
Selling and administrative		516,206			491,052			25,154			5.1	%
Other intangible assets amortization		19,519			20,238			(719	)		(3.6	)%
Restructuring		—			3,077			(3,077	)	NM
Severance and other charges		5,921			6,380			(459	)		(7.2	)%
Loss on sale of assets		—			384			(384	)	NM
Operating loss		(54,217	)		(15,814	)		(38,403	)	NM
Other income (expense):
Retirement benefits non-service income		125			960			(835	)		(87.0	)%
Interest expense		(35,142	)		(34,035	)		(1,107	)		(3.3	)%
Interest income		1,698			900			798			88.7	%
Change in fair value of derivative instruments		(1,171	)		(974	)		(197	)		(20.2	)%
Income from transition services agreement		4,248			—			4,248		NM
Loss from continuing operations before taxes		(84,459	)		(48,963	)		(35,496	)		(72.5	)%
Income tax expense		4,256			2,104			2,152		NM
Loss from continuing operations	$	(88,715	)	$	(51,067	)	$	(37,648	)		(73.7	)%
Income from discontinued operations, net tax		—			12,833			(12,833	)	NM
Net loss	$	(88,715	)	$	(38,234	)	$	(50,481	)	NM

NM = not meaningful

Net sales for the nine months ended September 30, 2019 increased $75.8 million, or 7.1%, from $1,073.4 million for the same period in 2018 to $1,149.2 million. The net sales increase was driven by a $87.3 million increase in our Education segment, offset by a $11.5 million decrease in our HMH Books & Media segment. Within our Education segment, the increase was due to higher net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, which increased by $50.0 million from $478.0 million in 2018 to $528.0 million. Within Extensions, Heinemann net sales continued to grow driven by sales of the Fountas & Pinnell Classroom and Calkins products. Such net sales were partially offset by lower intervention and supplemental product sales within Extensions. Further, net sales from Core Solutions increased by $37.0 million from $456.0 million in 2018 to $493.0 million. The primary driver of the increase in Core Solutions were net sales of the Texas and national versions of the Into Reading and Into Literature programs. Our billings associated with our Core Solutions increased $230.0 million for the nine months ended September 30, 2019 from the same period last year; however, due to the digital and print subscription nature of our offerings, a substantial portion of such billings were deferred and will be recognized in the future. Within our HMH Books & Media segment, the decrease in net sales was primarily due to 2018 licensing income of $16.0 million, pertaining to our classic backlist titles 1984 and Animal Farm, which did not repeat this year, partially offset by licensing revenue of $7.7 million related to the Carmen Sandiego series on Netflix.

33

Operating loss for the nine months ended September 30, 2019 changed unfavorably from a loss of $15.8 million for the same period in 2018 to a loss of $54.2 million, due primarily to the following:

• A $71.9 million increase in our cost of sales, excluding publishing rights and pre-publication amortization, from $461.5 million for the same period in 2018 to $533.4 million. Our billings increased $283.0 million in the nine months ended September 30, 2019 from the same period last year, however, our net sales which were deferred also increased $207.0 million. Since our costs of sales are primarily driven by billings, our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of sales, increased to 46.4% from 43.0% due to the increase in billings volume,

• A $25.2 million increase in selling and administrative expenses, primarily due to higher labor costs of $25.2 million, mainly attributable to support the increased billings, which increased $283 million from the same period last year. Further, there was an increase of variable expenses such as an increase in transportation and commissions of $10.9 million due to product mix and higher billings. Partially offsetting the increase in selling and administrative expenses was lower depreciation expense of $8.0 million and lower fixed costs, and

• A $21.1 million increase in net amortization expense related to publishing rights, pre-publication and other intangible assets, primarily due to an increase in pre-publication amortization attributed to the timing of 2019 major product releases partially offset by our use of accelerated amortization methods for publishing rights amortization,

• Partially offset by a $75.8 million increase in net sales,

• A $3.1 million decrease in costs associated with our 2017 Restructuring Plan due to real estate consolidation costs in the third quarter of 2018 that did not repeat,

• A $0.5 million net decrease in severance and other charges due to real estate consolidation costs of $3.4 million in 2019 offset by a reduction in severance of $3.9 million from 2018, and

• A $0.4 million net loss on the sale of assets associated with the divestiture of certain non-core products and intellectual property during 2018.

Retirement benefits non-service income for the nine months ended September 30, 2019 changed unfavorably by $0.8 million due to the lowering of the expected return on plan assets assumption and greater interest costs in the calculation of net periodic benefit cost in 2019.

Interest expense for the nine months ended September 30, 2019 increased $1.1 million from $34.0 million for the same period in 2018 to $35.1 million, primarily due to an increase in interest on the term loan facility of $2.8 million due to an increase in variable interest rates, offset by a reduction of $1.7 million of net settlement payments on our interest rate derivative instruments during the current period.

Interest income for the nine months ended September 30, 2019 increased $0.8 from the same period in 2018 primarily due to higher cash balances invested in money market funds in 2019.

Change in fair value of derivative instruments for the nine months ended September 30, 2019, unfavorably changed by $0.2 million from a loss of $1.0 million in the same period in 2018 to a loss of $1.2 million. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the strengthening of the U.S. dollar against the Euro.

Income from transition services agreement for the nine months ended September 30, 2019 was $4.2 million and was related to transition service fees under the transition services agreement with the purchaser of the Riverside Business pursuant to which we performed certain support functions through September 30, 2019.

Income tax expense for the nine months ended September 30, 2019 increased $2.2 million, from $2.1 million for the same period in 2018, to $4.3 million. For 2019, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (3.9)%. For 2018, our effective annual tax rate exclusive of discrete items was (3.8)%. For both periods income tax expense was primarily attributed to the movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions.

34

Adjusted EBITDA From Continuing Operations

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

Below is a reconciliation of our net loss to Adjusted EBITDA from continuing operations for the three and nine months ended September 30, 2019 and 2018:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Net income (loss) from continuing operations	$	69,260		$	83,908		$	(88,715	)	$	(51,067	)
Interest expense		11,597			11,627			35,142			34,035
Interest income		(509	)		(277	)		(1,698	)		(900	)
Provision (benefit) for income taxes		(2,602	)		(3,349	)		4,256			2,104
Depreciation expense		13,901			17,701			46,945			56,457
Amortization expense – film asset		—			—			6,772			—
Amortization expense		52,043			43,028			147,876			126,761
Non-cash charges – stock compensation		3,835			3,302			11,094			9,363
Non-cash charges – loss on derivative instruments		737			249			1,171			974
Fees, expenses or charges for equity offerings, debt or    acquisitions/dispositions		183			150			731			2,256
2017 Restructuring Plan		—			3,077			—			3,077
Severance, separation costs and facility closures		270			362			5,921			6,380
Loss on sale of assets		—			—			—			384
Adjusted EBITDA from continuing operations	$	148,715		$	159,778		$	169,495		$	189,824

35

Segment Operating Results

Results of Operations – Comparing Three Months Ended September 30, 2019 and 2018

Education

	Three Months Ended September 30,				Dollar			Percent
	2019		2018		Change			Change
Net sales	$	517,614	$	449,636	$	67,978			15.1	%
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		219,920		163,991		55,929			34.1	%
Publishing rights amortization		4,874		6,598		(1,724	)		(26.1	)%
Pre-publication amortization		39,051		28,008		11,043			39.4	%
Cost of sales		263,845		198,597		65,248			32.9	%
Selling and administrative		154,439		143,203		11,236			7.8	%
Other intangible asset amortization		4,876		5,214		(338	)		(6.5	)%
Operating income from continuing operations		94,454		102,622		(8,168	)		(8.0	)%
Net income from continuing operations	$	94,454	$	102,622	$	(8,168	)		(8.0	)%
Adjustments from net income from continuing    operations to Education segment Adjusted EBITDA
Depreciation expense	$	10,160	$	12,462	$	(2,302	)		(18.5	)%
Amortization expense		48,801		39,820		8,981			22.6	%
Education segment Adjusted EBITDA	$	153,415	$	154,904	$	(1,489	)		(1.0	)%

NM = not meaningful

Our Education segment net sales for the three months ended September 30, 2019 increased $68.0 million, or 15.1%, from $449.6 million for the same period in 2018 to $517.6 million. The increase was due to higher net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, which increased by $38.0 million from $207.0 million in 2018 to $244.0 million. Heinemann net sales continued to grow primarily driven by sales of the Fountas & Pinnell Classroom and Calkins products. Such net sales were partially offset by lower intervention and supplemental product sales within Extensions. Further, our net sales from Core Solutions increased by $30.0 million from $243.0 million in 2018 to $273.0 million. The primary driver of the increase in Core Solutions were net sales of Texas and national versions of the Into Reading and Into Literature programs. Our billings associated with our Core solutions increased $138.0 million in the third quarter of 2019 from the same period last year; however, due to the digital and print subscription nature of our offerings, a substantial portion of such billings were deferred and will be recognized in the future.  

Our Education segment cost of sales for the three months ended September 30, 2019 increased $65.2 million, or 32.9%, from $198.6 million for the same period in 2018 to $263.8 million. Our cost of sales, excluding publishing rights and pre-publication amortization, increased $55.9 million from $164.0 million in 2018 to $219.9 million. Our billings increased $195.0 million for the three months ended September 30, 2019 from the same quarter last year, however, our net sales which were deferred also increased $127.0 million. Since our costs of sales are primarily driven by billings, our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of sales, increased to 42.5% from 36.5% due to the increase in billings volume. Pre-publication amortization increased by $11.0 million from the same period in 2018 primarily due to the timing of 2019 major product releases, partially offset by a $1.7 million decrease in publishing rights amortization attributed to our use of accelerated amortization methods.

Our Education segment selling and administrative expense for the three months ended September 30, 2019 increased $11.2 million, or 7.8%, from $143.2 million for the same period in 2018 to $154.4 million. The increase was driven by higher labor costs and variable expenses such as samples, transportation, depository fees and commissions attributed to higher billings from the prior year.

Our Education segment other intangible asset amortization expense for the three months ended September 30, 2019 slightly decreased from the same period in 2018, which was due to our use of accelerated amortization methods.

Our Education segment Adjusted EBITDA for the three months ended September 30, 2019 decreased $1.5 million, from $154.9 million for the same period in 2018 to $153.4 million. Our Education segment Adjusted EBITDA excludes depreciation and amortization. The decrease is due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in Education segment Adjusted EBITDA.

36

HMH Books & Media

	Three Months Ended September 30,				Dollar			Percent
	2019		2018		Change			Change
Net sales	$	48,054	$	66,619	$	(18,565	)		(27.9	)%
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		26,607		37,757		(11,150	)		(29.5	)%
Publishing rights amortization		1,467		1,640		(173	)		(10.5	)%
Pre-publication amortization		268		86		182		NM
Cost of sales		28,342		39,483		(11,141	)		(28.2	)%
Selling and administrative		13,312		13,524		(212	)		(1.6	)%
Other intangible asset amortization		1,507		1,482		25			1.7	%
Operating income		4,893		12,130		(7,237	)		(59.7	)%
Net income	$	4,893	$	12,130	$	(7,237	)		(59.7	)%
Adjustments from net income to HMH Books & Media    segment Adjusted EBITDA
Depreciation expense	$	167	$	148	$	19			12.8	%
Amortization expense		3,242		3,208		34			1.1	%
HMH Books & Media segment Adjusted EBITDA	$	8,302	$	15,486	$	(7,184	)		(46.4	)%

NM = not meaningful

Our HMH Books & Media segment net sales for the three months ended September 30, 2019 decreased $18.6 million, or 27.9%, from $66.6 million for the same period in 2018 to $48.1 million. The decrease in net sales was primarily due to 2018 licensing income of $16.0 million, pertaining to our classic backlist titles 1984 and Animal Farm, which did not repeat this year.

Our HMH Books & Media segment cost of sales for the three months ended September 30, 2019 decreased $11.1 million, or 28.2%, from $39.5 million for the same period in 2018 to $28.3 million. The majority of the decrease was driven by our cost of sales, excluding publishing rights and pre-publication amortization, which decreased $11.2 million primarily due to lower royalties as the prior year had higher royalties associated with the licensing income from 1984 and Animal Farm. Our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of net sales, decreased to 55.4% from 56.7%.

Our HMH Books & Media segment selling and administrative expense for the three months ended September 30, 2019 slightly decreased from the same period in 2018. The decrease was primarily due to lower marketing and product management costs.

Our HMH Books & Media segment other intangible asset amortization expense for the three months ended September 30, 2019 slightly increased from the same period in 2018.

Our HMH Books & Media segment Adjusted EBITDA for the three months ended September 30, 2019 changed unfavorably from $15.5 million for the same period in 2018 to $8.3 million due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in our HMH Books & Media segment Adjusted EBITDA. Our HMH Books & Media segment Adjusted EBITDA excludes depreciation and amortization.

37

Corporate and Other

	Three Months Ended September 30,						Dollar			Percent
	2019			2018			Change			Change
Net sales	$	—		$	—		$	—			—
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		—			—			—			—
Publishing rights amortization		—			—			—			—
Pre-publication amortization		—			—			—			—
Cost of sales		—			—			—			—
Selling and administrative		21,206			19,475			1,731			8.9	%
Restructuring		—			3,077			(3,077	)	NM
Severance and other charges		270			362			(92	)		(25.4	)%
Operating loss		(21,476	)		(22,914	)		1,438			6.3	%
Retirement benefits non-service income		41			320			(279	)		(87.2	)%
Interest expense		(11,597	)		(11,627	)		30			0.3	%
Interest income		509			277			232			83.8	%
Change in fair value of derivative instruments		(737	)		(249	)		(488	)	NM
Income from transition services agreement		571			—			571		NM
Net loss before taxes		(32,689	)		(34,193	)		1,504			4.4	%
Income tax benefit		(2,602	)		(3,349	)		747			22.3	%
Net loss	$	(30,087	)	$	(30,844	)	$	757			2.5	%
Adjustments from net loss to Corporate and Other segment    Adjusted EBITDA
Interest expense	$	11,597		$	11,627		$	(30	)		(0.3	)%
Interest income		(509	)		(277	)		(232	)		83.8	%
Provision for income taxes		(2,602	)		(3,349	)		747			(22.3	)%
Depreciation expense		3,574			5,091			(1,517	)		(29.8	)%
Non-cash charges – loss on derivative instruments		737			249			488		NM
Non-cash charges – stock compensation		3,835			3,302			533			16.1	%
Fees, expenses or charges for equity offerings, debt or    acquisitions/dispositions		183			150			33			22.0	%
2017 Restructuring Plan		—			3,077			(3,077	)	NM
Severance, separation costs and facility closures		270			362			(92	)		(25.4	)%
Corporate and Other segment Adjusted EBITDA	$	(13,002	)	$	(10,612	)	$	(2,390	)		(22.5	)%

NM = not meaningful

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

Our selling and administrative expense for the Corporate and Other category for the three months ended September 30, 2019 increased $1.7 million to $21.2 million from $19.5 million, primarily attributed to planned merit increases and higher stock compensation, partially offset by lower depreciation.

Our restructuring costs for the three months ended September 30, 2019 decreased by $3.1 million due to real estate consolidation costs in the third quarter of 2018 that did not repeat.

Our severance and other charges for the three months ended September 30, 2019 slightly decreased from the same period in 2018.

Retirement benefits non-service income for the three months ended September 30, 2019 changed unfavorably by $0.3 million due to the lowering of the expected return on plan assets assumption and greater interest costs in the calculation of net periodic benefit cost in 2019.

38

Interest expense for the three months ended September 30, 2019 slightly decreased from the same period in 2018, primarily due to a reduction of net settlement payments on our interest rate derivative instruments offset by an increase in variable interest rates, during the current period.

Interest income for the three months ended September 30, 2019 slightly increased due to higher cash balances invested in money market funds in 2019.

Change in fair value of derivative instruments for the three months ended September 30, 2019, unfavorably changed by $0.5 million from a loss of $0.2 million in the same period in 2018 to a loss of $0.7 million. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the strengthening of the U.S. dollar against the Euro.

Income from transition services agreement for the three months ended September 30, 2019 was $0.6 million and was related to transition service fees under the transition services agreement with the purchaser of the Riverside Business pursuant to which we performed certain support functions through September 30, 2019.

Income tax benefit for the three months ended September 30, 2019 decreased $0.7 million, from $3.3 million for the same period in 2018, to $2.6 million. For 2019, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (3.9)%. For 2018, our effective annual tax rate exclusive of discrete items was (3.8)%. For both periods, income tax expense was primarily attributed to the movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions.

Adjusted EBITDA for the Corporate and Other category for the three months ended September 30, 2019 unfavorably changed $2.4 million, or 22.5%, from a loss of $10.6 million for the same period in 2018 to a loss of $13.0 million. Our Adjusted EBITDA for the Corporate and Other category excludes interest, taxes, depreciation, derivative instruments charges, equity compensation charges, acquisition/disposition-related activity, severance and facility vacant space costs. The unfavorable change in our Adjusted EBITDA for the Corporate and Other category was due to the factors described above after removing those items not included in Adjusted EBITDA for the Corporate and Other category.

Results of Operations – Comparing Nine Months Ended September 30, 2019 and 2018

Education

	Nine Months Ended September 30,				Dollar			Percent
	2019		2018		Change			Change
Net sales	$	1,021,259	$	933,935	$	87,324			9.4	%
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		450,567		375,426		75,141			20.0	%
Publishing rights amortization		15,737		21,462		(5,725	)		(26.7	)%
Pre-publication amortization		107,654		79,825		27,829			34.9	%
Cost of sales		573,958		476,713		97,245			20.4	%
Selling and administrative		415,913		392,487		23,426			6.0	%
Other intangible asset amortization		15,000		15,791		(791	)		(5.0	)%
Loss on sale of assets		—		384		(384	)	NM
Operating income from continuing operations		16,388		48,560		(32,172	)		(66.3	)%
Net income from continuing operations	$	16,388	$	48,560	$	(32,172	)		(66.3	)%
Adjustments from net income from continuing operations to    Education segment Adjusted EBITDA
Depreciation expense	$	34,127	$	42,029	$	(7,902	)		(18.8	)%
Amortization expense		138,391		117,078		21,313			18.2	%
Loss on sale of assets		—		384		(384	)	NM
Education segment Adjusted EBITDA	$	188,906	$	208,051	$	(19,145	)		(9.2	)%

NM = not meaningful

39

Our Education segment net sales for the nine months ended September 30, 2019 increased $87.3 million, or 9.4%, from $933.9 million for the same period in 2018 to $1,021.3 million. The increase was primarily due to higher net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, which increased by $50.0 million from $478.0 million in 2018 to $528.0 million. Heinemann net sales continued to grow and was driven by sales of the Fountas & Pinnell Classroom and Calkins products. Such Extension net sales were partially offset by lower intervention and supplemental product sales. Further, net sales from Core Solutions increased by $37.0 million from $456.0 million in 2018 to $493.0 million. The primary driver of the increase in Core Solutions were net sales of the Texas and national versions of the Into Reading and Into Literature programs. Our billings associated with our Core solutions increased $230.0 million for the nine months ended September 30, 2019 from the same period last year; however, due to the digital and print subscription nature of our offerings, a substantial portion of such billings were deferred and will be recognized in the future.

Our Education segment cost of sales for the nine months ended September 30, 2019 increased $97.2 million, or 20.4%, from $476.7 million for the same period in 2018 to $574.0 million. Our cost of sales, excluding publishing rights and pre-publication amortization, increased $75.1 million from $375.4 million in 2018 to $450.6 million. Our billings increased $296.0 million in the nine months ended September 30, 2019 from the same period last year, however, our net sales which were deferred also increased $209.0 million. Since our costs of sales are primarily driven by billings, our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of sales, increased to 44.1% from 40.2%, due to the increase in billings volume. Pre-publication amortization increased by $27.8 million from the same period in 2018 primarily due to the timing of 2019 major product releases, partially offset by a $5.7 million decrease in publishing rights amortization attributed to our use of accelerated amortization methods.

Our Education segment selling and administrative expense for the nine months ended September 30, 2019 increased $23.4 million, or 6.0%, from $392.5 million for the same period in 2018 to $415.9 million. The increase was driven by higher labor costs and variable expenses such as samples, commissions and travel and entertainment attributed to higher billings from the prior year.

Our Education segment other intangible asset amortization expense for the nine months ended September 30, 2019 decreased $0.8 million, or 5.0%, from the same period in 2018, due to our use of accelerated amortization methods.

Our Education segment Adjusted EBITDA for the nine months ended September 30, 2019 decreased $19.1 million, from $208.1 million for the same period in 2018 to $188.9 million. Our Education segment Adjusted EBITDA excludes depreciation, amortization and loss on sale of assets. The decrease is due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in Education segment Adjusted EBITDA.

HMH Books & Media

	Nine Months Ended September 30,					Dollar			Percent
	2019			2018		Change			Change
Net sales	$	127,940		$	139,444	$	(11,504	)		(8.2	)%
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		82,846			86,113		(3,267	)		(3.8	)%
Publishing rights amortization		4,480			5,014		(534	)		(10.7	)%
Pre-publication amortization		486			222		264			118.9	%
Cost of sales		87,812			91,349		(3,537	)		(3.9	)%
Selling and administrative		40,633			39,048		1,585			4.1	%
Other intangible asset amortization		4,519			4,447		72			1.6	%
Operating (loss) income		(5,024	)		4,600		(9,624	)	NM
Net (loss) income	$	(5,024	)	$	4,600	$	(9,624	)	NM
Adjustments from net (loss) income to HMH Books & Media    segment Adjusted EBITDA
Depreciation expense	$	1,027		$	442	$	585		NM
Amortization expense film asset		6,772			—		6,772		NM
Amortization expense		9,485			9,683		(198	)		(2.0	)%
HMH Books & Media segment Adjusted EBITDA	$	12,260		$	14,725	$	(2,465	)		(16.7	)%

NM = not meaningful

40

Our HMH Books & Media segment net sales for the nine months ended September 30, 2019 decreased $11.5 million, or 8.2%, from $139.4 million for the same period in 2018 to $127.9 million. The decrease in net sales was primarily due to 2018 licensing income of $16.0 million, pertaining to our classic backlist titles 1984 and Animal Farm, which did not repeat this year, partially offset by licensing revenue of $7.7 million related to the Carmen Sandiego series on Netflix.

Our HMH Books & Media segment cost of sales for the nine months ended September 30, 2019 decreased $3.5 million, or 3.9%, from $91.3 million for the same period in 2018 to $87.8 million. The majority of the decrease was driven by our cost of sales, excluding publishing rights and pre-publication amortization, which decreased $3.3 million due primarily to lower royalties as the prior year had higher royalties associated with the licensing income from 1984 and Animal Farm, partially offset by higher film asset amortization from the Carmen Sandiego series. Our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of net sales, increased to 64.8% from 61.8%.

Our HMH Books & Media segment selling and administrative expense for the nine months ended September 30, 2019 increased $1.6 million, or 4.1%, from $39.0 million for the same period in 2018 to $40.6 million. The increase was primarily due to higher marketing and product management costs along with variable expenses.

Our HMH Books & Media segment other intangible asset amortization expense for the nine months ended September 30, 2019 increased slightly from the same period in 2018.

Our HMH Books & Media segment Adjusted EBITDA for the nine months ended September 30, 2019 changed unfavorably from $14.7 million for the same period in 2018 to $12.3 million due to the identified factors impacting net sales, cost of sales and selling and administrative expenses after removing those items not included in our HMH Books & Media segment Adjusted EBITDA. Our HMH Books & Media segment Adjusted EBITDA excludes depreciation and amortization.

41

Corporate and Other

	Nine Months Ended September 30,						Dollar			Percent
	2019			2018			Change			Change
Net sales	$	—		$	—		$	—			—
Costs and expenses:
Cost of sales, excluding publishing rights and    pre-publication amortization		—			—			—			—
Publishing rights amortization		—			—			—			—
Pre-publication amortization		—			—			—			—
Cost of sales		—			—			—			—
Selling and administrative		59,660			59,517			143			0.2	%
Restructuring		—			3,077			(3,077	)	NM
Severance and other charges		5,921			6,380			(459	)		(7.2	)%
Operating loss		(65,581	)		(68,974	)		3,393			(4.9	)%
Retirement benefits non-service income		125			960			(835	)		(87.0	)%
Interest expense		(35,142	)		(34,035	)		(1,107	)		(3.3	)%
Interest income		1,698			900			798			88.7	%
Change in fair value of derivative instruments		(1,171	)		(974	)		(197	)		(20.2	)%
Income from transition services agreement		4,248			—			4,248		NM
Net loss before taxes		(95,823	)		(102,123	)		6,300			6.2	%
Income tax expense		4,256			2,104			2,152		NM
Net loss	$	(100,079	)	$	(104,227	)	$	4,148			4.0	%
Adjustments from net loss to Corporate and Other segment    Adjusted EBITDA
Interest expense	$	35,142		$	34,035		$	1,107			3.3	%
Interest income		(1,698	)		(900	)		(798	)		88.7	%
Provision for income taxes		4,256			2,104			2,152			102.3	%
Depreciation expense		11,791			13,986			(2,195	)		(15.7	)%
Non-cash charges loss (gain) on derivative instruments		1,171			974			197			20.2	%
Non-cash charges – stock compensation		11,094			9,363			1,731			18.5	%
Fees, expenses or charges for equity offerings, debt or    acquisitions/dispositions		731			2,256			(1,525	)		(67.6	)%
2017 Restructuring Plan		—			3,077			(3,077	)	NM
Severance, separation costs and facility closures		5,921			6,380			(459	)		(7.2	)%
Corporate and Other segment Adjusted EBITDA	$	(31,671	)	$	(32,952	)	$	1,281			(3.9	)%

NM = not meaningful

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

Our selling and administrative expense for the Corporate and Other category for the nine months ended September 30, 2019 increased slightly from the same period in 2018.

Our restructuring costs for the nine months ended September 30, 2019 decreased by $3.1 million due to real estate consolidation costs in the third quarter of 2018 that did not repeat.

Our severance and other charges for the nine months ended September 30, 2019 decreased $0.5 million, or 7.2%, from $6.4 million for the same period in 2018 to $5.9 million, due to real estate consolidation costs of $3.4 million in 2019, offset by a reduction in severance of $3.9 million from 2018.

Retirement benefits non-service income for the nine months ended September 30, 2019 changed unfavorably by $0.8 million due to the lowering of the expected return on plan assets assumption and greater interest costs in the calculation of net periodic benefit cost in 2019.

42

Interest expense for the nine months ended September 30, 2019 increased $1.1 million from $34.0 million for the same period in 2018 to $35.1 million, primarily due to an increase in interest on the term loan facility of $2.8 million due to an increase in variable interest rates, offset by a reduction of $1.7 million of net settlement payments on our interest rate derivative instruments during the current period.

Interest income for the nine months ended September 30, 2019 increased $0.8 from the same period in 2018 primarily due to higher cash balances invested in money market funds in 2019.

Change in fair value of derivative instruments for the nine months ended September 30, 2019, unfavorably changed by $0.2 million from a loss of $1.0 million in the same period in 2018 to a loss of $1.2 million. The change in fair value of derivative instruments was related to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the strengthening of the U.S. dollar against the Euro.

Income from transition services agreement for the nine months ended September 30, 2019 was $4.2 million and was related to transition service fees under the transition services agreement with the purchaser of the Riverside Business pursuant to which we performed certain support functions through September 30, 2019.

Income tax expense for the nine months ended September 30, 2019 increased $2.2 million, from $2.1 million for the same period in 2018, to $4.3 million. For 2019, our annual effective tax rate, exclusive of discrete items used to calculate the tax provision, is expected to be approximately (3.9)%. For 2018, our effective annual tax rate exclusive of discrete items was (3.8)%. For both periods, income tax expense was primarily attributed to the movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions.

Adjusted EBITDA for the Corporate and Other category for the nine months ended September 30, 2019 favorably changed $1.3 million, or 3.9%, from a loss of $33.0 million for the same period in 2018 to a loss of $31.7 million. Our Adjusted EBITDA for the Corporate and Other category excludes interest, taxes, depreciation, derivative instruments charges, equity compensation charges, acquisition/disposition-related activity, severance and facility vacant space costs. The favorable change in our Adjusted EBITDA for the Corporate and Other category was due to the factors described above after removing those items not included in Adjusted EBITDA for the Corporate and Other category.

Seasonality and Comparability

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

Approximately 85% of our net sales for the year ended December 31, 2018 were derived from our Education segment, which is a markedly seasonal business. Schools conduct the majority of their purchases in the second and third quarters of the calendar year in preparation for the beginning of the school year. Thus, over the last three completed fiscal years, approximately 67% of our consolidated net sales were realized in the second and third quarters. Sales of K-12 instructional materials are also cyclical, with some years offering more sales opportunities than others based on the state adoption calendar. The amount of funding available at the state level for educational materials also has a significant effect on year-to-year net sales. Although the loss of a single customer would not have a material adverse effect on our business, schedules of school adoptions and market acceptance of our products can materially affect year-to-year net sales performance.

Liquidity and Capital Resources

(in thousands)	September 30, 2019		December 31, 2018
Cash and cash equivalents	$	308,676	$	253,365
Short-term investments		—		49,833
Current portion of long-term debt		8,000		8,000
Revolving credit facility		—		—
Long-term debt, net of discount and issuance costs		752,241		755,649
Borrowing availability under revolving credit facility		223,791		167,434

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	Nine Months Ended September 30,
	2019			2018
Net cash provided by operating activities	$	127,372		$	43,467
Net cash used in investing activities		(65,079	)		(82,292	)
Net cash used in financing activities		(6,982	)		(5,850	)

Operating activities

Net cash provided by operating activities was $127.4 million for the nine months ended September 30, 2019, a $83.9 million increase from the $43.5 million of net cash provided by operating activities for the nine months ended September 30, 2018. Net cash provided by operating activities included $17.4 million of cash flow provided by discontinued operations in 2018. Net cash provided by operating activities from continuing operations was $127.4 million for the nine months ended September 30, 2019 compared to $26.1 million for the nine months ended September 30, 2018. The $101.3 million increase in cash provided by operating activities from continuing operations was primarily driven by favorable changes in net operating assets and liabilities of $106.1 million primarily due to an increase in deferred revenue of $206.7 million attributed to greater billings in 2019, an increase in accounts payable of $22.0 million due to timing of disbursements and an increase in royalties of $6.3 million, offset by unfavorable changes in accounts receivable of $70.8 million also attributed to greater billings in 2019, inventories of $8.2 million, operating lease liabilities of $12.5 million due to the recognition of liabilities for leases on the balance sheet in accordance with the new leases accounting standard in 2019, and other assets and liabilities of $37.4 million.  Additionally, operating profit, net of non-cash items, decreased by $4.8 million.

Investing activities

Net cash used in investing activities was $65.1 million for the nine months ended September 30, 2019, a decrease of $17.2 million from the nine months ended September 30, 2018. Net cash used in investing activities included $5.9 million of expenditures from discontinued operations in 2018. Net cash used in investing activities from continuing operations was $65.1 million for the nine months ended September 30, 2019 compared to net cash used in investing activities from continuing operations of $76.4 million for the nine months ended September 30, 2018. The decrease in cash used in investing activities from continuing operations of $11.3 million was primarily due to lower capital investing expenditures related to pre-publication costs and property, plant, and equipment of $24.8 million, offset by lower net proceeds from sales and maturities of short-term investments of $6.8 million compared to 2018, and by the acquisition of a business for $5.4 million and an investment in preferred stock of $0.8 million in 2019.

Financing activities

Net cash used in financing activities was $7.0 million for the nine months ended September 30, 2019, an increase of $1.1 million from the $5.9 million of net cash used in financing activities for the nine months ended September 30, 2018. The increase in cash used in financing activities was primarily due to an increase in tax withholding payments related to net share settlements of restricted stock units of $0.9 million and payments of deferred financing fees of $0.3 million related to our revolving credit facility amendment in 2019.

Debt

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

The obligations under the revolving credit facility and the term loan facility are guaranteed by us and each of our direct and indirect for-profit domestic subsidiaries (other than the Borrowers) (collectively, the “Guarantors”) and are secured by all capital stock and other equity interests of the Borrowers and the Guarantors and substantially all of the other tangible and intangible assets of the Borrowers and the Guarantors, including, without limitation, receivables, inventory, equipment, contract rights, securities, patents, trademarks, other intellectual property, cash, bank accounts and securities accounts and owned real estate. The revolving credit facility is secured by first priority liens on receivables, inventory, deposit accounts, securities accounts, instruments, chattel paper and other assets related to the foregoing (the “Revolving First Lien Collateral”), and second priority liens on the collateral which secures the term loan facility on a first priority basis. The term loan facility is secured by first priority liens on the capital stock and other equity interests of the Borrower and the Guarantors, equipment, owned real estate, trademarks and other intellectual property, general intangibles that are not Revolving First Lien Collateral and other assets related to the foregoing, and second priority liens on the Revolving First Lien Collateral.

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Term Loan Facility

On May 29, 2015, we entered into an amended and restated $800.0 million term loan credit facility (the “term loan facility”). As of September 30, 2019, we had approximately $766.0 million ($760.2 million, net of discount and issuance costs) outstanding under the term loan facility.

The term loan facility has a six-year term and matures on May 29, 2021. The interest rate applicable to borrowings under the facility is based, at our election, on LIBOR plus 3.0% or an alternative base rate plus applicable margins. LIBOR is subject to a floor of 1.0%, with the length of the LIBOR contracts ranging up to six months at our option. As of September 30, 2019, the interest rate of the term loan facility was 5.0%.

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

The term loan facility does not require us to comply with financial maintenance covenants. We are currently required to meet certain incurrence-based financial covenants as defined under our term loan facility.

The term loan facility is subject to customary conditions, representations, warranties and covenants, including restrictions on additional indebtedness, liens, investments, mergers, acquisitions, asset dispositions, dividends to stockholders, repurchase or redemption of our stock, transactions with affiliates and other matters. The term loan facility is subject to customary events of default. If an event of default occurs and is continuing, the administrative agent may, or at the request of certain required lenders shall, accelerate the obligations outstanding under the term loan facility.

We are subject to an annual excess cash flow provision under the term loan facility which is predicated upon our leverage ratio and cash flow. We were not required to make a payment under the excess cash flow provision in 2019 and 2018.

Management expects the Company’s term loan facility to be refinanced prior to maturity to support the Company’s longer term capital needs.

Revolving Credit Facility

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

On June 28, 2019, we entered into an amendment to the revolving credit facility extending the maturity date to the earlier of (i) July 22, 2021 or (ii) February 28, 2021 if our term loan facility is not refinanced by such date. The amendment became effective on July 1, 2019.

The revolving credit facility includes a letter of credit subfacility of $50.0 million, a swingline subfacility of $20.0 million and the option to expand the facility by up to $100.0 million in the aggregate under certain specified conditions. The amount of any outstanding letters of credit reduces borrowing availability under the revolving credit facility on a dollar-for-dollar basis. As of September 30, 2019, no amounts are outstanding on the revolving credit facility and we had approximately $24.2 million of outstanding letters of credit and approximately $223.8 million of borrowing availability under the revolving credit facility.

The interest rate applicable to borrowings under the facility is based, at our election, on LIBOR plus 1.75% or an alternative base rate plus 0.75%; such applicable margins may increase up to 2.25% and 1.25%, respectively, based on average daily availability. The revolving credit facility may be prepaid, in whole or in part, at any time, without premium.

The revolving credit facility requires us to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 on a trailing four-quarter basis for periods in which excess availability under the facility is less than the greater of $25.0 million and 12.5% of the lesser of the total commitment and the borrowing base then in effect, or less than $20.0 million if certain conditions are met. The minimum fixed charge coverage ratio was not applicable under the facility as of September 30, 2019, due to our level of borrowing availability.

The revolving credit facility is subject to customary conditions, representations, warranties and covenants, including restrictions on additional indebtedness, liens, investments, mergers, acquisitions, asset dispositions, dividends to stockholders, repurchase or redemption of our stock, transactions with affiliates and other matters. The revolving credit facility is subject to customary events of default. If an event of default occurs and is continuing, the administrative agent may, or at the request of certain required lenders shall, accelerate the obligations outstanding under the revolving credit facility.

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General

We had $308.7 million of cash and cash equivalents and no short-term investments at September 30, 2019. We had $253.4 million of cash and cash equivalents and $49.8 million of short-term investments at December 31, 2018.

Our business is impacted by the inherent seasonality of the academic calendar, which typically results in a cash flow usage in the first half of the year and a cash flow generation in the second half of the year. We expect our net cash provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund our current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months.

Our ability to fund planned operations is based on assumptions, which involve significant judgment and estimates of future revenues, capital spend and other operating costs.

Critical Accounting Policies and Estimates

Our financial results are affected by the selection and application of critical accounting policies and methods. Except for the adoption of the new lease accounting standard discussed below, there were no material changes in the nine months ended September 30, 2019 to the application of critical accounting policies and estimates as described in our audited consolidated financial statements, which were included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Leases

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

Impact of Inflation and Changing Prices

We believe that inflation has not had a material impact on our results of operations during the years ended December 31, 2018 and 2017 or year to date in 2019. We cannot be sure that future inflation will not have an adverse impact on our operating results and financial condition in future periods. Our ability to adjust selling prices has always been limited by competitive factors and long-term contractual arrangements which either prohibit price increases or limit the amount by which prices may be increased. Further, a weak domestic economy at a time of low inflation could cause lower tax receipts at the state and local level, and the funding and buying patterns for textbooks and other educational materials could be adversely affected.

Covenant Compliance

As of September 30, 2019, we were in compliance with all of our debt covenants and we expect to be in compliance over the next twelve months.

We are currently required to meet certain incurrence-based financial covenants as defined under our term loan facility and revolving credit facility. We have incurrence based financial covenants primarily pertaining to a maximum leverage ratio, fixed charge coverage ratio, and liquidity. A breach of any of these covenants, ratios, tests or restrictions, as applicable, for which a waiver is not obtained could result in an event of default, in which case our lenders could elect to declare all amounts outstanding to be immediately due and payable and result in a cross-default under other arrangements containing such provisions. A default would permit lenders to accelerate the maturity for the debt under these agreements and to foreclose upon any collateral securing the debt owed to these lenders and to terminate any commitments of these lenders to lend to us. If the lenders accelerate the payment of the indebtedness, our assets may not be sufficient to repay in full the indebtedness and any other indebtedness that would become due as a result of any acceleration. Further, in such an event, the lenders would not be required to make further loans to us, and assuming similar facilities were not established and we are unable to obtain replacement financing, it would materially affect our liquidity and results of operations.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Recently Issued Accounting Pronouncements

See Note 3 and Note 10 to the consolidated financial statements included under Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recently issued accounting pronouncements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

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

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

As of September 30, 2019, we had $766.0 million ($760.2 million, net of discount and issuance costs) of aggregate principal amount indebtedness outstanding under our term loan facility that bears interest at a variable rate. An increase or decrease of 1% in the interest rate will change our interest expense by approximately $7.7 million on an annual basis. We also have up to $250.0 million of borrowing availability, subject to borrowing base availability, under our revolving credit facility, and borrowings under the revolving credit facility bear interest at a variable rate. As of September 30, 2019, no amounts are outstanding on the revolving credit facility. Assuming that the revolving credit facility is fully drawn, an increase or decrease of 1% in the interest rate will change our interest expense associated with the revolving credit facility by $2.5 million on an annual basis.

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

We conduct various digital development activities in Ireland, and as such, our cash flows and costs are subject to fluctuations from changes in foreign currency exchange rates. We manage our exposures to this market risk through the use of short-term foreign exchange forward and option contracts, when deemed appropriate, which were not significant as of September 30, 2019 and December 31, 2018. We do not enter into derivative transactions or use other financial instruments for trading or speculative purposes.

Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer (“CEO”), and our Executive Vice President and Chief Financial Officer (“CFO”), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2019 pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Based on their evaluation, our CEO and CFO concluded that, as of September 30, 2019 our disclosure controls and procedures were effective.

During the quarter ended September 30, 2019, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Part II. Other Information

Item 1. Legal Proceedings

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

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

Item 1A. Risk Factors

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

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Item 6. Exhibits

Exhibit No.	Description
3.1	Amended and Restated By-Laws, as amended, effective September 24, 2019 (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed September 30, 2019 (File No. 001-36133)).
31.1*	Certification of CEO Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certification of CFO Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section  302 of the Sarbanes-Oxley Act of 2002.
32.1**	Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**	Certification of CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*	The instance document does not appear in the interactive file because its XBRL tags are embedded within the inline XBRL document
101.SCH*	Inline XBRL Taxonomy Extension Schema Document.
101.CAL*	Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF*	Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB*	Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE*	Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

* Filed herewith.

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

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SIGNATURES

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

	Houghton Mifflin Harcourt Company (Registrant)
October 31, 2019	By:	/s/ John J. Lynch, Jr.
		John J. Lynch, Jr.
		Chief Executive Officer (Principal Executive Officer)
	Houghton Mifflin Harcourt Company (Registrant)
October 31, 2019	By:	/s/ Joseph P. Abbott, Jr.
		Joseph P. Abbott, Jr.
		Executive Vice President and Chief Financial Officer (Principal Financial Officer)

50