HMH Holdings
(Delaware), Inc.
Annual Report for the year ended
December 31, 2012
HMH Holdings (Delaware), Inc. (“Company”) is not subject to the filing
requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934. Consequently, this report has not and will not be filed with the
Securities and Exchange Commission (“SEC”). The Company is
preparing this Annual Report and posting this Annual Report on its
website in accordance with the requirements of the investor rights
agreement, dated as of June 22, 2012, by and among the Company
and the holders party thereto from time to time.
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained in this report are “forward-looking statements” within the meaning of
applicable federal securities laws. All statements contained herein that are not clearly historical in nature
are forward-looking and the words “may,” “will,” “should,” “anticipate,” “believe,” “could,” “expect,”
“estimate,” “forecast,” “intend,” “plan,” “potential,” “project,” “target” and similar expressions are generally
intended to identify forward-looking statements. All statements contained in this report, other than
statements of historical fact, including without limitation, statements about our plans, strategies, prospects
and expectations regarding future events and our financial performance, are forward-looking statements
that involve certain risks and uncertainties. While these statements represent our current judgment on
what the future may hold, and we believe these judgments are reasonable in the circumstances, these
statements are not guarantees of any events or financial results, and our actual results may differ
materially. You are urged to consider these factors carefully in evaluating the forward-looking statements
and are cautioned not to place undue reliance on these forward-looking statements. The forward-looking
statements included in this report are made only as of the date of this report. All subsequent written and
oral forward-looking statements attributable to us or any person acting on our behalf are expressly
qualified in their entirety by the cautionary statements contained or referred to in this section. We
undertake no obligation to update these forward-looking statements to reflect new information, future
events or otherwise, except as required by law. All forward-looking statements involve risks and
uncertainties, many of which are beyond our control, which may cause actual results, performance or
achievements to differ materially from anticipated results, performance or achievements. We cannot
assure you that projected results or events will be achieved. Factors that could cause our actual results
to be materially different from our expectations include those factors described in this report and other
reports under the caption “Risk factors,” including, among others, the following:
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• adverse or worsening economic trends or the continuation of current economic conditions;
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changes in state and local educational funding and/or related programs, legislation and
procurement processes;
changes in consumer demand for, and acceptance of, our products;
changes in competitive factors;
industry cycles and trends;
conditions and/or changes in the publishing industry;
restrictions under the credit agreement governing our existing Term Loan and Revolving Credit
Facility;
changes in laws or regulations governing our business and operations;
changes or failures in the information technology systems we use;
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• demographic trends;
• uncertainty surrounding our ability to enforce our intellectual property rights;
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inability to retain management or hire employees; and
impact of potential impairment of goodwill and other intangibles in a challenging economy.
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HMH Holdings (Delaware), Inc.
Annual Report
Year Ended December 31, 2012
Table of Contents
Page(s)
Item 1. Business ........................................................................................................................................ 4
Item 1A. Risk Factors ................................................................................................................................ 15
Item 1B. Unresolved Staff Comments ....................................................................................................... 22
Item 2. Properties .................................................................................................................................... 23
Item 3. Legal Proceedings ...................................................................................................................... 24
Item 4. Mine Safety Disclosures…………………...…………………………………………………………...24
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities………………………………………………………………………………………...24
Item 6. Selected Financial Data…………………………………………...……………………………………25
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ...... 26
Item 7A. Quantitative and Qualitative Disclosures about Market Risk ..................................................... 48
Item 8. Financial Statements and Supplementary Data ......................................................................... 49
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ... 105
Item 9A. Controls and Procedures .......................................................................................................... 105
Item 9B. Other Information ...................................................................................................................... 105
Item 10. Directors, Executive Officers and Corporate Governance ....................................................... 105
Item 11. Executive Compensation ........................................................................................................ 111
Item 12. Security Ownership of Certain Beneficial Owner’s and Management and Related Stockholders
Matters ..................................................................................................................................... 126
Item 13. Certain Relationships and Related Transactions, and Director Independence ....................... 129
Item 14. Principal Accounting Fees and Services…..……………………………………………………….130
Item 15. Exhibits, Financial Statement Schedules ................................................................................. 130
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Company Overview
Item 1. Business
As used herein the terms “we”, “us”, “our” and “HMH” refer to HMH Holdings (Delaware), Inc. and its
consolidated subsidiaries unless otherwise expressly stated or the context otherwise requires. Among
the world’s largest providers of pre-K-12 education solutions and one of the longest-established
publishing houses, we are a global leader in supporting lifelong learning.
We are a leading provider of educational content, technology and professional services to the elementary
and secondary school market in the United States, including a full range of comprehensive curriculum,
supplemental products and service offerings. We have a long-standing expertise in teaching and
instructional strategy and the design and creation of print and electronic learning materials across all
grade levels. We distribute our solutions in multiple formats, including print and digital curriculum,
technology platforms, assessment tools and services. We believe our solutions are a mission critical tool
for school systems as they increasingly focus on outcomes-based learning and teaching solutions that
reach students both in the classroom and at home. We believe we are a leader in the transformation of
the traditional educational materials market and have the opportunity to increase net sales and
profitability by selling our innovative solutions through a comprehensive and integrated approach to
educating children. Furthermore, since 1832, we have published trade and reference materials including
award-winning adult and children’s books, fiction, and nonfiction.
Our mission is to change people’s lives by fostering passionate, curious learners. We are experts in the
learning process and continuously research, test, and improve what works, bringing to light new ideas
and approaches that make learning more dynamic, engaging and effective. By combining cutting-edge
research, editorial excellence and technological innovation, our goal is to improve teaching and learning
environments and solve complex literacy and education challenges. Our interactive, results-driven
education solutions are utilized by 60 million students in 120 countries.
We focus on two primary areas: pre-K-12 educational content and resources for institutions and
consumers; and trade publishing.
As the leading educational publisher in the U.S. public school market, our pre-K-12 education business
represented approximately 88% of our total revenue for the year ended December 31, 2012. Our revenue
is diversified by geography and subject, with the highest revenue from a single state or subject
representing approximately 7% and 20% of 2012 revenue, respectively, with less revenue derived from
any other single state or subject.
Our education business delivers quality, effective content and services through a variety of mediums –
including mobile learning applications, digital platforms, educational gaming, print materials, assessment
tools and professional development resources – across multiple platforms and devices. Our K-12 portfolio
includes widely recognized imprints such as Holt McDougal, Riverside and Heinemann.
Our Trade Publishing division is responsible for nearly two centuries worth of renowned and award-
winning novels, non-fiction, children’s books and reference titles. Our portfolio includes The Best
American series; The American Heritage and Webster’s New World dictionaries; Betty Crocker, Better
Homes and Gardens, How to Cook Everything, The Gourmet Cookbook, and other leading culinary
properties; the Peterson Field Guides; CliffsNotes; the works of J.R.R. Tolkien; and many
iconic children’s books and characters including Curious George, The Little Prince and The
Polar Express.
Across both segments, we focus on the expansion of our digital content portfolio to include web and
application-based social games and other products that build upon the skills and lessons taught in the
classroom and at home. Recently released mobile apps such as Curious George at the Zoo demonstrate
the opportunities to leverage our trusted consumer brands within our digital education offerings.
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For the years ended December 31, 2012, 2011 and 2010, our net sales were $1,285.6 million, $1,295.3
million and $1,507.0 million (on a combined basis), respectively.
Corporate history
HMH Holdings (Delaware), Inc.
HMH Holdings (Delaware), Inc. (“HMH Holdings”, “HMH”, “Company”, or “Houghton Mifflin Harcourt”,
“we”, “us”, “our”, or the “Company”) was incorporated as a Delaware corporation on March 5, 2010 and
was established to be the holding company of the current operating group. HMH is a leading global
education and learning company providing innovative solutions and approaches to the challenges facing
education today. We are one of the world’s largest providers of educational products and solutions for
pre-K–12 learning and we also develop and deliver interactive, results-driven learning solutions that
advance teacher effectiveness and student achievement in the Education market. Furthermore, since
1832, we have published trade and reference materials including award-winning adult and children’s
books, fiction, and nonfiction.
Restructuring and reorganization
On May 10, 2012, we entered into a Restructuring Support Agreement (“Plan Support Agreement”) with
consenting creditors holding greater than 74% of the principal amount of the outstanding senior secured
indebtedness of the Company and with equity owners holding approximately 64% of the Company’s
outstanding common stock. The consenting creditors agreed to support the Company’s Pre-Packaged
Chapter 11 Plan of Reorganization (“Plan”). Pursuant to the Plan Support Agreement, the Company
agreed to use its best efforts to (i) support and complete the restructuring and all transactions
contemplated by the Plan, (ii) take any and all necessary and appropriate actions in furtherance of the
restructuring contemplated under the Plan, (iii) complete the restructuring and all transactions
contemplated under the Plan within set time-frames, (iv) obtain any and all required regulatory and/or
third-party approvals for the restructuring, and (v) not directly or indirectly, seek, solicit, support, or
engage in the negotiation or formulation of alternate plans of reorganization that were inconsistent with
the reorganization as contemplated by the Plan Support Agreement.
On May 21, 2012 (the “Petition Date”), the U.S. based entities that borrowed or guaranteed the debt of
the Company (collectively the “Debtors”), filed voluntary petitions for relief under Chapter 11 of the federal
bankruptcy laws in the United States Bankruptcy Court for the Southern District of New York (“Court”).
Concurrently therewith, the Debtors also filed the Plan, the Disclosure Statement in support of the Plan
and filed various motions seeking relief to continue operations. Following the Petition Date, the Debtors
operated their business as “debtors in possession” (“DIP”) under the jurisdiction of the Court and in
accordance with the applicable provisions of the Bankruptcy Code and orders of the Court. Under
Chapter 11 of the United States Bankruptcy Code (“Chapter 11”), certain claims against us in existence
before the Petition Date were stayed while we operated our business as a DIP including any actions that
might be commenced with regards to secured claims, although the holders of such claims had the right to
move the Court for relief from the stay. Subsequent to the Petition Date, these claims were reflected in
the balance sheet as liabilities subject to compromise. Secured claims were secured primarily by liens on
the Company’s accounts receivable. Additional claims (liabilities subject to compromise) could have
potentially arisen after the filing date resulting from rejection of executory contracts or from the
determination by the Court (or agreed to by parties in interest).
On June 22, 2012, the Company successfully emerged from bankruptcy as a reorganized company
pursuant to the Plan. Ultimately, the Debtors did not reject any executory contracts during the bankruptcy
case, and the Company continues to review and reconcile claims that were filed against it by creditors.
On March 9, 2010, we completed a restructuring of certain indebtedness and an upper-tier
reorganization. As part of the reorganization, Riverdeep Interactive Learning, an Irish company and our
previous parent company (“RIL”), entered into a series of transactions that ultimately resulted in HMH
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Holdings and its subsidiaries no longer being subsidiaries of RIL. In the out-of-court restructuring, the
then-existing first lien lenders received approximately 90% of the equity of HMH Holdings (pre-dilution
from the associated rights offering) in exchange for converting $2 billion of debt and the then-existing
mezzanine lenders received approximately 10% of the equity and warrants to purchase up to an
additional 12.5% of the incremental value above a specified equity value (in each case, pre-dilution from
the rights offering) in exchange for converting $2 billion of debt. In addition, we used the proceeds from
the $650 million rights offering issued to certain then-existing first lien lenders and mezzanine lenders to
pay transaction fees, accrued cash interest and fund cash on the balance sheet.
As a result, the financial information presented in this report for the years ended December 31, 2012,
December 31, 2011 and the period from March 10, 2010 to December 31, 2010 represents the results of
operations of HMH Holdings and its consolidated subsidiaries, and the financial information presented in
this report for the period from January 1, 2010 to March 9, 2010 represents the results of operations of
HMH Publishing, our predecessor, and its consolidated subsidiaries.
The historical financial information presented for 2010 has been derived from the financial statements and
accounting records of HMH Holdings (Delaware), Inc. (“Successor”) for the period March 10, 2010 to
December 31, 2010 and from the financial statements and accounting records of HMH Publishing
Company (“Predecessor”) for the period January 1, 2008 through March 9, 2010. We have presented our
2010 results as the mathematical addition of the Predecessor and Successor periods (the “Combined
Period”). We believe that this presentation provides meaningful information about our results of
operations. This approach is not consistent with GAAP, may yield results that are not strictly comparable
on a period-to-period basis and may not reflect the actual results we would have achieved. Prior to
March 9, 2010, the financial information is for the Predecessor entity and following March 9, 2010 the
financial information is for the Successor entity.
Strategic Priorities
To promote sustainable growth, product diversification and a strong global brand, we continue to focus on
aligning our resources and efforts against the following priorities:
• Reinforce the Core Business – Maintain our market share of pre-K-12 by continuing to innovate
from a product and marketing perspective.
• Prudently Invest in Growth – Broaden our market presence from a geographic, customer and
product perspective through:
International expansion
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o Moving into the consumer (student, teacher, parent and lifelong learner) market
o Continued focus on products and services with proven efficacy and deep pedagogical
strength / market following
o Building a comprehensive portfolio of offerings to include supplemental materials and
services
• Lead Digital Transition – Reengineer our product development processes to allow for greater
focus on digital innovation and on building quality, adaptive content that can be consumed across
multiple platforms, devices and mediums.
• Know the Customer – Shift from a product-centric to a customer-focused approach in all aspects
of our business, including product and service design and delivery.
• Leverage Strategic Partnerships and Alliances – Develop and expand relationships with strategic
partners that already have a strong presence in HMH’s targeted growth markets; and forge
alliances with the world’s leading technology companies to ensure that our quality, device-
agnostic content is available to virtually any school district or household.
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• Drive Operational Excellence – Continue to increase profit margins by refining organizational
structure, investing in intelligence, process and tools, and attracting and retaining superior talent.
• Harvest Non-Core Product Lines – Evaluate divestment to ensure efficient use of capital and
invest only at maintenance levels in profitable but declining product lines.
Business Segments
We are organized along two business segments: Education and Trade Publishing. The Education
segment is our largest business, and represented on average approximately 90% of our total net sales for
the years ended December 31, 2012, 2011 and 2010.
Education
Our Education business provides a comprehensive suite of educational products, technology platforms
and services to meet the diverse needs of today’s classrooms. These products and services include print
and digital content in the form of textbooks, digital courseware, instructional aids, educational assessment
and intervention solutions (which are aimed at improving achievement and supporting learning for
students that are not keeping pace with peers), professional development and school reform services.
With an in-house editorial staff supplemented by external specialists, we develop programs that can be
aligned to state standards and customized for specific state requests. In addition, our Education segment
offers a wide range of educational, cognitive and developmental standardized testing products in print,
CD-ROM and online formats, targeting the educational and clinical assessment markets. The principal
markets for our Education products are elementary and secondary school systems.
The Education business includes such trusted brands as Holt McDougal, Great Source, Rigby, Saxon,
Steck-Vaughn, Math in Focus, Riverside and Heinemann. These brands offer solutions in reading,
language arts, mathematics, intervention, social studies, science and world languages, as well as
curriculum resources, professional development services and an array of highly regarded educational,
cognitive and developmental assessment products. Each brand benefits from strong market share as
well as strong relationships with its customers, most of which have been developed over many years
through a service-based approach to designing, marketing and implementing its programs.
The Education segment net sales and Adjusted EBITDA were $1,128.6 million and $329.7 million,
$1,169.6 million and $278.9 million and $1,383.1 million and $490.3 million, for the years ended
December 31, 2012, 2011 and 2010, respectively.
Our Education products are divided into the following subgroups:
• Comprehensive Curriculum. The Comprehensive Curriculum subgroup develops comprehensive
educational programs intended to provide a complete course of study in a subject, either at a
single grade level or across multiple grade levels, and are the primary source of classroom
instruction. We develop and market Comprehensive Curriculum programs for the Pre-K-12
market utilizing the Houghton Mifflin Harcourt brands in grades Pre-K-6 and the Holt McDougal
brands in grades 6-12. This subgroup focuses its publishing portfolio on the subjects that have
consistently received the highest priority from educators and educational policy makers, namely
reading, literature/language arts, mathematics, science, world languages and social studies. In
each subject, comprehensive learning programs are designed and then marketed with a variety of
proprietary products to maximize teaching effectiveness, including textbooks, workbooks,
teachers’ guides and resources, audio/visual aids and technology-based products. Our
Comprehensive Curriculum subgroup accounted for approximately 56.2%, 60.6% and 67.8% of
our total Education segment net sales for the years ended December 31, 2012, 2011 and 2010,
respectively.
• Supplemental products. We develop products targeted at addressing struggling learners through
comprehensive intervention solutions, products targeted at assisting English language learners
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and products providing incremental instruction in a particular subject area. Curriculum solutions
are used both as alternatives and as supplements to Comprehensive Curriculum programs,
enabling local educators to tailor their education programs in a cost-effective way that is
irrespective of adoption schedules. As a result, the Supplemental Products subgroup creates net
sales and earnings that do not vary greatly with the adoption cycle. In addition, the development
of supplemental materials tends to require significantly less capital investment than the
development of a Comprehensive Curriculum program. Our Supplemental Products subgroup
accounted for approximately 13.0%, 12.5% and 10.1% of our total Education segment net sales
for the years ended December 31, 2012, 2011 and 2010, respectively.
• Heinemann. Our Heinemann products include professional books and development resources to
teachers of grades pre-K-12 and are known by educators for empowering teachers and giving
them access to highly regarded and recognized experts in the education field. The author base
includes some of the most prominent experts in teaching, who support the practice of other
teachers through books, videos, workshops and classroom tools. Heinemann has also
developed a market leading literacy intervention program with Benchmarks/LLI, which comprises
roughly 50% of Heinemann product revenues. Our Heinemann subgroup accounted for
approximately 10.9%, 8.8% and 6.8% of our total Education segment net sales for the years
ended December 31, 2012, 2011 and 2010, respectively.
• Professional Services. To extend our value proposition beyond curriculum, assessment and
technology solutions, we provide consulting services to assist school districts in increasing
accountability for improvement and offering professional development training, comprehensive
services and school turnaround solutions. We believe our professional services, led by The
Leadership and Learning Center business, offer unique integrated solutions that combine the best
learning resources available today with services that support deep implementation. These include
learning resources that are supported with effective professional development in classroom
assessment, teacher effectiveness and high impact leadership, which are all proven to have a
measurable and sustainable impact on student achievement. Our Professional Services
subgroup accounted for approximately 6.1%, 4.4% and 0.0% of our total Education business net
sales for the years ended December 31, 2012, 2011 and 2010, respectively.
• Riverside Assessment. Riverside Assessment products provide district and state level solutions
focused on clinical, group and formative assessment tools and platform solutions. Clinical
solutions provide psychological and special needs testing to assess intellectual, cognitive and
behavioral development. Our products include measurements relating to intellectual ability,
academic achievement assessments around cognitive abilities and several diagnostic and
assessment tools that assist in identifying the learning needs of students. Riverside Assessment
products accounted for 8.2%, 9.0% and 8.0% of our total Education segment net sales for the
years ended December 31, 2012, 2011 and 2010, respectively.
•
International. Our International business primarily focuses on selling educational solutions and
products into global education markets predominantly to large English language schools in high
growth territories primarily in Asia, the Pacific, the Middle East, Latin America, the Caribbean and
Africa. In addition to a dedicated sales and business development team, we have a global
network of international partners and alliances, including distributors, in local markets around the
world. International sales accounted for approximately 5.6%, 4.7% and 7.3% of our total
Education segment net sales for the year ended December 31, 2012, 2011 and 2010,
respectively.
Trade Publishing
Our Trade Publishing business, which dates back to 1832, primarily develops, markets and sells
consumer books in print and digital formats and licenses book rights to other publishers and electronic
businesses in the United States and abroad. The principal markets for Trade Publishing products are
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retail stores, both physical and online, and wholesalers. Reference materials are also sold to schools,
colleges, libraries, office supply distributors and other businesses.
Our Trade Publishing business offers a rich library of general interest, children’s and reference works that
include beloved characters and well-known brands. Our award-winning general interest titles encompass
literary fiction, culinary, and non-fiction in hardcover, ebook and paperback formats, including the Mariner
Books and Harvest Books paperback lines. Among the general interest properties are the popular J.R.R.
Tolkien titles and the Best American series. The general interest group also publishes comprehensive
culinary works and field guides, such as the Peterson Field Guides and Taylor’s Gardening Guides. With
the 2012 acquisition of certain culinary and reference assets, we became the #2 publisher in those
respective market niches. Our vast catalog of books for young readers features numerous Newbery and
Caldecott medal winners, including a 2012 Caldecott Honor winner. Our young readers list addresses a
broad age group, spanning board books for the very young to novels for young adults, and includes
recognized characters such as Curious George and Martha Speaks, both successful television programs
featured on PBS, Five Little Monkeys, Gossie and Gertie, and many more. In the reference category, we
are the publisher of the American Heritage and Webster dictionary, and related titles.
Even before ebooks gained prominence in the market, we had developed in-house experience in
converting, structuring, storing and distributing dictionary and other reference content for digital platforms,
and leveraged our knowledge and tools in the digital space to apply to consumer trade content including
e-books and applications. As such, we have an established, innovative and flexible solution for
converting, manipulating and distributing trade content to the many rapidly emerging digital consumer
platforms such as e-readers and tablets. We have been able to move quickly to take advantage of the
rapidly accelerating market for e-books, book or character based apps and other digital products with net
sales from e-books reaching approximately $25.0 million for the year ended December 31, 2012, and now
representing a meaningful piece of our Trade Publishing business. We continue to focus on the
development of innovative new digital products which capitalize on our strong content, our digital
expertise, and the growing consumer demand for these products.
For the years ended December 31, 2012, 2011 and 2010, Trade Publishing net sales and Adjusted
EBITDA were approximately $157.1 million and $28.8 million,$125.7 million and $12.9 million, and $123.9
million and $12.7 million, respectively.
Our Industry
K-12 comprehensive curriculum (basal) market
The United States K-12 comprehensive curriculum (basal) market provides educational programs and
assessments to approximately 56 million students across approximately 116,000 elementary and
secondary schools. Basal programs cover curriculum standards in a particular subject and include a
comprehensive offering of teacher and student materials required to conduct the class throughout the
year. Products and services in basal programs include students’ print and digital offerings and a variety of
supporting materials such as teacher’s editions, formative assessments, whole group instruction
materials, practice aids, educational games and services.
Comprehensive curriculum programs are the primary source of classroom education for most K-12
academic subjects, and as a result, enrollment trends are a major driver of industry growth. Although
economic cycles may affect short-term buying patterns, school enrollments, a driver of growth in the
educational publishing industry, are highly predictable and are trending favorably over the longer term.
In addition, the market for comprehensive curriculum programs is affected by changes in state curriculum
standards, which drive instruction, assessment, and accountability in each state. A significant change in
state curriculum standards requires that assessments, teacher training programs, and instructional
materials be revised or replaced to align to the new standards and historically has driven demand for new
comprehensive curriculum programs.
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Forty-five states have adopted a new, common set of curriculum standards in mathematics and English
language arts, known as the Common Core State Standards. These standards are the product of a
state-led effort to establish a single set of clear educational standards for grades K-12. States that have
adopted the Common Core State Standards must base at least 85% of their state curricula on the
standards. Most of these states also belong to one of two multistate testing consortia that are developing
common state assessments in English language arts and mathematics, aligned to the new
standards. The tests, which will be designed to replace existing statewide tests, are expected to be
administered beginning in 2014-15. Schools in these states will need to augment and replace
instructional materials, including comprehensive curriculum programs, to align to Common Core State
Standards and to prepare students for the new state assessments.
Textbook adoption process
Twenty states approve and procure basal programs on a state-wide basis (“adoption states”) before
individual schools or school districts can purchase materials. In all remaining states, referred to as “open
states” or “open territories,” each individual school or school district can procure materials without state
restrictions.
The following chart illustrates the current adoption and open states:
Adoption states represent over 50% of the U.S. elementary and secondary school-age population. Many
adoption states provide “categorical funding” for instructional materials, which means that state funds
cannot be used for any other purpose. A majority of adoption states provide categorical state funding for
instructional materials, i.e., funds that typically cannot be used for any purpose other than to purchase
instructional content or, is some cases, technology equipment used to deliver instruction. In some states,
categorical instructional materials funds can be used only for the purchase of materials on the state-
approved list.
In adoption states, the state education board’s decision to approve a certain program developed by an
educational publisher depends on recommendations that align to state’s educational standards from
instructional materials committees, which are often comprised of educators and curriculum specialists.
These committees will recommend a program only if it aligns to the state’s educational content standards.
To ensure the approval and subsequent success of a new instructional materials program, extensive
market research is conducted, including: discussions of the planned curriculum with the state level
curriculum advisors to secure their support; development of prototype instructional materials that are
focus-tested with educators, often against competing programs, to gather feedback on the program’s
content and design; and incorporation of qualitative input from existing customers in terms of classroom
needs.
In open territories, sales teams present to instructional materials selection committees, which in turn
make recommendations to district level school boards. Products are generally customized to meet the
states’ curriculum standards with similar research methods as in adoption states.
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We believe that a publisher’s ultimate success in a given state will depend on a variety of factors,
including the quality of its programs and materials, the strength of its relationships with key decision-
makers at the state and district level and the magnitude of its marketing and sales efforts. As a result,
educational publishers often implement formal market research efforts that include educator focus
groups, prototypes of student and ancillary materials and comparisons against competing products. At the
same time, marketing and editorial staffs work closely together to incorporate the results of research into
products and developing the most updated, research- and needs-based curricula.
Supplemental materials market
The supplemental materials market includes a wide range of product offerings targeted at addressing
specific needs in a district generally not addressed through a comprehensive curriculum solution. These
products come in the form of print, digital, service and blended product solutions. The development of
supplemental materials tends to require significantly less capital investment than the development of a
basal program. These materials enable local educators to tailor their education programs in a cost-
effective way that is not tied to adoption schedules.
Supplemental products and services are funded through state and local resources as well as government
funding allocations through Title 1 and the Individuals with Disabilities Education Act (IDEA). Title 1
distributes funding to schools and school districts with a high percentage of students from low income
families. In addition, Title 1 appropriates money for the education system for the prevention of dropouts
and the improvement of schools. IDEA governs how states and public agencies provide early
intervention, special education and related services to children with disabilities. In recent years, the
supplemental materials that schools have purchased have changed as the demands and expectations for
educators and students have changed. Educational institutions have increasingly purchased digital
solutions along with traditional supplemental materials and, with the growing emphasis on accountability,
targeted intervention solutions, school reform and turnaround services are increasingly in demand.
Assessment market
The assessment market includes summative, formative/in-classroom, and diagnostic assessments.
Summative assessments are concluding or “final” exams that measure students’ proficiency in a particular
subject or group of subjects on an aggregate level or against state standards. Formative assessments are
on-going, in-classroom tests that occur throughout the school year and monitor progress in certain
subjects or curriculum units. Diagnostic assessments are designed to pinpoint areas of need and are
often administered by specialists to identify learning difficulties and qualify individuals for special services
under the requirements of Individual Disabilities Education Act (IDEA).
As a result of RTTT (Race to the Top) funding, more states and districts are also placing greater
emphasis on teacher evaluation systems that measure teacher performance based on standardized test
scores and other elements required in formulas derived by the policymakers. Federal agencies are
pushing the focus to children at even younger ages to provide intervention before significant achievement
gaps are realized. This is leading to more opportunity in the early childhood market space from birth to
eight.
The two assessment consortia —Smarter Balanced Assessment Consortia (SBAC) and Partnership
Assessment of Readiness for College and Careers (PARCC)—continue to work towards operational tests
for the 2014–2015 school year. There are 24 states in SBAC and 23 states in PARCC. Some states are
still in both and will have to make a determination about which test to use over the next year or so.
As states plan for how they will deal with the upcoming consortia assessments, districts continue to
transition to the Common Core State Standards as well as focus on their state standards being measured
in the short term for accountability purposes. There is anticipation now for the Next Generation Science
Standards, which are due to be final and released in March 2013. District demand for quality measures to
help them prepare for the content coverage and item types anticipated on the common core assessment
should continue to increase as the 2014–2015 requirement draws near.
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International market
The global education market continues to demonstrate strong macro long-term growth characteristics.
There are 1.4 billion students out of a 7.1 billion world population. Population growth is a leading
indicator for pre-primary school enrollments, which subsequently impact on secondary and higher
education enrolments. Globally, rapid population growth in the past 5 years has caused pre-primary
enrolments to grow at 16% worldwide, this is expected to be 20% with new growth rates. The global
population is expected to be 9.2 billion by 2050, as countries develop and improvements in medical
conditions increase the birth rate.
In 2011, global education expenditure was $4,435 billion. K-12 education represents a total of 58.6% of
global education expenditure. Global education expenditure is projected to grow at 7.4% through to
2017.
We predominantly export and sell K-12 books into the niche global market of high-end international
private schools that follow the US curriculum. We sell to schools in this market across Asia, the Pacific,
the Middle East, Latin America and the Caribbean. Our International sales team utilizes a global network
of international partners and alliances, including distributors in local markets around the world. The size
of the K-12 US Export market is estimated at $165 million, of which we have a strong market share.
Our immediate strategy is to expand our addressable market through working with local partners to
localize our K-12 content for sale into public & private schools in targeted international markets and to sell
digitized content through key partnerships / alliances into global school and consumer markets.
Trade Publishing market
The market for consumer books (Trade Publishing market) includes works of fiction and non-fiction for
adults and children, 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) has developed rapidly over the past several years, and the industry has quickly evolved to
embrace new technologies for developing, producing, marketing and distributing Trade works.
Seasonality
In the K-12 market, we typically receive payments for products and services from individual school
districts, and, to a lesser extent, individual schools and states. In the trade publishing market, payment is
received for products and services from book distributors and retail booksellers. In the case of testing and
assessment products and services, payment is received from the individually contracted parties.
Approximately 88% of our fiscal 2012 net sales was derived from educational publishing, which is a
markedly seasonal business. Schools make most of their purchases in the second and third quarters of
the calendar year in preparation for the beginning of the school year. Thus, over the past three years,
approximately 69% of consolidated net sales have historically been realized in the second and third
quarters. Sales of K-12 instructional materials and customized testing products are also cyclical, with
some years offering more sales opportunities than others. The amount of funding available at the state
level for educational materials also has a significant effect on year-to-year net sales.
Competition
We sell our products in competitive markets. In these markets, product quality, customer service and
perceived stability and longevity are major factors in generating sales growth. Other factors affecting
sales growth in the K-12 market include the level of student enrollment in subjects that are up for adoption
and the level of spending per student appropriated in each state and/or school district. Profitability is
affected by industry developments including: (i) competitive selling, sampling and implementation costs;
(ii) development costs for customized instructional materials and assessment programs; and (iii) higher
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technology costs due to the increased number of textbook program components being developed in
digital formats. There are three primary traditional Comprehensive Curriculum publishers in the K-12
market, which also compete with a variety of specialized or regional publishers that focus on select
disciplines and/or geographic regions. There are multiple competitors in the Trade Publishing,
supplemental and assessment markets.
Printing and binding; raw materials
We outsource the printing and binding of our products, with approximately 81% of our printing currently
handled by two vendors. We have a procurement agreement with each printer that provides volume and
scheduling flexibility and price predictability. We have a longstanding relationship with each provider.
Paper is one of our principal raw materials. We purchase our paper directly from suppliers and two paper
merchants with whom we have various agreements that protect against price increases. We have not
experienced and do not anticipate experiencing difficulty in obtaining adequate supplies of paper for our
operations, as we have contracts with numerous suppliers that assure us of 100% availability on all main
paper grades that we procure.
Distribution
We operate five distribution facilities from which we coordinate our own distribution process: one each in
Indianapolis, Indiana; Geneva, Illinois; Lewisville, Texas; Troy, Missouri; and Kennesaw, Georgia.
Additionally, some adoption states require us to use in-state textbook depositories for educational
materials sold in that particular state. We utilize delivery firms including United Parcel Service Inc., CH
Robinson Worldwide Inc., Roadrunner Transportation Services and DHL Worldwide Express Inc. to
facilitate the principally ground transportation of products.
Employees
As of December 31, 2012, we had approximately 3,300 employees, none of which were covered by
collective bargaining agreements. These employees are substantially located in the United States with
approximately 200 employees located outside of the United States. We believe that relations with
employees are generally good.
Intellectual property
Our principal intellectual property assets consist of our trademarks and copyrights in our content.
Substantially all of our publications are protected by copyright, whether registered or unregistered, either
in our name as the author of a work made for hire or the assignee of copyright, or in the name of an
author who has licensed us to publish the work. Such copyrights secure the exclusive right to publish the
work in the United States and in many countries abroad for specified periods: in the United States in most
cases either 95 years from publication or for the author’s life plus 70 years, but in any event a minimum of
28 years for works published prior to 1978 and 35 years for works published thereafter.
We do not own any material patents, franchises or concessions, but we have registered certain
trademarks and service marks in connection with our publishing businesses. We believe we have taken,
and take in the ordinary course of business, all appropriate available legal steps to reasonably protect our
intellectual property in all material jurisdictions.
Environmental matters
We generally contract with independent printers and binders for their services, and our operations are
generally not otherwise affected by environmental laws and regulations. However, as the owner and
lessee of real property, we are subject to environmental laws and regulations, including those relating to
the discharge of hazardous materials into the environment, the remediation of contaminated sites and the
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handling and disposal of wastes. It is possible that we could face liability, regardless of fault, and can be
held jointly or severally liable, if contamination were to be discovered on the properties that we own or
lease or on properties that we have formerly owned or leased. We are currently unaware of any material
environmental liabilities or other material environmental issues relating to our properties or operations and
anticipate no material expenditures for compliance with environmental laws or regulations.
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Item 1A. Risk Factors
The following factors affect our business and the industry in which we operate. The risks and
uncertainties described below are not the only ones we face. Additional risks and uncertainties not
presently known or that we currently consider immaterial may also have an adverse effect on our
business. If any of the matters discussed in the following risk factors were to occur, our business,
financial position, results of operations, cash flows, or prospects could be materially adversely affected.
Introduction of new products, services or technologies could impact our profitability.
We operate in highly competitive markets that continue to change to adapt to customer needs. In order to
maintain a competitive position, we must continue to invest in new offerings and new ways to deliver our
products and services. These investments may not be profitable or may be less profitable than what we
have experienced historically. In particular, in the context of the Company’s current focus on key digital
opportunities, including e-books, the market is beginning to develop and the Company may be
unsuccessful in establishing itself as a significant factor in any market which does develop. New
distribution channels, such as digital platforms, the internet, online retailers and growing delivery
platforms (e.g., e-readers), present both threats and opportunities to the Company’s traditional publishing
models, potentially impacting both sales volumes and pricing.
Our U.S. educational comprehensive curriculum, supplemental and assessment business may be
adversely affected by changes in state and local educational funding resulting from either general
economic conditions, changes in government educational funding, programs and legislation (both
at the federal and state level), and/or changes in the state procurement process.
The results and growth of our U.S. educational comprehensive curriculum, supplemental and assessment
businesses are dependent on the level of federal and state educational funding, which in turn is
dependent on the robustness of state finances and the level of funding allocated to educational programs.
Most public school districts, the primary customers for K-12 products and services, are largely dependent
on state and local funding to purchase materials. In school districts in states that primarily rely on local
tax proceeds, significant reductions in those proceeds for any reason can severely restrict district
purchases of instructional materials. In districts and states that primarily rely on state funding for
instructional materials, a reduction in state funds or loosening of restrictions on the use of those funds
may reduce net sales. Additionally, many school districts receive substantial sums through Federal
education programs, funding for which may be reduced as a result of the Federal sequester.
Federal and/or state legislative changes can also affect the funding available for educational expenditure,
which include the impact of education reform such as the reauthorization of the Elementary and
Secondary Education Act (“ESEA”) and the implementation of Common Core State Standards. Existing
programs and funding streams could be changed or eliminated in connection with legislation to
reauthorize the ESEA and/or the federal appropriations process, in ways that could negatively affect
demand and sources of funding for our products and services. Similarly, changes in the state
procurement process for textbooks, supplemental material and student tests, particularly in adoption
states, can also affect our markets and sales. For example, changes in curricula, delays in the timing of
the adoptions and changes in the student testing process can all affect these programs and therefore the
size of our market in any given year.
There are multiple competing demands for educational funds and there is no guarantee that states will
fund the purchase of new textbooks or testing programs, or that we will win this business.
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Changes in educational funding could have a material and adverse impact on our business, results of
operations, financial condition, liquidity and future prospects, and, as a result, could also cause us not to
be in compliance with the financial covenants in our credit facilities.
A significant portion of net sales is derived from sales of K-12 instructional materials pursuant to
cyclical adoption schedules, and if we are unable to maintain residual sales and continue to
generate new business, net sales could be materially and adversely affected.
Due to the revolving and staggered nature of state adoption schedules, sales of K-12 instructional
materials have traditionally been cyclical, with some years offering more sales opportunities than others.
Furthermore, we cannot make assurances that states that have adopted our programs, or that schools
and school districts that have purchased our products and services, will do so again in the future. A
significant portion of net sales is dependent upon our ability to maintain residual sales and to continue to
generate new business. For example, over the next couple of years, adoptions are scheduled in the
primary subjects of reading, language arts and literature, social studies and mathematics in, among
others, the states of Texas and Florida, two of the largest adoption states. The inability to succeed in
these two states, or reductions in their anticipated funding levels, could materially and adversely affect net
sales for subsequent years. Furthermore, allowing districts flexibility to use State funds previously
dedicated exclusively to the purchase of instructional materials for things such as technology hardware
and training, which could adversely affect district expenditures on state-adopted instructional materials in
the future.
Our operating results fluctuate on a seasonal and quarterly basis and in the event we do not
generate sufficient net sales in the third quarter, we may not be able to meet our obligations.
Our business is seasonal. For the year ended December 31, 2012, we derived approximately 88% of net
sales from educational publishing in the Education business. For sales of educational products,
purchases typically are made primarily in the second and third quarters of the calendar year, in
preparation for the beginning of the school year, though testing net sales are primarily generated in the
second and fourth quarters. We typically realize a significant portion of net sales during the third quarter,
making third-quarter results material to full-year performance. This sales seasonality affects operating
cash flow from quarter to quarter. We normally incur a net cash deficit from all of our activities through
the middle of the third quarter of the year. We cannot make assurances that our third quarter net sales
will continue to be sufficient to meet our obligations or that they will be higher than net sales for our other
quarters.
Our business will be impacted by the rate of and state of technological change, including the
digital evolution and other disruptive technologies.
A common trend in the publishing industry is the digitalization of content and proliferation of distribution
channels, either over the internet, or via other electronic means, replacing traditional print formats. The
digital migration brings the need for change in product distribution, consumers’ perception of value and
the publisher’s position between retailers and authors.
Such digitalization increases competitive threats both from large media players and from smaller
businesses, online and mobile portals. If we are unable to adapt and transition to the move to
digitalization at the rate of our competitors, our ability to effectively compete in the marketplace will be
affected.
We are a party to at-will contracts with significant customers and the termination of these
contracts could harm our business.
We currently provide or have agreements to provide products and services to governmental agencies,
school districts and educational facilities under contracts that are generally terminable at-will. The fact
that these customers have at-will contracts with us gives rise to the possibility that we may have no
recourse in the event of customer cancellation of a contract. In addition, contracts awarded by states
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pursuant to a procurement process are subject to challenge by competitors and other parties during and
after that process. We anticipate that we will continue to rely predominately upon customers under such
at-will contractual arrangements. As a result of this reliance, the election by these customers to terminate
any or all of their at-will contracts with us, or the loss of or decrease in business from several of our large
customers, could materially and adversely affect our business, prospects, financial condition and results
of operations.
We may not be able to identify successful business models for generating sales of technology
based programs. Furthermore, customers’ expectations for the number and sophistication of
technology-based programs that are given to them at no additional charge may increase, as may
development costs.
The core curriculum elementary school, core curriculum secondary school and educational testing
customers have become accustomed to being given technology-based products at no additional charge
from publishers, such as us, as incentives to adopt programs and other products. The sophistication and
expense of technology-based products continues to grow. Our profitability may decrease materially if we
are unable to realize sales of these products, customers continue to expect/insist on an increasing
number of technology-based materials of increasing quality being given to them, or costs of these
products continue to rise.
The presence and development of open-sourced content could continue to increase as
foundations and other parties fund development of educational content to be offered to schools
and the public at no cost, which could adversely affect our revenue.
In recent years there have been initiatives by non-profit organizations such as the Gates Foundation and
the Hewlett Foundation to develop educational content that can be “open sourced” and made available to
educational institutions for free or nominal cost. To the extent that such open sourced content is
developed and made available to educational customers and is competitive with our instructional
materials, our sales opportunities and net sales could be adversely affected.
Changes in product distribution channels and/or customer bankruptcy may restrict our ability to
grow and affect our profitability in our Trade Publishing business.
New distribution channels such as digital formats, the internet, online retailers, growing delivery platforms
(e.g. e-readers), combined with the concentration of retailer power, pose threats and provide
opportunities to our traditional consumer publishing models in our Trade Publishing business, potentially
impacting both sales volumes and pricing. The economic slowdown combined with the trend to e-books
has created contraction in the consumer books retail market that has increased the risk of bankruptcy of
major retail customers as evidenced by the 2010 bankruptcy filing of the Borders book chain, which
resulted in the write-off of a receivable of $4.4 million. Additional bankruptcies of traditional “bricks and
mortar” retailers of Trade Publishing could negatively affect our financial performance.
Expansion of our investments and business outside of our traditional core U.S. market may result
in lower than expected returns and incremental risks.
To take advantage of international growth opportunities and to reduce our reliance on our core U.S.
market, we are increasing our investments in a number of countries and emerging markets, including Asia
and the Middle East, some of which are inherently more risky than our investments in the U.S. market.
Political, economic, currency, reputational and corporate governance risks (including fraud) as well as
unmanaged expansion are all factors which could limit our returns on investments made in these markets.
For example, current political instability in the Middle East has caused uncertainty in the region, which
could affect our results of operations in the region. Also, certain international customers require longer
payment terms, increasing our credit risk. As we expand internationally, these risks will become more
pertinent to us and could have a bigger impact on our business.
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We operate in a highly competitive environment that is subject to rapid change and we must
continue to invest and adapt to remain competitive.
Our businesses operate in highly competitive markets. These markets continue to change in response to
technological innovations and other factors. Profitability is affected by developments in our markets
beyond our control, including: changing U.S. federal and state standards for educational materials; rising
development costs due to customers’ requirements for more customized instructional materials and
assessment programs; changes in prevailing educational and testing methods and philosophies; higher
technology costs due to the trend toward delivering more educational content in both traditional print and
electronic formats; market acceptance of new technology products, including online or computer-based
testing; an increase in the amount of materials given away in the K-12 markets as part of a bundled pack;
the impact of the expected increase in turnover of K-12 teachers and instructors on the market
acceptance of our products; customer consolidation in the retail and wholesale trade book market and the
increased dependence on fewer but stronger customers; rising advances for popular authors and market
pressures to maintain competitive retail pricing; a material increase in product returns or in certain costs
such as paper; and overall uncertain economic issues that affect all markets.
We cannot predict with certainty the changes that may occur and the effect of those changes on the
competitiveness of our businesses, and the acceleration of any of these developments may materially
and adversely affect our profitability.
The means of delivering our products may be subject to rapid technological change. Although we have
undertaken several initiatives and invested significant amounts of capital to adapt to and benefit from
these changes, we cannot predict whether technological innovations will, in the future, make some of our
products, particularly those printed in traditional formats, wholly or partially obsolete. If this were to occur,
we might be required to invest significant resources to further adapt to the changing competitive
environment. In addition, we cannot predict whether end customers will have sufficient funding to
purchase the equipment needed to use our new technology products.
In order to maintain a competitive position, we must continue to invest in new offerings and new ways to
deliver our products and services. These investments may not be profitable or may be less profitable
than what we have experienced historically. We could experience threats to our existing businesses from
the rise of new competitors due to the rapidly changing environment within which we operate.
Our ability to enforce our intellectual property and proprietary rights may be limited, which may
harm our competitive position and materially and adversely affect our business and results of
operations.
Our products are largely comprised of intellectual property content delivered through a variety of media,
including books and digital and web-based media. We rely on copyright, trademark and other intellectual
property laws to establish and protect our proprietary rights in these products. However, we cannot make
assurances that our proprietary rights will not be challenged, invalidated or circumvented. We conduct
business in other countries where the extent of effective legal protection for intellectual property rights is
uncertain, and this uncertainty could affect future growth. Moreover, despite the existence of copyright
and trademark protection under applicable laws, third parties may nonetheless violate our intellectual
property rights, and our ability to remedy such violations, particularly in foreign countries, may be limited.
In addition, the copying and distribution of content over the Internet creates additional challenges for us in
protecting our proprietary rights. If we are unable to adequately protect and enforce our intellectual
property and proprietary rights, our competitive position may be harmed and our business and financial
results could be materially and adversely affected.
We operate in markets which are dependent on Information Technology (“IT”) systems and
technological change.
Our business is dependent on information technology. We either provide software and/or internet based
services to our customers or we use complex IT systems and products to support our business activities,
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particularly in infrastructure and as we move our products and services to an increasingly digital delivery
platform.
We face several technological risks associated with software product development and service delivery in
our educational businesses, information technology security (including virus and hacker attacks), e-
commerce, enterprise resource planning, system implementations and upgrades. The failure to recruit
and retain staff with relevant skills may constrain our ability to grow as we combine traditional publishing
products with online service offerings.
We are reliant on third-party software development as part of our digital platform.
Some of the technologies and software that compose our instruction and assessment technologies are
developed by third parties. We are reliant on those third parties for the development of future
components and modules. Thus, we face risks associated with software product development and the
ability of those third parties to meet our needs and their obligations under our contracts with them.
A major data privacy breach or unanticipated IT system failure may cause reputational damage to
our brands and financial loss.
Across our businesses we hold large volumes of personal data, including that of employees, customers
and students. Failure to adequately protect personal data could lead to penalties, significant remediation
costs, reputational damage, potential cancellation of existing contracts and inability to compete for future
business. We have policies, processes, internal controls and cybersecurity mechanisms to ensure the
stability of our information technology, provide security from unauthorized access to our systems and
maintain business continuity, but our operating results may be adversely impacted by unanticipated
system failures, data corruption or breaches in security.
We may not be able to complete, or achieve the expected benefits from, any future acquisitions,
which could materially and adversely affect our growth.
We have at times used acquisitions as a means of expanding our business and expect that we will
continue to do so. If we do not successfully integrate acquisitions, anticipated operating advantages and
cost savings may not be realized. The acquisition and integration of companies involve a number of
risks, including: use of available cash, new borrowings or borrowings under our accounts receivable
securitization facility to consummate the acquisition; demands on management related to the increase in
our size after an acquisition; diversion of management’s attention from existing operations to the
integration of acquired companies; integration of companies existing systems into our systems; difficulties
in the assimilation and retention of employees; and potential adverse effects on our operating results.
We may not be able to maintain the levels of operating efficiency that acquired companies achieved
separately. Successful integration of acquired operations will depend upon our ability to manage those
operations and to eliminate redundant and excess costs. We may not be able to achieve the cost savings
and other benefits that we would hope to achieve from acquisitions, which could materially and adversely
affect our financial condition and results.
We may not be able to retain or attract the key management, creative, editorial and sales
personnel that we need to remain competitive and grow.
Our success depends, in part, on our ability to continue to retain key management and other personnel.
We operate in a number of highly visible industry segments where there is intense competition for
experienced and highly effective individuals, including authors. Our successful operations in these
segments may increase the market visibility of members of key management, creative and editorial teams
and result in their recruitment by other businesses. There can be no assurance that we can continue to
attract and retain the necessary talented employees, including executive officers and other key members
of management and, if we fail to do so, it could adversely affect our business.
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In addition, our sales personnel make up about approximately 24% of our employees, and our business
results depend largely upon the experience, knowledge of local market dynamics and long-standing
customer relationships of such personnel. Our inability to retain or hire effective sales people at
economically reasonable compensation levels could materially and adversely affect our ability to operate
profitably and grow our business.
A significant increase in operating costs and expenses could have a material adverse effect on
our profitability.
Our major expenses include employee compensation and printing, paper and distribution costs for
product-related manufacturing. We offer competitive salary and benefit packages in order to attract and
retain the quality employees required to grow and expand our businesses. Compensation costs are
influenced by general economic factors, including those affecting the cost of health insurance and
postretirement benefits, and any trends specific to the employee skill sets we require. We could
experience changes in pension costs and funding requirements due to poor investment returns and/or
changes in pension laws and regulations.
Paper prices fluctuate based on the worldwide demand and supply for paper in general and for the
specific types of paper used by us. Paper is one of our principal raw materials and, for the year ended
December 31, 2012, our paper purchases totaled approximately $47 million while our manufacturing
costs totaled approximately $234 million. Our books and workbooks are printed by third parties and we
typically have multi-year contracts for the production of books and workbooks in order to reduce price
fluctuations over the contract term. Increases in any of our operating costs and expenses could
materially and adversely affect our profitability and our results of operations.
We make significant investments in information technology data centers and other technology initiatives
as well as significant investments in the development of programs for the K-12 marketplace. Although we
believe we are prudent in our investment strategies and execution of our implementation plans, there is
no assurance as to the ultimate recoverability of these investments.
Exposure to litigation could have a material effect on our financial position and results of
operations.
We are involved in legal actions and claims arising from our business practices and face the risk that
additional actions and claims will be filed in the future. Litigation alleging infringement of copyrights and
other intellectual property rights has become extensive in the educational publishing industry. At present,
there are various suits pending or threatened which claim that we exceeded the print run limitation or
other restrictions in licenses granted to us to reproduce photographs in our textbooks. A number of
similar claims against us have already been settled. While management does not expect any of these
matters to have a material adverse effect on our results of operations, financial position or cash flows,
due to the inherent uncertainty of the litigation process, the resolution of any particular legal proceeding or
change in applicable legal standards could have a material effect on our financial position and results of
operations.
We have insurance in such amounts and with such coverage and deductibles as management believes is
reasonable. However, there can be no assurance that our liability insurance will cover all events or that
the limits of coverage will be sufficient to fully cover all potential liabilities.
Operational disruption to our business caused by a major disaster and/or external threats could
restrict our ability to supply products and services to our customers.
Across all our businesses, we manage complex operational and logistical arrangements including
distribution centers, data centers and large office facilities as well as relationships with third party print
vendors. We have also outsourced some support functions, including application maintenance support,
to third party providers. Failure to recover from a major disaster (such as fire, flood or other natural
disaster) at a key facility or the disruption of supply from a key third party vendor or partner (for example,
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due to bankruptcy) could restrict our ability to service our customers. External threats, such as terrorist
attacks, strikes, weather and political upheaval, could affect our business and employees, disrupting our
daily business activities.
We are subject to contingent liabilities that may affect liquidity and our ability to meet our
obligations.
In the ordinary course of business, we issue performance-related surety bonds and letters of credit
posted as security for our operating activities, some of which obligate us to make payments if we fail to
perform under certain contracts in connection with the sale of textbooks and assessment tests. The
surety bonds are partially backstopped by letters of credit. As of December 31, 2012, our contingent
liability for all letters of credit was approximately $26.2 million, of which $6.4 million were issued to
backstop $11.7 million of surety bonds. The letters of credit reduce the borrowing availability on our
Revolving Credit Facility, which could affect liquidity and, therefore, our ability to meet our obligations.
We may increase the number and amount of contracts that require the use of letters of credit, which may
further restrict liquidity and, therefore, our ability to meet our obligations in the future.
We may be adversely affected by significant changes in interest rates.
Our new financing indebtedness, including borrowings under a revolver, bears interest at variable rates.
We have $248.1 million of aggregate principal amount indebtedness outstanding under our Term Loan
that bears interest at a variable rate. An increase or decrease of 1% in the interest rate will change our
interest expense by approximately $2.5 million on an annual basis. We also have up to $250.0 million of
borrowing availability, subject to borrowing base availability, under our Revolving Credit Facility, and
borrowings under the Revolving Credit Facility bear interest at a variable rate. Assuming that the
Revolving Credit Facility is fully drawn, an increase or decrease of 1% in the interest rate will change our
interest expense associated with the Revolving Credit Facility by $2.5 million on an annual basis.
If market interest rates increase, variable-rate debt will create higher debt service requirements, which
could adversely affect our cash flow. While we may enter into agreements limiting exposure to higher
interest rates, these agreements may not offer complete protection from this risk.
We may not be able to generate sufficient cash to service all of our indebtedness and may be
forced to take other actions to satisfy our obligations under our indebtedness, which may not be
successful.
Our ability to make scheduled payments or to refinance our debt obligations and to fund planned capital
expenditures and other growth initiatives depends on our financial and operating performance, which is
subject to prevailing economic and competitive conditions and to certain financial, business and other
factors beyond our control. We may not be able to maintain a level of cash flow from operating activities
sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness or to fund
our other liquidity needs.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be
forced to reduce or delay capital expenditures, sell assets, seek additional capital or seek to restructure or
refinance our indebtedness. These alternative measures may not be successful and may not permit us to
meet our scheduled debt service obligations. In the absence of such operating results and resources, we
could face substantial liquidity problems and might be required to sell material assets or operations to
attempt to meet our debt service and other obligations. Our Term Loan and Revolving Credit Facility
restrict our ability to use the proceeds from asset sales. We may not be able to consummate those asset
sales to raise capital or sell assets at prices that we believe are fair and proceeds that we do receive may
not be adequate to meet any debt service obligations then due.
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Despite our current leverage, we may still be able to incur substantially more debt. This could
further exacerbate the risks that we and our subsidiaries face.
We and our subsidiaries may be able to incur substantial additional indebtedness, including additional
secured indebtedness, in the future. The terms of the credit agreements do and the agreements
governing our existing and future indebtedness may restrict, but will not completely prohibit, us from doing
so. As of December 31, 2012, we had approximately $185.9 million of borrowing availability under our
Revolving Credit Facility. This may have the effect of reducing the amount of proceeds paid to you in the
event of a liquidation. If new debt or other liabilities are added to our current debt levels, the related risks
that we and our subsidiaries now face could intensify.
A small group of stockholders own a substantial percentage of our common stock, and their
interests could conflict with yours.
As of December 31, 2012, a small group of stockholders and their affiliates, including Paulson & Co Inc.,
Anchorage Advisors L.L.C., Blackrock Financial Management, Inc., Avenue Investments, L.P., Q
Investments L.P., Oak Hill Advisors L.P. and Lehman Commercial Paper, Inc., beneficially owned in the
aggregate approximately 73% of the outstanding shares of our common stock. In addition, affiliates of
Paulson & Co. Inc. currently have the right to nominate two directors to the board of directors so long as
they own 25% or more of the Company’s stock.
There can be no assurance as to the liquidity of the trading market for the common stock or that a
trading market for such securities will develop.
Our common stock is not listed on any securities exchange. This may negatively affect the value and the
pricing of the common stock in the secondary market, the transparency and availability of trading prices,
and the liquidity of such securities. As a result, holders of such securities may be unable to resell such
securities at an acceptable price or at all.
We may record future goodwill or indefinite-lived intangibles impairment charges related to one or
more of our business units, which could materially adversely impact our results of operations.
We test our goodwill and indefinite-lived intangibles asset balances for impairment during the fourth
quarter of each year, or more frequently if indicators are present or changes in circumstances suggest
that impairment may exist. We assess goodwill for impairment at the reporting unit level and, in
evaluating the potential for impairment of goodwill, we make assumptions regarding estimated revenue
projections, growth rates, cash flows and discount rates. Although we use consistent methodologies in
developing the assumptions and estimates underlying the fair value calculations used in our impairment
tests, these estimates are uncertain by nature and can vary from actual results. Declines in the future
performance and cash flows of the reporting unit or small changes in other key assumptions may result
future goodwill impairment charges, which could materially adversely impact our results of operations.
We have goodwill and indefinite-lived intangible assets of approximately $520.1 million and $440.5
million, $520.1 million and $440.8 million as of December 31, 2012 and 2011, respectively. There was no
goodwill impairment charge for the year ended December 31, 2012. For the year ended December 31,
2011, goodwill impairment charges were $1,442.5 million. For the years ended December 31, 2012 and
2011, impairment charges for indefinite-lived intangible assets were $5.0 million and $161.0 million,
respectively.
Item 1B. Unresolved Staff Comments
Not applicable.
22
Item 2. Properties
Our principal executive office is located at 222 Berkeley Street, Boston, Massachusetts 02116. The
following table describes the approximate building areas in square feet, principal uses and the years of
expiration on leased premises of our significant operating properties as of December 31, 2012. We
believe that these properties are suitable and adequate for our present and anticipated business needs,
satisfactory for the uses to which each is put, and, in general, fully utilized.
Location
Expiration year Approximate area Principal use of space
Segment used by
Owned Premises:
Indianapolis, Indiana. . . . . . Owned
Troy, Missouri . . . . . . . . . . . Owned
Bellmawr, New Jersey . . . . .Owned
Leased Premises:
Orlando, Florida . . . . . . . . . 2019
Evanston, Illinois . . . . . . . . . 2017
Rolling Meadows, Illinois . . . 2015
Geneva, Illinois . . . . . . . . . . 2019
Wilmington,
Massachusetts . . . . . . . . . . 2015
Boston, Massachusetts . . . . 2017
(Corporate offices)
Portsmouth, New
Hampshire . . . . . . . . . . . . . 2017
New York, New York . . . . . 2016
Lewisville, Texas . . . . . . . . 2013
Austin, Texas . . . . . . . . . . . 2016
Dublin, Ireland . . . . . . . . . . 2025
Rancho Cucamonga,
California . . . . . . . . . . 2015
Englewood, Colorado . . . . 2014
Orlando, Florida . . . . . . . . . 2016
Kennesaw, Georgia . . . . . . 2015
Itasca, Illinois . . . . . . . . . . 2016
All segments
491,779 Warehouse
575,000 Office and warehouse
Education
380,000 Warehouse Education
Office
250,842
Office
150,050
112,014
Office
485,989 Office and warehouse
Education
Education
Education
Education
40,602
328,686
Office
Office
Office
20,645
Office
28,704
434,898 Office and warehouse
Office
195,230
Office
39,944
All segments
All segments
Education
Education
Education
Education
Trade
Office
Office
13,346
17,024
25,400 Warehouse Corporate Records Ctr.
59,450 Warehouse
46,823 Warehouse
Education
Education
Education
Education
In addition, we lease several other offices that are not material to our operations and, in some instances,
are either currently vacant due to consolidating our operations or are fully sublet.
23
Item 3. Legal Proceedings
We are involved in ordinary and routine litigation and matters incidental to our business. Specifically,
there have been various settled, pending and threatened litigation that allege we exceeded the print run
limitation or other restrictions in licenses granted to us to reproduce photographs in our textbooks. While
management believes that there is a reasonable possibility we may incur a loss associated with the
pending and threatened litigation, we are not able to estimate such amount, but we do not expect any of
these matters to have a material adverse effect on our results of operations, financial position or cash
flows. We have insurance in such amounts and with such 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.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Market Information
Not applicable. There is no established trading market for our common stock.
Holders
There were approximately 190 holders of our common stock as of February 28, 2013.
Dividends
We paid no dividends to the holders of our common stock in the years ended December 31, 2012 and
2011, respectively. The credit agreement governing our revolving credit facility restricts our ability to pay
dividends to the holders of our common stock.
24
Item 6. Selected Financial Data
( in $ 0 0 0 s )
O pe ra t ing D a t a
2 0 12
2 0 11
F o r t he P e rio d F o r t he P e rio d
M a rc h 10 ,
2 0 10 t o
D e c e m be r 3 1,
2 0 10
J a nua ry 1,
2 0 10 t o
M a rc h 9 ,
2 0 10
2 0 0 9
2 0 0 8
Net sales
Gro ss pro fit
Impairment charge fo r go o dwill, intangible assets,
pre-publicatio n co sts and fixed assets
Operating lo ss
Lo ss befo re reo rganizatio n items and taxes
Reo rganizatio n items, net
Net lo ss
$
1,285,641
454,217
$
1,295,295
375,230
$
1,397,142
420,051
$
109,905
(21,624)
$
1,562,415
400,189
$
2,049,254
640,075
8,003
(120,687)
(242,196)
(149,114)
(87,139)
1,674,164
(2,037,130)
(2,282,523)
-
(2,182,370)
103,933
(327,868)
(495,798)
-
(507,727)
4,028
(146,697)
(311,996)
-
(311,776)
953,587
(1,392,268)
(2,206,540)
-
824,009
(1,102,786)
(1,858,724)
-
(2,145,147)
(1,463,842)
B a la nc e S he e t D a t a
2 0 12
2 0 11
2 0 10
2 0 0 9
2 0 0 8
Wo rking capital
Cash, cash equivalents and
sho rt-term investments
To tal assets
Debt (sho rt-term and lo ng-term)
Sto ckho lders' equity (deficit)
$
599,085
$
440,844
$
380,678
$
(570,115)
$
274,643
475,119
3,029,584
248,125
1,943,701
413,610
3,263,903
3,011,588
(674,552)
397,740
5,257,155
2,861,594
1,517,828
94,002
5,295,149
6,953,629
(2,614,736)
153,408
7,013,611
6,257,316
(856,060)
The financial information presented above for the years ended December 31, 2012, December 31, 2011
and the period from March 10, 2010 to December 31, 2010 represents the results of operations of HMH
Holdings and its consolidated subsidiaries, and the financial information presented above for the period
from January 1, 2010 to March 9, 2010 and for the years ended December 31, 2009 and December 31,
2008, represents the results of operations of HMH Publishing, our predecessor, and its consolidated
subsidiaries.
25
Item 7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
The following Management’s Discussion and Analysis (“MD&A”) is intended to facilitate an understanding
of our results of operations and financial condition.
This MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated
financial statements and the accompanying notes (“Financial Statements”) for the years ended December
31, 2012, 2011 and 2010. The following discussion and analysis of our financial condition and results of
operations contains forward-looking statements about our business, operations and industry that involve
risks and uncertainties, such as statements regarding our plans, objectives, expectations and intentions.
See “Cautionary Statement Regarding Forward-Looking Statements.”
Overview
We are a leading provider of educational content, technology and professional services to the elementary
and secondary school market in the United States, including a full range of comprehensive curriculum,
supplemental products and service offerings. We have a long-standing expertise in teaching and
instructional strategy and the design and creation of print and electronic learning materials across all
grade levels. We distribute our solutions in multiple formats, including print and digital curriculum,
technology platforms, assessment tools and services. We believe our solutions are a mission critical tool
for school systems as they increasingly focus on outcomes-based learning and teaching solutions that
reach students both in the classroom and at home. We believe we are a leader in the transformation of
the traditional educational materials market and have the opportunity to increase net sales and
profitability by selling our innovative solutions through a comprehensive and integrated approach to
educating children. Furthermore, since 1832, we have published trade and reference materials including
award-winning adult and children’s books, fiction, and nonfiction.
Recent Developments
Chapter 11 Reorganization
On May 10, 2012, we entered into a Plan Support Agreement with consenting creditors holding greater
than 74% of the principal amount of the outstanding senior secured indebtedness of the Company and
with equity owners holding approximately 64% of the Company’s outstanding common stock. The
consenting creditors agreed to support the Company’s Pre-Packaged Chapter 11 Plan of Reorganization
(“Plan”). Pursuant to the Plan Support Agreement, the Company agreed to use its best efforts to (i)
support and complete the restructuring and all transactions contemplated by the Plan, (ii) take any and all
necessary and appropriate actions in furtherance of the restructuring contemplated under the Plan, (iii)
complete the restructuring and all transactions contemplated under the Plan within set time-frames, (iv)
obtain any and all required regulatory and/or third-party approvals for the restructuring, and (v) not directly
or indirectly, seek, solicit, support, or engage in the negotiation or formulation of alternate plans of
reorganization that were inconsistent with the reorganization as contemplated by the Plan Support
Agreement.
On May 21, 2012 (the “Petition Date”), the U.S. based entities that borrowed or guaranteed the debt of
the Company (collectively the “Debtors”), filed voluntary petitions for relief under Chapter 11 of the federal
bankruptcy laws in the United States Bankruptcy Court for the Southern District of New York (“Court”).
Concurrently therewith, the Debtors also filed the Plan, the Disclosure Statement in support of the Plan
and filed various motions seeking relief to continue operations. Following the Petition Date, the Debtors
operated their business as “debtors in possession” (“DIP”) under the jurisdiction of the Court and in
accordance with the applicable provisions of the Bankruptcy Code and orders of the Court. Under
Chapter 11 of the United States Bankruptcy Code (“Chapter 11”), certain claims against us in existence
before the Petition Date were stayed while we operated our business as a DIP including any actions that
might be commenced with regards to secured claims, although the holders of such claims had the right to
move the Court for relief from the stay. Subsequent to the Petition Date, these claims were reflected in
26
the balance sheet as liabilities subject to compromise. Secured claims were secured primarily by liens on
the Company’s accounts receivable. Additional claims (liabilities subject to compromise) could have
potentially arisen after the filing date resulting from rejection of executory contracts or from the
determination by the Court (or agreed to by parties in interest).
On June 22, 2012, the Company successfully emerged from bankruptcy as a reorganized company
pursuant to the Plan. Ultimately, the Debtors did not reject any executory contracts during the bankruptcy
case, and the Company continues to review and reconcile claims that were filed against it by creditors.
Subsequent to the Petition Date, the provisions in U.S. Generally Accepted Accounting Principles
guidance for reorganizations applied to the Company’s financial statements while it operated under the
provisions of Chapter 11. The accounting guidance did not change the application of generally accepted
accounting principles in the preparation of financial statements. However, it does require that the
financial statements, for periods including and subsequent to the filing of the Chapter 11 petition,
distinguish transactions and events that are directly associated with the reorganization from the ongoing
operations of the business. Accordingly, all transactions (including, but not limited to, all professional
fees, realized gains and losses and provisions for losses) directly associated with the reorganization and
restructuring of our businesses are reported separately in the financial statements. All such expense or
income amounts are reported in reorganization items in the accompanying consolidated statements of
operations for the year ended December 31, 2012.
Summary of Emergence
On June 22, 2012, the Company successfully emerged from bankruptcy as a reorganized company
pursuant to the Plan after voluntarily filing for bankruptcy on May 21, 2012. The financial restructuring
realized by the confirmation of the Plan was accomplished through a debt-for-equity exchange. The Plan
deleveraged the Company’s balance sheet by eliminating the Company’s secured indebtedness in
exchange for new equity in the Company. Existing stockholders, in their capacity as stockholders,
received warrants for the new equity in the Company in exchange for the existing equity.
Upon the Company’s emergence from Chapter 11 bankruptcy proceedings on June 22, 2012, the
Company was not required to apply fresh-start accounting based on U.S. Generally Accepted Accounting
Principles guidance for reorganizations due to the fact that the pre-petition holders who owned more than
50% of the Company’s outstanding common stock immediately before confirmation of the Plan received
more than 50% of the Company’s outstanding common stock upon emergence. Accordingly, a new
reporting entity was not created for accounting purposes.
Below is a summary of the significant transactions affecting the Company’s capital structure as a result of
the effectiveness of the Plan.
Equity Transactions
On June 22, 2012, pursuant to the Plan, all of the issued and outstanding shares of common stock of the
Company, including all options, warrants or any other agreements to acquire shares of common stock of
the Company that existed prior to the Petition Date, were cancelled and in exchange, holders of such
interests received distributions pursuant to the terms of the Plan. Following the emergence on June 22,
2012, the authorized capital stock of the Company consists of (i) 190,000,000 shares of common stock, of
which 69,958,989 shares of common stock are issued and outstanding at December 31, 2012, 3,684,211
shares of common stock which are reserved for issuance upon exercise of warrants at December 31,
2012, and 8,187,135 shares of common stock which are reserved for issuance upon exercise of certain
other warrants and awards to be issued by the Company at December 31, 2012 under the MIP (defined
below) and (ii) 10,000,000 shares of preferred stock, $0.01 par value per share, of which no shares are
issued and outstanding at December 31, 2012. There are no other outstanding obligations, warrants,
options, or other rights to subscribe for or purchase from the Company any class of capital stock of the
Company.
27
On June 22, 2012, the Company issued an aggregate of 70,000,000 post-emergence shares of new
common stock pursuant to the final Plan on a pro rata basis to the holders of the then-existing first lien
term loan (the “Term Loan”), of which 41,011 are treasury shares as of December 31, 2012, the then-
existing first lien revolving loan facility (the “Revolving Loan”), and the 10.5% Senior Secured Notes due
2019 (the “10.5% Senior Notes”) as of the Petition Date. The Company relied on Section 1145(a)(1) of
the Bankruptcy Code to exempt from the registration requirements of the Securities Act of 1933, the
issuance of such new common stock.
A new Management Incentive Plan (“MIP”) became effective upon emergence. The MIP provides for
grants of options and restricted stock at a strike price equal to or greater than the fair market value per
share of common stock as of the date of the grant and reserved for management and employees up to
10% of the new common stock of the Company. During 2012, the Company granted to certain
employees, including executive officers, stock options totaling 4,912,281 shares of the Company’s
common stock. Each of the stock options granted have an exercise price equal to the fair market value
on the date of grant and generally vest over a three or four year period. During 2012, the Company
granted 22,200 restricted stock units to independent directors, which generally vest after one year. As of
December 31, 2012, there are 3,252,654 shares remaining which are reserved for issuance under the
MIP.
In accordance with the Plan, each existing common stockholder prior to bankruptcy received its pro rata
share of warrants to purchase 5% of the common stock of the Company, subject to dilution for equity
awards issued in connection with the MIP. The exercise price for the warrants is based upon a $3.1
billion enterprise valuation of the Company, and the warrants have a term of seven years. All of the then-
existing common stock was extinguished on the effective date of the Plan. As of December 31, 2012,
there are 3,684,211 shares reserved for issuance upon the exercise of such warrants. These warrants
are referred to as the “New Warrants.”
Debt Transactions
On June 22, 2012, the Company’s creditors converted the First Lien Credit Agreement consisting of the
Term Loan with an aggregate outstanding principal balance of $2.6 billion and the Revolving Loan with an
aggregate outstanding principal balance of $235.8 million, and the outstanding $300.0 million principal
amount of 10.5% Senior Notes to 100 percent pro rata ownership of the Company’s common stock,
subject to dilution pursuant to the MIP and the exercise of the New Warrants, and received $30.3 million
in cash.
In connection with the Chapter 11 filing on May 22, 2012, the Company entered into a new $500.0 million
senior secured credit facility (DIP facility), which converted into an exit facility on the effective date of the
emergence from Chapter 11. This exit facility consists of a $250.0 million revolving credit facility, which is
secured by the Company’s accounts receivable and inventory, and a $250.0 million term loan credit
facility. The proceeds of the exit facility were used to fund the costs of the reorganization and are
providing working capital to the Company since its emergence from Chapter 11.
28
A summary of the transactions affecting the Company’s debt balances is as follows:
Debt balance prior to emergence from bankruptcy (including accrued interest)
Exchange of debt for new common shares
Elimination of debt discount and deferred financing fees
Adequate protection payments
Conversion fees
Professional fees
(Gain) loss on extinguishment
$
$
(3,142,234)
1,750,000
98,352
69,701
30,299
21,726
(1,172,156)
Reorganization Items
Reorganization items represent expense or income amounts that were recorded in the consolidated
financial statements as a result of the bankruptcy proceedings. Reorganization items were incurred
starting with the date of the bankruptcy filing through the date of bankruptcy emergence. The gain from
reorganization items for the year ended December 31, 2012 were as follows:
Debt to equity conversion
Elimination of debt discount and deferred financing fees
Adequate protection payments
Conversion fees
Professional fees
(Gain) loss on extinguishment
Stock compensation
Issuance of warrants
Reorganization items, net
Total
$
(1,392,234)
98,352
69,701
30,299
21,726
(1,172,156)
2,027
10,747
(1,159,382)
$
Adjusted to
Capital in excess
of par value
Reorganization
items, net
$
(1,199,549)
84,740
60,054
26,106
18,381
(1,010,268)
$
(192,685)
13,612
9,647
4,193
3,345
(161,888)
-
-
$
(1,010,268)
2,027
10,747
(149,114)
$
Liabilities Subject to Compromise
Certain pre-petition liabilities and indebtedness were subject to compromise under the Plan and were
reported at amounts allowed or expected to be allowed by the Court. A summary of liabilities subject to
compromise reflected in the consolidated balance sheet as of May 21, 2012 is as follows:
May 21,
2012
$
$
2,570,815
235,751
300,000
35,668
3,142,234
$2,668,690 Term Loan due June 12, 2014
$235,751 Revolving Loan due December 12, 2013
$300,000 10.5% senior secured notes due June 1, 2019
Accrued interest
Total
As of December 31, 2012, there were no liabilities subject to compromise.
29
All pre-petition claims were considered liabilities subject to compromise at May 21, 2012. As discussed
above, the Term Loan, the Revolving Loan, the 10.5% Senior Notes, and the associated accrued interest
were exchanged for new common stock in the Company. There were no other liabilities subject to
compromise as of May 21, 2012. We honored other prepetition obligations, including employee wages
and trade payables in the ordinary course of business.
Seasonality and Comparability
Our net sales, operating profit and operating cash flow are impacted by the inherent seasonality of the
academic calendar. Consequently, the performance of our businesses may not be comparable quarter to
consecutive quarter and should be considered on the basis of results for the whole year or by comparing
results in a quarter with results in the same quarter for the previous year.
In the K-12 market, we typically receive payments for products and services from individual school
districts, and, to a lesser extent, individual schools and states. In the trade publishing markets, payment
is received for products and services from book distributors and retail booksellers. In the case of testing
and assessment products and services, payment is received from the individually contracted parties.
Approximately 88% of our fiscal 2012 net sales were derived from educational publishing, which is a
markedly seasonal business. Schools make most of their purchases in the second and third quarters of
the calendar year in preparation for the beginning of the school year. Thus, over the past three years,
approximately 69% of consolidated net sales have historically been realized in the second and third
quarters. Sales of K-12 instructional materials and customized testing products are also cyclical, with
some years offering more sales opportunities than others. The amount of funding available at the state
level for educational materials also has a significant effect on year-to-year net sales. Although the loss of
a single customer would not have a material adverse effect on our business, schedules of school
adoptions and market acceptance of our products can materially affect year-to-year net sales
performance.
30
Financial Presentation
The historical financial information discussed in this annual report has been derived from the financial
statements and accounting records of HMH Holdings (Delaware), Inc. (“Successor”) for periods on and
after March 10, 2010 and from the financial statements and accounting records of HMH Publishing
Company (“Predecessor”) for the period from January 1, 2010 through March 9, 2010. For purposes of
presenting a comparison of our 2011 results to 2010, we have presented our 2010 results as the
mathematical addition of the Predecessor and Successor periods (the “Combined Period”). We believe
that this presentation provides meaningful information about our results of operations. This approach is
not consistent with U.S. GAAP, may yield results that are not strictly comparable on a period-to-period
basis and may not reflect the actual results we would have achieved. The table showing the combined
2010 results follows:
(in thousands)
Successor
For the Period
March 10 -
December 31,
2010
Predecessor
For the Period
January 1, -
March 9,
2010
Combined
For the Period
January 1, -
December 31,
2010
Net sales
$
1,397,142
$
109,905
$
1,507,047
Costs and expenses
Cost of sales, excluding pre-publication and publishing
rights amortization
Publishing rights amortization
Pre-publication amortization
Cost of sales
Selling and administrative
Other intangible asset amortization
Impairment charge for goodwill, intangible assets,
pre-publication costs and fixed assets
Severance and other charges
Gain on sale of assets
Operating loss
Other income (expense)
Interest expense
Other (loss) income, net
Change in fair value of derivative instruments
Loss before taxes
Income tax expense (benefit)
Net loss
559,593
235,977
181,521
977,091
598,807
57,601
103,933
(11,243)
(1,179)
1,725,010
(327,868)
45,270
48,336
37,923
131,529
119,039
2,006
4,028
-
-
256,602
(146,697)
604,863
284,313
219,444
1,108,620
717,846
59,607
107,961
(11,243)
(1,179)
1,981,612
(474,565)
(258,174)
(6)
90,250
(167,930)
(495,798)
11,929
(507,727)
$
(157,947)
9
(7,361)
(165,299)
(311,996)
(220)
(311,776)
$
(416,121)
3
82,889
(333,229)
(807,794)
11,709
(819,503)
$
31
Consolidated Operating Results
(in thousands)
Net sales
Costs and expenses
Cost of sales, excluding pre-publication and publishing
rights amortization
Publishing rights amortization
Pre-publication amortization
Cost of sales
Selling and administrative
Other intangible asset amortization
Impairment charge for goodwill, intangible
assets, pre-publication costs and fixed assets
Severance and other charges
Gain on bargain purchase
Gain on sale of assets
Operating loss
Other income (expense)
Interest expense
Change in fair value of derivative instruments
Loss before reorganization items and taxes
Reorganization items, net
Income tax expense (benefit)
Net loss
NM = not meaningful
Year
Ended
Year
Ended
December 31,
December 31,
2012
2011
Percent
Change
$
1,285,641
$
1,295,295
-0.7%
515,948
177,747
137,729
831,424
533,462
54,815
8,003
9,375
(30,751)
-
512,612
230,624
176,829
920,065
640,023
67,372
1,674,164
32,801
-
(2,000)
0.7%
-22.9%
-22.1%
-9.6%
-16.6%
-18.6%
-99.5%
-71.4%
NM
NM
(120,687)
(2,037,130)
-94.1%
(123,197)
1,688
(242,196)
(149,114)
(5,943)
(244,582)
(811)
(2,282,523)
-
(100,153)
$
(87,139)
$
(2,182,370)
-49.6%
NM
-89.4%
NM
-94.1%
-96.0%
Results of Operations – Comparing Years Ended December 31, 2012 and 2011
Net sales for the year ended December 31, 2012, decreased $9.7 million, or 0.7%, from $1,295.3 million
for the same period in 2011 to $1,285.6 million. The decrease was due to a $47.0 million decline in the
domestic education sales from the prior year. Our addressable new adoption and open territory sales
were down from the prior year primarily due to known lower adoptions in 2012 coupled with a continuing
decline in the open territory market. The addressable adoption market was down approximately 23%
when compared to prior year and the open territory market was down approximately 8%. Offsetting a
portion of the decline was a $31.4 million increase in our Trade sales primarily due to a number of best
sellers and an increase in e-book sales.
Operating loss for the year ended December 31, 2012 decreased $1,916.4 million, or 94.1%, from a loss
of $2,037.1 million for the same period in 2011 to a loss of $120.7 million, primarily due to a 2011 goodwill
impairment charge of $1,442.5 million. The goodwill impairment was due to the carrying value of the
Education reporting unit exceeding the implied fair value. Further, the increased loss in 2011 was also
due to tradename and other impairments of $231.6 million. Other significant components of the decrease
in operating loss were as follows:
32
• A $104.5 million decrease in amortization expense related to publishing rights, pre-publication
and other intangible assets due to our use of accelerated amortization methods and lower plate
spend over the past several years than earlier years;
• A $106.6 million decrease in selling and administrative expenses related primarily to a reduction
in labor related costs of $32.0 million; a reduction in variable expenses such as commissions and
depository fees of $11.0 million associated with lower revenue; lower travel and entertainment
expenses of $11.0 million; with the remainder attributed to lower fixed and discretionary expenses
such as rent, bad debt and professional fees;
• A $23.4 million decrease in severance and other charges as 2011 included a significant executive
and workforce realignment; and
• A $30.8 million gain on bargain purchase associated with the acquisition of certain asset product
lines for our Trade Publishing business.
Interest expense for the year ended December 31, 2012 decreased $121.4 million, or 49.6%, from
$244.6 million for the same period in 2011 to $123.2 million, primarily as a result of the emergence from
bankruptcy with substantially reduced debt. Going forward, we expect our full year interest expense to
approximate $25.0 million annually.
Change in fair value of derivative instruments for the year ended December 31, 2012 increased $2.5
million from an unrealized loss of $0.8 million for the same period in 2011 to an unrealized gain of $1.7
million. The increase was due to favorable euro currency fluctuations on our foreign exchange forward
contracts.
Reorganization items, net for the year ended December 31, 2012 was $149.1 million. The amount
represents expense and income amounts that were recorded to the statement of operations as a result of
the bankruptcy proceedings. Reorganization items were incurred starting with the date of the bankruptcy
filing through the date of bankruptcy emergence.
Income tax benefit for the year ended December 31, 2012 decreased $94.2 million from a tax benefit of
$100.2 million for the year ended December 31, 2011 to a tax benefit of $5.9 million. The full year
effective tax rate for 2012 was 6.4% primarily due to a tax benefit allocated to continuing operations after
considering the gain recorded in 2012 in equity as a result of the reorganization. Such gain serves as a
source of income that enables realization of the tax benefit of the current year loss in continuing
operations. This tax benefit in continuing operations is offset by the deferred tax liabilities associated with
tax amortization on indefinite-lived intangibles as well as expected foreign, state and local taxes for
2012. The full year effective tax rate for 2011 was approximately 4.4% due to the deferred tax benefit
resulting from the decrease in deferred tax liabilities associated with book impairments on indefinite-lived
intangibles and goodwill.
33
Consolidated Operating Results
(in thousands)
Net sales
Costs and expenses
Cost of sales, excluding pre-publication and publishing
rights amortization
Publishing rights amortization
Pre-publication amortization
Cost of sales
Selling and administrative
Other intangible asset amortization
Impairment charge for goodwill, intangible
assets, pre-publication costs and fixed assets
Severance and other charges
Gain on sale of assets
Operating loss
Other income (expense)
Interest expense
Other (loss) income, net
Change in fair value of derivative instruments
Loss before taxes
Income tax expense (benefit)
Net loss
NM = not meaningful
Year
Ended
Combined
Year
Ended
December 31,
December 31,
2011
2010
Percent
Change
$
1,295,295
$
1,507,047
-14.1%
512,612
230,624
176,829
920,065
640,023
67,372
1,674,164
32,801
(2,000)
(2,037,130)
604,863
284,313
219,444
1,108,620
717,846
59,607
107,961
(11,243)
(1,179)
(474,565)
-15.3%
-18.9%
-19.4%
-17.0%
-10.8%
13.0%
NM
NM
69.6%
329.3%
(244,582)
(416,121)
-41.2%
-
(811)
(2,282,523)
(100,153)
3
82,889
(807,794)
11,709
$
(2,182,370)
$
(819,503)
NM
NM
NM
NM
NM
Results of Operations – Comparing Years Ended December 31, 2011 and 2010
Net sales for the year ended December 31, 2011, decreased $211.8 million, or 14.1%, from $1,507.0
million for the same period in 2010 to $1,295.3 million. The decline was largely driven by a reduction in
the Texas adoption market by over $250 million from 2010 coupled with a decline in sales to open
territories along with a decline in international sales. Net sales for Texas for the year ended December
31, 2011 was $72.0 million, approximately $119.0 million less than the same period in 2010. Additionally,
sales to open territories were approximately $61.0 million lower for the year ended 2011 compared to the
same period in 2010 due primarily to the contraction of spending throughout most states. Lastly, our
international sales were $33.0 million lower in 2011 than 2010 due to a tightening of credit terms with our
middle east distribution partners.
Operating loss for the year ended December 31, 2011 increased $1,562.6 million, or 329.3%, from a
loss of $474.6 million for the same period in 2010 to a loss of $2,037.1 million, primarily due to a goodwill
impairment charge of $1,442.5 million. The goodwill impairment was due to the carrying value of the
Education reporting unit exceeding the implied fair value. Further, the increased loss was also due to
34
tradename and other impairments of $231.6 million and $44.0 million increase in severance and other
expenses and lower annual net sales partially offset by:
• A $88.5 million decrease in amortization expense related to publishing rights, pre-publication and
other intangible assets due to our use of accelerated amortization methods and lower plate spend
over the past several years than earlier years;
• A $77.8 million decrease in selling and administrative expenses related primarily to a reduction in
variable expenses such as commissions and depository fees associated with lower revenue; and
• A $92.3 million decrease in cost of sales (excluding pre-publication and publishing rights
amortization) due to a reduction of the inventory step up amortization of $41.7 million, which was
included in 2010, along with lower net sales.
Interest expense for the year ended December 31, 2011 decreased $171.5 million, or 41.2%, from
$416.1 million for the same period in 2010 to $244.6 million, primarily a result of the expiration of legacy
swap agreements with unfavorable fixed interest rates and the conversion of $4.0 billion of debt to equity
in March 2010 as part of the restructuring. The components for the decline were:
•
In 2010, we paid $93.1 million related to the interest rate swap agreements in place at the time.
The swap agreements, which were mandatory under our Credit Agreement, expired at December
31, 2010;
• The Mezzanine debt, which bore interest at 17.5% through March 9, 2010, incurred $67.0 million
in interest in 2010 that did not exist in 2011;
• A reduction of $5.1 million of deferred financing costs as a substantial amount of deferred
financing fees that existed at March 9, 2010 were written off; and
• A reduction of $8.1 million related to the accounts receivable securitization facility as we had
$140.0 million outstanding on the securitization facility from February 2010 through August 3,
2010 and an average outstanding balance of $30.1 million for only two months during 2011.
Change in fair value of derivative instruments for the year ended December 31, 2011 decreased
$83.7 million from a gain of $82.9 million for the same period in 2010 to an unrealized loss of $0.8 million.
The decrease was due to interest rate swap payments made during 2010, which effectively reduced the
unrealized liability established on the balance sheet. No interest rate swap agreements were in place
during 2011. The $0.8 million unrealized loss on change in fair value of derivative instruments related to
unfavorable foreign exchange forward contracts in place during 2011.
Income tax expense for the year ended December 31, 2011 decreased $111.9 million from an expense
of $11.7 million for the year ended December 31, 2010 to a benefit of $100.2 million. The full year
effective tax rate for 2011 was approximately 4.4% due to the deferred tax benefit resulting from the
decrease in deferred tax liabilities associated with book impairments on indefinite-lived intangibles and
goodwill. An income tax benefit was recorded in the fourth quarter of 2011 and was due primarily to the
book impairment on indefinite-lived intangible assets and goodwill, which reduced the related deferred tax
liabilities.
35
Non-GAAP Financial Measures
To supplement our Financial Statements presented in accordance with accounting principles generally
accepted in the United States of America (“GAAP”), we have presented certain financial measures in
addition to our GAAP results. We believe that these non-GAAP financial measures provide useful
information for evaluating our business performance. 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. In addition, these non-GAAP financial
measures may not be the same as similarly entitled measures reported by other companies.
We present the following non-GAAP financial measures in this report:
Adjusted EBITDA
Management believes that the presentation of Adjusted EBITDA provides useful information to investors
regarding our results of operations because it assists both investors and management in analyzing and
benchmarking the performance and value of our business. Adjusted EBITDA provides an indicator of
general economic performance that is not affected by debt restructurings, fluctuations in interest rates or
effective tax rates, or levels of depreciation or amortization. Accordingly, our management believes that
this measurement is useful for comparing general operating performance from period to period.
Furthermore, the agreements governing our indebtedness contain covenants and other tests based on
Adjusted EBITDA. In addition, targets and positive trends in Adjusted EBITDA are used as performance
measures and to determine certain compensation of management. Other companies may define Adjusted
EBITDA differently and, as a result, our measure of Adjusted EBITDA may not be directly comparable to
Adjusted EBITDA of other companies. Although we use Adjusted EBITDA as a financial measure to
assess the performance of our business, the use of Adjusted EBITDA is limited because it does not
include certain material costs, such as interest and taxes, necessary to operate our business. Adjusted
EBITDA should be considered in addition to, and not as a substitute for, net earnings in accordance with
GAAP as a measure of performance. You are cautioned not to place undue reliance on Adjusted
EBITDA.
36
Below is a reconciliation of our net loss to this non-GAAP measure:
(in thousands)
Successor
Predecessor
Net loss
Consolidated interest expense
Provision (benefit) for income taxes
Depreciation expenses
Amortization expenses (including capitalized permission
settlements)
Non-cash charges - stock compensation
Non-cash charges - gain (loss) on foreign currency and interest hedge
Non-cash charges - asset impairment charges
Purchase accounting adjustments (a)
Fees, expenses or charges for equity offerings, debt or
acquisitions
Non-recurring debt restructuring (b)
Non-recurring restructuring (c)
Severance, separation costs and facility closures (d)
Reorganziation items, net (e)
ADJUSTED EBITDA
Year Ended,
December 31,
2012
Year Ended,
December 31,
2011
For the Period
March 10, 2010 to
December 31,
2010
For the Period
January 1, 2010
to March 9,
2010
$
(87,139)
123,197
(5,943)
58,131
$
(2,182,370)
244,582
(100,153)
58,392
$
(507,727)
258,174
11,929
48,649
$
(311,776)
157,947
(220)
10,900
370,291
4,227
(1,688)
8,003
(16,511)
474,825
8,558
811
1,674,164
22,732
475,099
4,274
(90,250)
103,933
113,182
88,265
925
7,361
4,028
-
267
-
6,716
9,375
(149,114)
319,812
$
3,839
-
-
32,818
-
238,198
$
1,513
30,000
-
23,975
-
472,751
$
-
9,564
-
992
-
(32,014)
$
(a) Represents certain non-cash accounting adjustments, most significantly relating to deferred revenue, and inventory costs , that we were
required to record as a direct result of the March 9, 2010 Restructuring and the acquisitions for the years ended 2012, 2011 and 2010.
(b) Represents fees paid and charged to operations relating to the March 9, 2010 Restructuring.
(c) Represents non-recurring restructuring costs (other than severance and real estate) such as consulting and realignment.
(d) Represents costs associated with the restructuring. Included in such costs are severance, facility integration and vacancy of excess
facilities. 2010 costs also includes program integration and related inventory obsolescence and consulting costs.
(e) Represents net gain associated with the Chapter 11 Reorganization.
37
Unlevered Free Cash Flow
Free cash flow is a measure generally used by investors, analysts and management to gauge a
company’s ability to generate cash from operations in excess of that necessary to be reinvested to
sustain and grow the business and fund its obligations. We calculate unlevered free cash flow as net
cash provided by operating activities excluding cash paid for interest and reorganization items, reduced
for cash expenditures relating to additions to pre-publication costs and additions to property, plant and
equipment. We believe that our unlevered free cash flow calculation provides a relevant measure of
liquidity and a useful basis for assessing our ability to fund operations. Unlevered free cash flow is not a
financial measure under GAAP and should be used in conjunction with GAAP cash measures provided in
our Consolidated Statement of Cash Flows.
Below is a reconciliation of our net cash provided by operating activities to this non-GAAP measure:
2012
Year Ended December 31,
2011
2010
Net cash provided by operating activities
Add back:
Cash paid for interest
Reorganization items included in operating activities
Less: Additions to pre-publication costs
Less: Additions to property, plant and equipment
Unlevered Free Cash Flow
$
104,802
$
132,796
$
141,670
92,481
16,705
(114,522)
(50,943)
48,523
$
180,647
-
(122,592)
(71,817)
119,034
$
273,772
-
(118,670)
(67,698)
229,074
$
38
Business Operating Results
We are organized along two business segments: Education and Trade Publishing. The Education
business is the largest division, and represented approximately 88% and 90% of our total net sales for the
years ended December 31, 2012 and 2011, respectively. Our Trade Publishing represented
approximately 12% and 10% our total net sales for the year ended December 31, 2012 and 2011,
respectively. The Corporate/Other category represents non-allocated corporate expenses. The majority
of our non-GAAP reconciling items for Adjusted EBITDA reflected herein impact the Education business
and Corporate/Other category. We changed our corporate cost allocation policy in the fourth quarter of
2012; thus the 2011 amounts have been adjusted to conform with the 2012 presentation.
Results of Operations – Comparing Years Ended December 31, 2012 and 2011
Year Ended
Percentage
Change
2012
2011
Net sales:
Education
Trade Publishing
Corporate/Other
Total
$
1,128,591
157,050
-
$
1,169,645
125,650
-
$
1,285,641
$
1,295,295
Adjusted EBITDA:
Education
Trade Publishing
Corporate/Other
Total
Net Sales
$
$
329,723
28,774
(38,685)
319,812
278,930
12,888
(53,620)
238,198
$
$
-3.5%
25.0%
-
18.2%
123.3%
-27.9%
Education
The Education business net sales for the year ended December 31, 2012, decreased $41.1 million, or
3.5% from $1,169.6 million for the same period in 2011 to $1,128.6 million. The decrease was primarily
due to a $47.0 million decline in domestic education sales from the prior year. This is a result of our
addressable new adoption and open territory sales being down from the prior year largely due to known
lower adoptions in 2012 coupled with a continuing decline in the open territory market. The addressable
adoption market is down approximately 23% when compared to the prior year and the open territory
market is down approximately 8% from the prior year. While our Singapore Math product continues to
outperform, certain other supplemental product sales are down due to aging products. The decrease was
partially offset by the strength of our professional development and reading intervention sales which
increased $20.5 million.
Trade Publishing
Net sales for the Trade Publishing business for the year ended December 31, 2012 increased $31.4
million, or 25.0% to $157.1 million from $125.7 million for the same period in 2011. The increase is
primarily attributed to the theatrical releases of “The Hobbit”, “Life of Pi” and “Extremely Loud and
Incredibly Close” which drove increased book sales. Further, there was a continued increase in e-Book
sales driven by an overall growth in digital devices.
39
Adjusted EBITDA
Education
Our Education business Adjusted EBITDA for the year ended December 31, 2012 increased $50.8
million, or 18.2%, from $278.9 million for the same period in 2011 to $329.7 million. The increase was
attributed to a reduction in labor related costs due to the head count reduction associated with the
restructuring activity and a reduction in travel expense and other fixed and discretionary costs realized as
part of cost control measures. The increase was offset by the effect of the $41.1 million decrease in net
sales for the year.
Trade Publishing
Adjusted EBITDA for the Trade Publishing business for the year ended December 31, 2012 increased
$15.9 million, or 123.3%, to $28.8 million from $12.9 million for the same period in 2011. The increase
was primarily attributed to the effect of the $31.4 million increase in net sales offset by slightly higher
royalties.
Corporate/Other
Corporate/Other represents certain general overhead costs not fully allocated to the business units such
as Legal, Accounting, Treasury, Human Resources and C-suite functions. Additionally, 2011 included
headcount associated with certain incubator initiatives which were terminated in the latter half of 2011
resulting in labor savings in 2012. Adjusted EBITDA for Corporate/Other for the year ended December
31, 2012 increased $14.9 million, to a loss of $38.7 million from a loss of $53.6 million for the same period
in 2011. The increase was due to lower headcount and administrative expenses associated with cost
control measures.
Results of Operations – Comparing Years Ended December 31, 2011 and 2010
Year Ended
Percentage
Change
2011
2010
Net sales:
Education
Trade Publishing
Corporate/Other
Total
$
1,169,645
125,650
-
$
1,383,147
123,900
-
$
1,295,295
$
1,507,047
Adjusted EBITDA:
Education
Trade Publishing
Corporate/Other
Total
Net Sales
$
$
278,930
12,888
(53,619)
238,199
490,262
12,730
(62,255)
440,737
$
$
-15.4%
1.4%
-
-43.1%
1.2%
-13.9%
Education
The Education business net sales for the year ended December 31, 2011, decreased $213.5 million, or
15.4%, from $1,383.1 million for the same period in 2010 to $1,169.6 million. The decline was largely
driven by a reduction in the Texas adoption market by over $250 million from 2010 coupled with a decline
in sales to open territories along with a decline in international sales. Net sales for Texas for the year
ended December 31, 2011 was $72.0 million, approximately $119.0 million less than the same period in
2010. Additionally, sales to open territories were approximately $61.0 million lower for the year ended
2011 compared to the same period in 2010 due primarily to the contraction of spending throughout most
40
states. Lastly, our international sales were $33.0 million lower in 2011 than 2010 due to a tightening of
credit terms with our middle east distribution partners.
Trade Publishing
Net sales for the Trade Publishing business for the year ended December 31, 2011 increased $1.8
million, or 1.4%, to $125.7 million from $123.9 million for the same period in 2010. The increase was
primarily attributed to favorable returns compared to the prior year due to a shift to e-book sales from print
sales partially offset by a decline in sub-rights income.
Adjusted EBITDA
Education
Our Education business Adjusted EBITDA for the year ended December 31, 2011 decreased $211.3
million, or 43.1%, from $490.3 million for the same period in 2010 to $278.9 million. The decline was
largely driven by the 2011 decline in net sales attributed to the smaller markets in Texas and open
territories. Additionally, our cost of sales rate increased as we shifted to more development and
consulting services from the more profitable print products. Additionally, we incurred higher bad debt
expense and returns expense attributed to a tightening of credit terms with middle east distribution
partners.
Trade Publishing
Adjusted EBITDA for the Trade Publishing business for the year ended December 31, 2011 increased
$0.2 million, or 1.2%, to $12.9 million from $12.7 million for the same period in 2010. The increase was
primarily attributed to cost management.
Corporate/Other
Corporate/Other represents certain general overhead costs not fully allocated to the business units along
with incubator initiatives focusing on consumer and emerging markets and research and development.
Adjusted EBITDA for Corporate/Other for the year ended December 31, 2011 decreased $8.6 million, to a
loss of $53.6 million from a loss of $62.2 million for the same period in 2010. The increase was due to
the elimination of our corporate office in Dublin.
Liquidity and Capital Resources
(in thousands)
Cash and cash equivalents
Short-term investments
Current portion of long-term debt
Long-term debt
Operating cash flow
Unlevered free cash flow
Year Ended December 31,
2011
2010
2012
$
329,078
146,041
2,500
245,625
104,802
48,523
$
413,610
-
43,500
2,968,088
132,796
119,034
$
380,073
17,667
193,064
2,668,530
141,670
229,074
As discussed in Note 2 to the Financial Statements, on June 22, 2012, our creditors converted the First
Lien Credit Agreement consisting of the Term Loan with an aggregate outstanding principal balance of
$2.6 billion and the Revolving Loan with an aggregate outstanding principal balance of $235.8 million,
and the outstanding $300.0 million principal amount of 10.5% Senior Notes to 100 percent pro rata
ownership of the Company’s common stock.
41
On May 22, 2012, we entered into a new $500.0 million senior secured credit facility (DIP facility) which
was converted into an exit facility on the effective date of the emergence from Chapter 11. This exit
facility consists of a $250.0 million revolving credit facility, which is secured by the Company’s accounts
receivable and inventory, and a $250.0 million term loan credit facility. The proceeds of the exit facility
were used to fund the costs of the reorganization and provide post-closing working capital to the
Company. As of December 31, 2012, we had approximately $248.1 million outstanding under our term
loan credit facility and no amounts outstanding under our revolving credit facility. We had approximately
$185.9 million of borrowing availability under our revolving credit facility and approximately $26.2 million
of outstanding letters of credit as of December 31, 2012. We had approximately $329.1 million of cash
and cash equivalents and $146.0 million of short-term investments at December 31, 2012.
We expect our cash flows from operations combined with our cash on hand and borrowings under our
revolving credit facility to provide sufficient liquidity to fund our current obligations, capital spending, debt
service requirements and working capital requirements over at least the next twelve months.
Operating activities
Net cash provided by operating activities was $104.8 million for the year ended December 31, 2012, a
$28.0 million decrease from the $132.8 million provided by operating activities for the year ended
December 31, 2011. The decrease in cash provided by operating activities from 2011 to 2012 was
primarily due to decreases in working capital, primarily consisting of lower deferred revenue and a
decrease in accounts payable partially offset by stronger operating performance.
Net cash provided by operating activities was $132.8 million for the year ended December 31, 2011, a
$8.9 million decrease from the $141.7 million provided by operating activities for the year ended
December 31, 2010. The decrease in cash provided by operating activities from 2010 to 2011 was driven
by an unfavorable change in receivables as a substantial amount of prior year adoption sales were
collected by the end of the fourth quarter of 2010, along with lower inventory levels and decreased
interest payable. These changes were partially offset by favorable changes in accounts payable and
severance and other charges.
Investing activities
Net cash used in investing activities was $296.0 million for the year ended December 31, 2012, a
increase of $100.7 million from the $195.3 million used in investing activities for the year ended
December 31, 2011. The increase in cash expenditures for 2012 is primarily attributable to purchases of
$165.6 million of short-term investments offset by reductions in capital expenditures of $28.9 million for
property, plant, and equipment and pre-publication costs, and reductions in cash outlays over the prior
year for acquisitions of $24.6 million.
Net cash used in investing activities was $195.3 million for the year ended December 31, 2011, a
decrease of $62.4 million from the $257.7 million used in investing activities for the year ended December
31, 2010. The decrease reflects $17.8 million in proceeds from the sale of short term investments and
$16.8 million in proceeds from restricted cash accounts related to cash collateralized letter of credit which
were released in 2011. In the year ended December 31, 2010, $18.0 million had been used for the
purchase of short term investments and $42.7 million had been deposited to restricted cash accounts.
Partially offsetting the source of cash from investing activities was $30.0 million of additional capital
expenditure over the prior period for an acquisition of an intangible asset.
Financing activities
Net cash provided by financing activities was $106.7 million for the year ended December 31, 2012,
which was $10.7 million higher than the net cash provided by financing activities for the year ended
December 31, 2011. During 2012, in connection with our emergence from bankruptcy, we issued new
term debt with proceeds of $250.0 million and we paid $104.0 million in restructuring costs and $26.6
million in deferred financing fees relating to the bankruptcy and new term debt. We also paid $10.9
42
million of principal payments on the debt existing prior to bankruptcy and three quarters of principal
payments related to the new term debt totaling $1.9 million. During 2011, we issued secured notes with
proceeds of $300.0 million and we paid $150.0 million to retire the 7.2% secured notes that matured on
March 15, 2011. We also made principal payments on our long term debt totaling $43.5 million and paid
approximately $10.5 million of fees in connection with the issuance of the $300.0 million 10.5% Senior
Notes.
Net cash provided by financing activities was $96.0 million for the year ended December 31, 2011, which
was $306.1 million lower than the net cash provided by financing activities for the year ended December
31, 2010. During 2011, we received $300.0 million through a 10.5% Senior Notes offering and paid $8.8
million for fees associated with that offering. We also paid $1.6 million of deferred financing fees related
to the amendments to our accounts receivable securitization facility. We paid $150.0 million to retire the
7.2% secured notes that matured on March 15, 2011. During the year ended December 31, 2010, we
raised $649.6 million, net of fees, from our rights offering. Offsetting this inflow was a payment of $43.7
million of related restructuring costs.
Unlevered Free Cash Flow
Unlevered Free Cash Flow was $48.5 million for the year ended December 31, 2012, which was $70.5
million lower than the $119.0 million unlevered free cash flow for the year ended December 31, 2011.
The decrease was primarily due to a negative impact of changes in our operating assets and liabilities
partially offset by decreases in capital expenditures and stronger operating results.
Unlevered Free Cash Flow was $119.0 million for the year ended December 31, 2011, which was $110.1
million lower than the $229.1 million unlevered free cash flow for the year ended December 31, 2010.
The decrease was primarily due to lower operating results and a negative impact of changes in our
operating assets and liabilities.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. GAAP requires the use of estimates,
assumptions and judgments by management that affect the reported amounts of assets, liabilities, net
sales, expenses and related disclosure of contingent assets and liabilities in the amounts reported in the
financial statements and accompanying notes. On an on-going basis, we evaluate our estimates and
assumptions, including, but not limited to, book returns, allowance for bad debts, recoverability of
advances to authors, valuation of inventory, financial instruments, depreciation and amortization periods,
recoverability of long-term assets such as property, plant and equipment, capitalized pre-publication
costs, other identified intangibles, goodwill, deferred revenue, income taxes, pensions and other
postretirement benefits, contingencies, litigation and purchase accounting. We base our estimates on
historical experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual results may differ from those
estimates. For more information regarding our critical accounting policies, see Note 3 to our Financial
Statements.
Revenue Recognition
We derive revenue primarily from the sale of print and digital textbooks and instructional materials, trade
books, reference materials, multimedia instructional programs, license fees for book rights, content,
software and services that include test development, test scoring, consulting and training. Revenue from
print and digital textbooks and instructional materials, trade books, reference materials, assessment
materials and multimedia instructional programs is recognized in the period when persuasive evidence of
an arrangement with the customer exists, the products are shipped, title and risk of loss have transferred
to the customer, all significant obligations have been performed and collection is reasonably assured.
43
We enter into certain contractual arrangements that have multiple elements, one or more of which may be
delivered subsequent to the initial sale. These multiple deliverable arrangements may include print and
digital media, professional development, training services, software, software as a service (SaaS), and
various services related to the software including but not limited to hosting, maintenance and support, and
implementation. At the inception of these arrangements, consideration is allocated using the Relative
Sales Value (RSV) method. For each element, we determine whether the element falls under the
accounting guidance within multiple element arrangements or software revenue recognition. For
elements which fall under the accounting guidance for multiple element arrangements, we apply the
highest applicable relative selling price guidance available, Vendor Specific Objective Evidence (VSOE),
Third Party Evidence (TPE), or Best Estimate of Selling Price (BESP). For elements which fall under the
accounting guidance for software revenue recognition, we apply VSOE and the residual method. If we
are not able to establish VSOE, we estimate relative selling price based on TPE or BESP for purposes of
allocation of total project discount, and defer until all such elements are fulfilled assuming all other
revenue recognition criteria have been met. For multiple deliverable arrangements, fair value is
determined for all elements and the relative sales value of revenue for items to be delivered after the
initial sale is deferred until such time as the items are delivered. A significant component of revenue that
is deferred relates to gratis items delivered in connection with sales to customers within adoption states.
As our business model shifts to more digital and on-line learning components, additional revenue could
be deferred. As products are shipped with right of return, a provision for estimated returns on these sales
is made at the time of sale based on historical experience.
License fees for software products without future obligations are recognized upon delivery. Certain
contracts include software and on-going fees for maintenance and other support. If VSOE of the fair
value of each element of the arrangement exists, the elements of the contract are unbundled and the
revenue is recognized for each element when or as delivered. Revenue for test delivery, test scoring and
training are recognized when the services have been completed, the fee is fixed or determinable and
collection is reasonably assured. Revenue for test development is recognized as the services are
provided. Differences between what has been billed and what has been recognized as revenue is
recorded as deferred revenue. We enter into agreements to license certain book publishing rights and
content. We recognize revenue on such arrangements when all materials have been delivered to the
customer and collection is reasonably assured.
Accounts Receivable
Accounts receivable are recorded net of allowances for doubtful accounts and reserves for book returns.
In the normal course of business, we extend credit to customers that satisfy predefined criteria. We
estimate the collectability of our receivables. Allowances for doubtful accounts are established through
the evaluation of accounts receivable aging and prior collection experience to estimate the ultimate
collectability of these receivables. Reserves for book returns are based on historical return rates and
sales patterns.
Inventories
Inventories are stated at the lower of weighted average cost or net realizable value. The level of obsolete
and excess inventory is estimated on a program or title level-basis by comparing the number of units in
stock with the expected future demand. The expected future demand of a program or title is determined
by the copyright year, the previous years’ sales history, the subsequent year’s sales forecast, known
forward-looking trends including our development cycle to replace the title or program and competing
titles or programs.
Pre-publication costs
We capitalize the art, prepress, manuscript and other costs incurred in the creation of the master copy of
a book or other media (the “pre-publication costs”). Pre-publication costs are primarily amortized from the
year of copyright, or sale if earlier, over five years using the sum-of-the-years-digits method. This policy
is used throughout the Company, except for the Trade Publishing consumer books, which expenses such
44
costs as incurred, and the assessment products, which uses the straight-line amortization method. The
amortization methods and periods chosen best reflect the pattern of expected sales generated from
individual titles or programs. We periodically evaluate the remaining lives and recoverability of capitalized
pre-publication costs, which are often dependent upon program acceptance by state adoption authorities.
Amortization expense related to pre-publication costs for the years ended December 31, 2012 and 2011
were $137.7 million and $176.8 million, respectively. For the period January 1, 2010 to March 9, 2010
amortization expense related to pre-publication costs was $37.9 million and for the period March 10, 2010
to December 31, 2010 amortization expense related to pre-publication costs was $181.5 million
Pre-publication costs recorded on the balance sheet are periodically reviewed for impairment by
comparing the unamortized capitalized costs of the assets to the fair value of those assets.
For the years ended December 31, 2012 and 2011, the period January 1, 2010 to March 9, 2010, and the
period March 10, 2010 to December 31, 2010, pre-publication costs of $0.4 million, $33.5 million, zero
and $16.9 million, respectively, were deemed to be impaired. The impairment was included as a charge
to the statement of operations in the impairment charge for goodwill, intangible assets, pre-publication
costs and fixed assets caption.
Goodwill and indefinite-lived intangible assets
Goodwill is the excess of the purchase price paid over the fair value of the net assets of the business
acquired. Other intangible assets principally consist of branded trademarks and trade names, acquired
publishing rights and customer relationships. Goodwill and indefinite-lived intangible assets (certain trade
names) are not amortized but are reviewed at least annually for impairment or earlier, if an indication of
impairment exists. Recoverability of goodwill and indefinite lived intangibles is evaluated using a two-step
process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the fair
value of a reporting unit exceeds the carrying value of the net assets assigned to a reporting unit, goodwill
is considered not impaired and no further testing is required. If the carrying value of the net assets
assigned to a reporting unit exceeds the fair value of a reporting unit, the second step of the impairment
test is performed in order to determine the implied fair value of a reporting unit’s goodwill. Determining
the implied fair value of goodwill requires valuation of a reporting unit’s tangible and intangible assets and
liabilities in a manner similar to the allocation of purchase price in a business combination. If the carrying
value of a reporting unit’s goodwill exceeds its implied fair value, goodwill is deemed impaired and is
written down to the extent of the difference. We estimate total fair value of each reporting unit using
discounted cash flow analysis, and make assumptions regarding future revenue, gross margins, working
capital levels, investments in new products, capital spending, tax, cash flows and the terminal value of the
reporting unit. With regard to other intangibles with indefinite lives, we determine the fair value by asset,
which is then compared to its carrying value to determine if the assets are impaired.
Goodwill is allocated entirely to our Education reporting unit. Determining the fair value of a reporting unit
is judgmental in nature, and involves the use of significant estimates and assumptions. These estimates
and assumptions may include revenue growth rates and operating margins used to calculate projected
future cash flows, risk-adjusted discount rates, future economic and market conditions, the determination
of appropriate market comparables as well as the fair value of individual assets and liabilities. Consistent
with prior years, we used an income approach to establish the fair value of the reporting unit as of
October 1, 2012. As in prior years, we used the most recent five year strategic plan as the initial basis of
our analysis.
We completed our annual goodwill and indefinite-lived intangible asset impairment tests as of October 1,
2012, 2011, and 2010 and recorded a noncash impairment charge of $5.0 million for the year ended
December 31, 2012, $1,635.1 million for the year ended December 31, 2011 and $87.0 million for the
period March 10, 2010 to December 31, 2010. There was no impairment for the period January 1, 2010 to
March 9, 2010. The impairments principally related to one specific tradename within the Education
45
segment in 2012, goodwill and tradenames within the Education segment in 2011, and related to
tradenames within the Education segment and Trade Publishing segment in 2010. The impairment
charges resulted primarily from a decline in revenue from previously projected amounts as a result of the
economic downturn and reduced educational spending by states and school districts. All impairment
charges are included in operating income.
Publishing Rights
A publishing right is an acquired right which allows us to publish and republish existing and future works
as well as create new works based on previously published materials. We determine the fair market
value of the publishing rights arising from business combinations by discounting the after-tax cash flows
projected to be derived from the publishing rights and titles to their net present value using a rate of return
that accounts for the time value of money and the appropriate degree of risk. The useful life of the
publishing rights is based on the lives of the various copyrights involved. We calculate amortization using
the percentage of the projected operating income before taxes derived from the titles in the current year
as a percentage of the total estimated operating income before taxes over the remaining useful life.
Acquired publication rights, as well as customer-related intangibles with definitive lives, are primarily
amortized on an accelerated basis over periods ranging from three to 20 years.
Royalty advances
Royalty advances to authors are capitalized and represent amounts paid in advance of the sale of an
author’s product and are recovered as earned. As advances are recorded, a partial reserve may be
recorded immediately based primarily upon historical sales experience. Advances are evaluated
periodically to determine if they are expected to be recovered. Any portion of a royalty advance that is
not expected to be recovered is fully reserved.
Impact of inflation and changing prices
Although inflation is currently well below levels in prior years and has, therefore, benefited recent results,
particularly in the area of manufacturing costs, there are offsetting costs. Our ability to adjust selling
prices has always been limited by competitive factors and long-term contractual arrangements which
either prohibit price increases or limit the amount by which prices may be increased. Further, a weak
domestic economy at a time of low inflation could cause lower tax receipts at the state and local level,
and the funding and buying patterns for textbooks and other educational materials could be adversely
affected. Prices for paper moderated during the last three years
The most significant investments affected by inflation include pre-publication, other property, plant and
equipment and inventories. We use the weighted average cost method to value substantially all inventory.
We have negotiated favorable pricing through contractual agreements with our two top print and sourcing
vendors, and from our other major vendors, which has helped to stabilize our unit costs, and therefore our
cost of inventories sold. Our publishing business requires a high level of investment in pre-publication for
our educational and reference works, and in other property, plant and equipment. We expect to continue
to commit funds to the publishing areas through both internal growth and acquisitions. We believe that by
continuing to emphasize cost controls, technological improvements and quality control, we can continue
to moderate the impact of inflation on our operating results and financial position.
Covenant Compliance
As of December 31, 2012, we were in compliance with all of our debt covenants.
We are currently required to meet certain restrictive financial covenants as defined under our Term Loan
and Revolving Credit Facility. We have financial covenants primarily pertaining to interest coverage and
maximum leverage ratios. A breach of any of these covenants, ratios, tests or restrictions, as applicable,
for which a waiver is not obtained could result in an event of default, in which case our lenders could elect
46
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.
Contractual Obligations
The following table provides information with respect to our estimated commitments and obligations as of
December 31, 2012:
(in thousands)
Contractual Obligations
Total
Less than 1
year
1-3 years
3-5 years
More than 5
years
Term loan due May 2018 (1)
$ 248,125
$ 2,500
(dollars)
$ 5,000
$ 5,000
$ 235,625
Capital Leases
Operating leases (2)
Purchase obligations (3)
5,925
1,689
4,236
-
-
192,930
43,818
82,642
48,388
18,082
407,535
187,628
210,329
9,513
65
Total cash contractual obligations
$
854,515
$
235,635
$
302,207
$
62,901
$
253,772
(1)
The Term loan due May 2018 amortizes at a rate of 1% per annum of the original $250.0 million amount. Amounts in the table above
exclude interest payable on the Term loan.
(2)
Represents minimum lease payments under non-cancelable operating leases.
(3)
Purchase obligations are agreements to purchase goods or services that are enforceable and legally binding. These goods and services
consist primarily of author advances, subcontractor expenses, information technology licenses, and outsourcing arrangements.
In addition to the payments described above, we have employee benefit obligations that require future
payments. For example, we have made $19.8 million in cash contributions to our pension and
postretirement benefit plans in 2012 and expect to make another $13.5 million of contributions in 2013
relating to our pension and postretirement benefit plans although we are not obligated to do so. We
expect to periodically draw and repay borrowings under the accounts receivable securitization facility.
We believe that we will be able to meet our cash interest obligations on our outstanding debt when they
are due and payable.
Off-Balance Sheet Arrangement
We have no off-balance sheet arrangements.
47
Item 7A. 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 these derivative contracts change with
fluctuations in interest rates and/or currency rates and are designed so that any changes in their values
are offset by changes in the values of the underlying exposures. Derivative financial instruments are held
solely as risk management tools and not for trading or speculative purposes.
By their nature, all derivative instruments involve, to varying degrees, elements of market and credit risk
not recognized in our financial statements. The market risk associated with these instruments resulting
from currency exchange and interest rate movements is expected to offset the market risk of the
underlying transactions, assets and liabilities being hedged. Our policy is to deal with counterparties
having a single A or better credit rating at the time of the execution. We manage credit risk through the
continuous monitoring of exposures to such counterparties.
We continue to review liquidity sufficiency by performing various stress test scenarios, such as cash flow
forecasting which considers hypothetical interest rate movements. Furthermore, we continue to closely
monitor current events and the financial institutions that support our credit facility, including monitoring
their credit ratings and outlooks, credit default swap levels, capital raising and merger activity.
We have $248.1 million of aggregate principal amount indebtedness outstanding under our Term Loan
that bears interest at a variable rate. An increase or decrease of 1% in the interest rate will change our
interest expense by approximately $2.5 million on an annual basis. We also have up to $250.0 million of
borrowing availability, subject to borrowing base availability, under our Revolving Credit Facility, and
borrowings under the Revolving Credit Facility bear interest at a variable rate. We have no borrowings
outstanding under the Revolving Credit Facility at December 31, 2012. Assuming that the Revolving
Credit Facility is fully drawn, an increase or decrease of 1% in the interest rate will change our interest
expense associated with the Revolving Credit Facility by $2.5 million on an annual basis.
We conduct various digital development activities in Ireland, and as such, our cash flows and costs are
subject to fluctuations from changes in foreign currency exchange rates. We manage our exposures to
this market risk through the use of short-term forward exchange contracts, when deemed appropriate,
which were not significant as of December 31, 2012. We do not enter into derivative transactions or use
other financial instruments for trading or speculative purposes.
48
Item 8. Financial Statements and Supplementary Data
HMH Holdings (Delaware), Inc.
Financial Statements
Table of Contents
Page(s)
Reports of Independent Auditors………………………………………………………….…………………..50-51
Consolidated Balance Sheets .................................................................................................................... 52
Consolidated Statements of Operations .................................................................................................... 53
Consolidated Statements of Comprehensive Income (Loss) ..................................................................... 54
Consolidated Statements of Cash Flows ................................................................................................... 55
Consolidated Statements of Stockholders’ Equity (Deficit) ........................................................................ 56
Notes to Consolidated Financial Statements ...................................................................................... 57-104
49
Independent Auditor’s Report
To the Board of Directors and Stockholders of
HMH Holdings (Delaware), Inc.
We have audited the accompanying consolidated financial statements of HMH Holdings (Delaware), Inc. and its subsidiaries
(Successor), which comprise the consolidated balance sheets as of December 31, 2012 and 2011, and the related
consolidated statements of operations, comprehensive income (loss), stockholders’ equity (deficit), and cash flows for the
years ended December 31, 2012 and 2011 and for the period March 10, 2010 to December 31, 2010 (Successor Periods).
Management's Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance
with accounting principles generally accepted in the United States of America; this includes the design, implementation, and
maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are
free from material misstatement, whether due to fraud or error.
Auditor's Responsibility
Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our
audits in accordance with auditing standards generally accepted in the United States of America. Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are
free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated
financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material
misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we
consider internal control relevant to the Company's preparation and fair presentation of the consolidated financial statements
in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also
includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting
estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial
position of HMH Holdings (Delaware), Inc. and its subsidiaries at December 31, 2012 and December 31, 2011, and the
results of their operations and their cash flows for the years ended December 31, 2012 and 2011 and for the period March
10, 2010 to December 31, 2010 in accordance with accounting principles generally accepted in the United States of
America.
Other Matter
Our audit was conducted for the purpose of forming an opinion on the financial statements taken as a whole. The Schedule
II Valuation and Qualifying Accounts for the years ended December 31, 2012 and 2011 and for the period March 10, 2010 to
December 31, 2010 (Successor Periods) is presented for purposes of additional analysis and is not a required part of the
financial statements. The information is the responsibility of management and was derived from and relates directly to the
underlying accounting and other records used to prepare the financial statements. The information has been subjected to
the auditing procedures applied in the audit of the financial statements and certain additional procedures, including
comparing and reconciling such information directly to the underlying accounting and other records used to prepare the
financial statements or to the financial statements themselves and other additional procedures, in accordance with auditing
standards generally accepted in the United States of America. In our opinion, the information is fairly stated, in all material
respects, in relation to the financial statements taken as a whole.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 29, 2013
50
Report of Independent Auditors
To the Board of Directors and Stockholders of
HMH Holdings (Delaware), Inc.
In our opinion, the accompanying consolidated statements of operations, comprehensive income (loss), stockholders’
equity (deficit), and cash flows for the period January 1, 2010 to March 9, 2010 present fairly, in all material respects,
the results of operations and cash flows of HMH Publishing Company and its subsidiaries (Predecessor) for the
period January 1, 2010 to March 9, 2010 in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of
these statements in accordance with auditing standards generally accepted in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole.
The Schedule II Valuation and Qualifying Accounts for the period January 1, 2010 to March 9, 2010 is presented for
purposes of additional analysis and is not a required part of the financial statements. Such information has been
subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic financial statements taken as a whole.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 30, 2011
51
HMH Holdings (Delaware), Inc.
Consolidated Balance Sheets
December 31, 2012
(in thousands of dollars, except share information)
Assets
Current assets
Cash and cash equivalents
Restricted cash
Short-term investments
Accounts receivable, net of allowance for bad debts and book
returns of $36.4 million and $43.8 million, respectively
Inventories
Deferred income taxes
Prepaid expenses and other assets
Total current assets
Property, plant, and equipment, net
Pre-publication costs, net
Royalty advances to authors, net of allowance of $20.5 million and
$12.3 million, respectively
Goodwill
Other intangible assets, net
Other assets
Total assets
Liabilities and Stockholders' Equity (Deficit)
Current liabilities
Current portion of long-term debt
Accounts payable
Royalties payable
Salaries, wages, and commissions payable
Deferred revenue
Interest payable
Severance and other charges
Accrued postretirement benefits
Other liabilities
Total current liabilities
Long-term debt
Royalties payable
Long-term deferred revenue
Accrued pension benefits
Accrued postretirement benefits
Deferred income taxes
Other liabilities
Total liabilities
Commitments and contingencies (Note 14)
Stockholders' equity (deficit)
Preferred stock, $0.01 par value: 10,000,000 shares authorized; no shares
issued and outstanding at December 31, 2012
Common stock, $0.01 par value: 190,000,000 shares authorized;
69,958,989 shares issued and outstanding at December 31, 2012
and $0.001 par value: 600,000,000 shares authorized; 283,636,235
shares issued and outstanding at December 31, 2011
Treasury stock, 41,011 shares as of December 31, 2012
Capital in excess of par value
Accumulated deficit
Accumulated other comprehensive income (loss)
Total stockholders' equity (deficit)
Total liabilities and stockholders' equity (deficit)
December 31,
2012
December 31,
2011
$
329,078
-
146,041
$
413,610
26,495
-
229,118
197,613
42,858
13,731
958,439
149,227
256,202
256,271
242,162
14,152
13,811
966,501
152,212
289,125
48,247
520,088
1,067,052
30,329
3,029,584
$
42,700
520,088
1,274,213
19,064
3,263,903
$
$
2,500
86,416
60,352
34,730
124,216
87
18,290
2,342
30,421
359,354
245,625
2,070
171,105
48,714
27,231
124,588
107,196
1,085,883
$
43,500
130,128
52,294
43,515
141,763
30,843
35,750
2,252
45,612
525,657
2,968,088
1,313
208,173
64,490
33,718
32,072
104,944
3,938,455
-
-
700
-
4,741,765
(2,777,236)
(21,528)
1,943,701
3,029,584
$
284
-
2,038,714
(2,690,097)
(23,453)
(674,552)
3,263,903
$
The accompanying notes are an integral part of these consolidated financial statements.
52
HMH Holdings (Delaware), Inc.
Consolidated Statements of Operations
(in thousands of dollars)
Net sales
Costs and expenses
Cost of sales, excluding pre-publication and publishing
rights amortization
Publishing rights amortization
Pre-publication amortization
Cost of sales
Selling and administrative
Other intangible asset amortization
Impairment charge for goodwill, intangible assets,
pre-publication costs and fixed assets
Severance and other charges
Gain on bargain purchase
Gain on sale of assets
Operating loss
Other income (expense)
Interest expense
Other (loss) income, net
Change in fair value of derivative instruments
Loss before reorganization items and taxes
Reorganization items, net
Income tax expense (benefit)
Net loss
Successor
For the Year
Ended December
31, 2012
For the Year
Ended December
31, 2011
For the Period
March 10,
2010 to
December 31,
2010
Predecessor
For the Period
January 1,
2010 to
March 9,
2010
$
1,285,641
$
1,295,295
$
1,397,142
$
109,905
515,948
177,747
137,729
831,424
533,462
54,815
8,003
9,375
(30,751)
-
(120,687)
512,612
230,624
176,829
920,065
640,023
67,372
1,674,164
32,801
-
(2,000)
(2,037,130)
559,593
235,977
181,521
977,091
598,807
57,601
103,933
(11,243)
-
(1,179)
(327,868)
45,270
48,336
37,923
131,529
119,039
2,006
4,028
-
-
-
(146,697)
(123,197)
-
1,688
(242,196)
(149,114)
(5,943)
(87,139)
$
(244,582)
-
(811)
(2,282,523)
-
(100,153)
(2,182,370)
$
(258,174)
(6)
90,250
(495,798)
-
11,929
(507,727)
$
(157,947)
9
(7,361)
(311,996)
-
(220)
(311,776)
$
The accompanying notes are an integral part of these consolidated financial statements.
53
HMH Holdings (Delaware), Inc.
Consolidated Statements of Comprehensive Income (Loss)
(in thousands of dollars)
Net loss
Other comprehensive income (loss), net of taxes:
Foreign currency translation adjustments
Change in pension and benefit plan liability, net of tax expense
of $85 for 2012
Unrealized gain on short-term investments
Other comprehensive income (loss), net of taxes
Successor
For the Year
Ended December
31, 2012
For the Year
Ended December
31, 2011
For the Period
March 10,
2010 to
December 31,
2010
Predecessor
For the Period
January 1,
2010 to
March 9,
2010
$
(87,139)
$
(2,182,370)
$
(507,727)
$
(311,776)
(465)
2,378
12
1,925
(4,241)
(14,509)
181
(18,569)
1,829
(6,533)
(180)
(4,884)
392
(1,313)
-
(921)
Comprehensive loss
$
(85,214)
$
(2,200,939)
$
(512,611)
$
(312,697)
The accompanying notes are an integral part of these consolidated financial statements.
54
HMH Holdings (Delaware), Inc.
Consolidated Statements of Cash Flows
(in thousands of dollars)
Cash flows from operating activities
Net loss
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Noncash interest expense
Gain on bargain purchase
Gain on sale of assets
Depreciation and amortization expense
Amortization of debt discount and deferred financing costs
Deferred income taxes (benefit)
Noncash stock-based compensation expense
Noncash issuance of warrants
Reorganization items
Impairment charge for goodwill, intangible assets, pre-publication
costs and fixed assets
Allowance for loan receivable from officer
Change in fair value of derivative instruments
Changes in operating assets and liabilities, net of acquisitions
Accounts receivable
Inventories
Accounts payable and accrued expenses
Royalties, net
Deferred revenue
Interest payable
Severance and other charges
Accrued pension and postretirement benefits
Other, net
Net cash provided by (used in) operating activities
Cash flows from investing activities
Proceeds from (deposits into) restricted cash accounts
Proceeds from sale of short-term investments
Purchases of short-term investments
Additions to pre-publication costs
Additions to property, plant, and equipment
Proceeds from sale of assets
Acquisition of intangible asset
Acquisition of business, net of cash acquired
Net cash (used in) provided by investing activities
Cash flows from financing activities
(Payments) borrowings under receivables funding agreement
Proceeds from term loan
Payments of long-term debt
Payments of short-term debt
Proceeds from secured notes offering
Payments of deferred financing fees
Dividend to affiliate
Proceeds from issuance of common stock, net
Loan advances to officer
Payment of capital restructuring costs
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents
Beginning of period
Net increase (decrease) in cash and cash equivalents
End of period
Supplementary disclosure of cash flow information
Income taxes paid (refunded)
Interest paid
Deferred/contingent consideration for acquisitions, net (non cash)
Pre-publication costs included in accounts payable (non cash)
Property, plant, and equipment included in accounts payable (non cash)
Property, plant, and equipment acquired under capital leases (non cash)
Chapter 11 Reorganization (See Note 2)
March 2010 Restructuring (See Note 1)
Successor
For the Year
Ended
December 31,
2012
For the Year
Ended
December 31,
2011
For the Period
March 10,
2010 to
December 31,
2010
Predecessor
For the Period
January 1,
2010 to
March 9,
2010
$
(87,139)
$
(2,182,370)
$
(507,727)
$
(311,776)
-
(30,751)
-
428,422
24,584
(10,076)
6,254
10,747
(179,024)
8,003
-
(1,688)
25,826
44,549
(44,594)
9,478
(54,615)
4,912
(17,460)
(19,710)
(12,916)
104,802
26,495
19,575
(165,603)
(114,522)
(50,943)
-
-
(11,000)
(295,998)
-
250,000
(12,750)
-
-
(26,586)
-
-
-
(104,000)
106,664
(84,532)
-
-
(2,000)
532,996
46,249
(117,616)
8,559
-
-
1,674,164
-
811
(2,356)
39,825
18,488
5,778
110,993
18,013
4,570
(10,568)
(12,740)
132,796
16,751
17,800
-
(122,592)
(71,817)
150
(30,000)
(5,592)
(195,300)
-
-
(43,500)
(150,000)
300,000
(10,459)
-
-
-
-
96,041
33,537
-
-
(1,179)
523,651
37,040
11,708
4,274
-
-
103,933
18,875
(90,250)
(27,996)
98,329
(13,145)
11,653
130,683
(49,328)
(30,977)
(19,003)
(17,575)
182,966
(42,745)
-
(17,978)
(96,613)
(64,139)
2,177
-
(12,824)
(232,122)
(140,000)
-
(43,640)
-
-
-
-
649,600
(20,000)
(43,671)
402,289
353,133
20,737
-
-
99,260
13,680
(220)
925
-
-
4,028
-
7,361
86,787
(22,741)
(30,990)
(9,867)
(9,539)
118,423
(4,257)
1,297
(4,404)
(41,296)
-
-
-
(22,057)
(3,559)
-
-
-
(25,616)
2,350
-
-
-
-
-
(2,500)
-
-
-
(150)
(67,062)
413,610
(84,532)
329,078
$
380,073
33,537
413,610
$
26,940
353,133
380,073
$
94,002
(67,062)
26,940
$
$
7,699
92,481
-
(10,630)
1,438
4,799
$
2,825
180,647
4,695
-
-
-
$
(2,210)
268,925
(15,626)
-
-
-
$
855
4,847
-
-
-
-
The accompanying notes are an integral part of these consolidated financial statements.
55
HMH Holdings (Delaware), Inc.
Consolidated Statements of Stockholders’ Equity (Deficit)
(in thousands of dollars, except share information)
Shares
Par Value
Com m on Stock
Treasury Stock
Predecessor Com pany
Capital
in excess
of Par
Value
Accum ulated
Deficit
Accum ulated
Other
Com prehensive
Incom e (Loss)
Total
Balance at Decem ber 31, 2009
Net loss
Other comprehensive income (loss)
Stock compensation
Dividend to aff iliate
Recapitalization of amounts due from Parent
Balance at March 9, 2010
3,100
-
-
-
-
-
3,100
$
-
-
-
-
-
-
$
-
$
-
-
-
-
-
-
$
-
2,135,798
-
-
925
(2,500)
(1,154)
2,133,069
(4,734,442)
(311,776)
-
-
-
-
(5,046,218)
(16,092)
-
(921)
-
-
-
(17,013)
(2,614,736)
(311,776)
(921)
925
(2,500)
(1,154)
(2,930,162)
$
$
$
$
$
$
$
$
Successor Com pany
(in thousands of dollars, except share information)
Shares
Par Value
Treasury Stock
Com m on Stock
Capital
in excess
of Par
Value
Balance at March 10, 2010
Net loss
Other comprehensive income (loss)
Issuance of common stock, net
Stock compensation
Balance at Decem ber 31, 2010
Net loss
Other comprehensive income (loss)
Stock compensation
Balance at Decem ber 31, 2011
Net loss
Other comprehensive income (loss), net of tax
expense of $85
Issuance of common stock
Gain on debt-for-equity exchange, net of tax
expense of $73,801
Issuance of w arrants
Stock compensation
Addition of treasury stock, 41,011 shares
Balance at Decem ber 31, 2012
129,999,970
-
-
153,636,265
-
283,636,235
-
-
-
283,636,235
-
-
$
$
130
-
-
154
-
284
-
-
-
284
-
-
-
$
-
-
-
-
-
-
-
-
-
$
-
-
1,376,435
-
-
649,446
4,274
2,030,155
-
-
8,559
2,038,714
-
-
$
$
Accum ulated
Deficit
-
$
(507,727)
-
-
-
(507,727)
(2,182,370)
-
-
(2,690,097)
(87,139)
-
$
Accum ulated
Other
Com prehensive
Incom e (Loss)
Total
-
$
-
(4,884)
-
-
(4,884)
-
(18,569)
-
(23,453)
-
1,925
$
$
1,376,565
(507,727)
(4,884)
649,600
4,274
1,517,828
(2,182,370)
(18,569)
8,559
(674,552)
(87,139)
1,925
$
69,958,989
(283,636,235)
700
(284)
-
-
1,749,300
936,750
-
-
-
-
1,750,000
936,466
-
-
-
69,958,989
-
-
-
700
$
-
-
-
$
-
10,747
6,254
-
4,741,765
$
-
-
-
(2,777,236)
$
-
-
-
(21,528)
$
10,747
6,254
-
1,943,701
$
The accompanying notes are an integral part of these consolidated financial statements.
56
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
1.
Basis of Presentation
HMH Holdings (Delaware), Inc., ("HMH", “Houghton Mifflin Harcourt”, “we”, “us”, “our”, or the
“Company”), is a leading global education and learning company providing innovative solutions and
approaches to the challenges facing education today. We are one of the world’s largest providers
of educational products and solutions for pre-K–12 learning and we also develop and deliver
interactive, results-driven learning solutions that advance teacher effectiveness and student
achievement in the Education market. Furthermore, since 1832, we have published trade and
reference materials including award-winning adult and children’s books, fiction, and nonfiction.
The consolidated December 31, 2012 and 2011 financial statements of HMH include the accounts
of all of our wholly-owned subsidiaries as of and for the periods ended December 31, 2012,
December 31, 2011, December 31, 2010 and March 9, 2010. Prior to the March 2010
Restructuring noted below, our operations were held by HMH Publishing Company ("HMH
Publishing" or “Predecessor”), a wholly-owned subsidiary of Education Media and Publishing
Group Limited ("EMPG" or "Former Parent") formed through the combination of Houghton Mifflin
and Harcourt Education (both education learning companies) and Riverdeep Group Limited, a
digital publishing business. Throughout the notes to the consolidated financial statements, both
HMH and HMH Publishing are referred to collectively as the “Company”.
The accompanying consolidated financial statements have been prepared in accordance with
principles generally accepted in the United States of America (“GAAP”). All intercompany accounts
and transactions have been eliminated.
Seasonality and Comparability
Our net sales, operating profit and operating cash flows are impacted by the inherent seasonality of
the academic calendar. Consequently, the performance of our businesses may not be comparable
quarter to consecutive quarter and should be considered on the basis of results for the whole year
or by comparing results in a quarter with results in the same quarter for the previous year.
Schools make most of their purchases in the second and third quarters of the calendar year in
preparation for the beginning of the school year. Thus, over the past three years, approximately
69% of consolidated net sales have historically been realized in the second and third quarters.
Sales of K-12 instructional materials and customized testing products are also cyclical, with some
years offering more sales opportunities than others. The amount of funding available at the state
level for educational materials also has a significant effect on year-to-year revenue. 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 revenue
performance.
Chapter 11 Reorganization
On May 10, 2012, we entered into a Restructuring Support Agreement (“Plan Support Agreement”)
with consenting creditors holding greater than 74% of the principal amount of the outstanding senior
secured indebtedness of the Company and with equity owners holding approximately 64% of the
Company’s outstanding common stock. The consenting creditors agreed to support the Company’s
Pre-Packaged Chapter 11 Plan of Reorganization (“Plan”). Pursuant to the Plan Support
Agreement, the Company agreed to use its best efforts to (i) support and complete the restructuring
and all transactions contemplated by the Plan (as defined below), (ii) take any and all necessary
and appropriate actions in furtherance of the restructuring contemplated under the Plan, (iii)
complete the restructuring and all transactions contemplated under the Plan within set time-frames,
(iv) obtain any and all required regulatory and/or third-party approvals for the restructuring, and (v)
not directly or indirectly, seek, solicit, support, or engage in the negotiation or formulation of
alternate plans of reorganization that were inconsistent with the reorganization as contemplated by
the Plan Support Agreement.
57
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
On May 21, 2012 (the “Petition Date”), the U.S. based entities that borrowed or guaranteed the debt
of the Company (collectively the “Debtors”), filed voluntary petitions for relief under Chapter 11 of
the federal bankruptcy laws in the United States Bankruptcy Court for the Southern District of New
York (“Court”). Concurrently therewith, the Debtors also filed the Plan, the Disclosure Statement in
support of the Plan and filed various motions seeking relief to continue operations. Following the
Petition Date, the Debtors operated their business as “debtors in possession” (“DIP”) under the
jurisdiction of the Court and in accordance with the applicable provisions of the Bankruptcy Code
and orders of the Court. Under Chapter 11 of the United States Bankruptcy Code (“Chapter 11”),
certain claims against us in existence before the Petition Date were stayed while we operated our
business as a DIP including any actions that might be commenced with regards to secured claims,
although the holders of such claims had the right to move the Court for relief from the stay.
Subsequent to the Petition Date, these claims were reflected in the balance sheet as liabilities
subject to compromise. Secured claims were secured primarily by liens on the Company’s
accounts receivable. Additional claims (liabilities subject to compromise) could have potentially
arisen after the filing date resulting from rejection of executory contracts or from the determination
by the Court (or agreed to by parties in interest).
On June 22, 2012, the Company successfully emerged from bankruptcy as a reorganized company
pursuant to the Plan. Ultimately, the Debtors did not reject any executory contracts during the
bankruptcy case, and the Company continues to review and reconcile claims that were filed against
it by creditors.
March 2010 Restructuring
As a result of lower than expected operating results beginning in the latter half of 2008 and
continuing through 2009, primarily due to a downturn in the economy and state budget deficits
adversely affecting many of our customers, we failed several of our debt covenants and faced
liquidity constraints. Waivers were obtained from our first lien lenders and mezzanine lenders for
the covenant violations through March 9, 2010.
On March 9, 2010, the Company and its first lien and mezzanine lenders and its shareholders
consummated a restructuring of the Company (the “Restructuring”). As part of the Restructuring, a
new legal entity was formed, HMH Holdings (Delaware), Inc., to hold all of the assets of the
operating companies. On March 9, 2010, the then-existing senior secured lenders in the first lien
credit facility received 90% (pre-dilution from the rights offering noted below) of the equity in HMH,
in exchange for converting $1,983.7 million of their senior secured position in the first lien credit
agreement to equity in HMH. The then-existing mezzanine lenders received 10% of the equity of
HMH (pre-dilution from the rights offering) and 40,519,431 warrants at a strike price of $12.26, in
exchange for converting all of their $2,124.8 million subordinated secured position in the
mezzanine credit agreement to equity. The former shareholder, EMPG, cancelled its equity
ownership in the Company in exchange for 18,956,473 warrants with a strike price of $22.32.
Additionally, on March 9, 2010, HMH raised $650.0 million of new equity capital through a rights
offering from the then-existing senior secured and mezzanine lenders who agreed to convert a
portion of their first lien and mezzanine positions to equity. The proceeds were used to pay
transaction fees, accrued interest and fund working capital needs.
As a result of this change in control, we applied the acquisition method of accounting, as required
by authoritative literature. Accordingly, the consolidated financial statements prior to the closing of
the Restructuring reflect the historical accounting basis in the assets and liabilities and are labeled
Predecessor Company, while such records subsequent to the Restructuring are labeled Successor
Company and reflect the fair values determined as part of applying the acquisition method. This is
presented in the consolidated financial statements by a vertical black line division which appears
between the columns labeled Predecessor and Successor in the financial statements and the
58
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
relevant notes. The black line signifies that the periods prior to the Restructuring are not
comparable.
A valuation was performed to determine the acquisition price using the Income Approach
employing a Discounted Cash Flow (“DCF”) methodology. The DCF method explicitly recognizes
that the value of a business enterprise is equal to the present value of the cash flows that are
expected to be available for distribution to the equity and/or debt holders of a company. In the
valuation of a business enterprise, indications of value are developed by discounting future net
cash flows available for distribution to their present worth at a rate that reflects both the current
return requirements of the market and the risk inherent in the specific investment.
We used a multi-year DCF model to derive a Total Invested Capital value which was adjusted for
cash, non-operating assets, debt and any negative net working capital to calculate a Business
Enterprise Value of approximately $5.0 billion which was then used to value our equity. In
connection with the Income Approach portion of this exercise, we made the following assumptions:
(1) the discount rate was based on an average of a range of scenarios with rates between 8.6%
and 11.4%; (2) management’s estimates of future performance of our operations; and (3) a
terminal growth rate of 3.5%. The discount rate and market growth rate reflect the risks associated
with the general economic pressure impacting both the economy in general and more specifically
the publishing industry. Costs and professional fees incurred as part of the refinancing totaled
$43.7 million and were recorded in other assets and long-term receivables in the Predecessor
Company and were treated as a reduction to the equity value in the Successor Company.
59
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
We finalized the valuation and completed the allocation of the business enterprise value. The
allocation of the business enterprise value at March 10, 2010 was as follows:
Cash and cash equivalents
Accounts receivable
Inventories
Note receivable - related party
Prepaid expenses and other assets
Property, plant, and equipment
Pre-publication costs
Royalty advances to authors
Goodwill
Other intangible assets
Other assets
Accounts payable
Royalties payable
Salaries, wages, and commissions payable
Deferred revenue
Interest payable
Interest rate swap liability
Severance and other charges
Accrued postretirement benefits
Other liabilities
Debt
Royalties payable
Accrued pension benefits
Accrued postretirement benefits
Deferred income taxes
Other liabilities
Total net assets
$
22,995
222,213
380,243
73
12,191
128,282
463,459
44,415
1,935,965
2,108,538
9,123
(105,688)
(34,621)
(46,872)
(107,609)
(30,517)
(121,891)
(62,157)
(2,443)
(124,761)
(3,009,212)
(3,243)
(80,026)
(31,526)
(153,003)
(37,363)
1,376,565
$
Subsequent Events
The Company has performed an evaluation of subsequent events through March 29, 2013, which
is the date the financial statements were issued.
2.
Chapter 11 Reorganization Disclosures
As discussed in Note 1, the Company filed voluntary petitions for relief under Chapter 11. On June
21, 2012, the Bankruptcy Court entered an order confirming and approving the Plan for the Debtors
and the Plan became effective and the transactions contemplated under the Plan were
consummated on June 22, 2012.
Subsequent to the Petition Date, the provisions in U.S. Generally Accepted Accounting Principles
guidance for reorganizations applied to the Company’s financial statements while it operated under
the provisions of Chapter 11. The accounting guidance did not change the application of generally
accepted accounting principles in the preparation of financial statements. However, it does require
that the financial statements, for periods including and subsequent to the filing of the Chapter 11
petition, distinguish transactions and events that are directly associated with the reorganization
from the ongoing operations of the business. Accordingly, all transactions (including, but not limited
to, all professional fees, realized gains and losses and provisions for losses) directly associated
with the reorganization and restructuring of our businesses are reported separately in the financial
60
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
statements. All such expense or income amounts are reported in reorganization items in the
accompanying consolidated statements of operations for the year ended December 31, 2012.
Summary of Emergence
On June 22, 2012, the Company successfully emerged from bankruptcy as a reorganized company
pursuant to the Plan after voluntarily filing for bankruptcy on May 21, 2012. The financial
restructuring realized by the confirmation of the Plan was accomplished through a debt-for-equity
exchange. The Plan deleveraged the Company’s balance sheet by eliminating the Company’s
secured indebtedness in exchange for new equity in the Company. Existing stockholders, in their
capacity as stockholders, received warrants for the new equity in the Company in exchange for the
existing equity.
Upon the Company’s emergence from Chapter 11 bankruptcy proceedings on June 22, 2012, the
Company was not required to apply fresh-start accounting based on U.S. Generally Accepted
Accounting Principles guidance for reorganizations due to the fact that the pre-petition holders who
owned more than 50% of the Company’s outstanding common shares immediately before
confirmation of the Plan received more than 50% of the Company’s outstanding common stock
upon emergence. Accordingly, a new reporting entity was not created for accounting purposes.
Below is a summary of the significant transactions affecting the Company’s capital structure as a
result of the effectiveness of the Plan.
Equity Transactions
On June 22, 2012, pursuant to the Plan, all of the issued and outstanding shares of common stock
of the Company, including all options, warrants or any other agreements to acquire shares of
common stock of the Company that existed prior to the Petition Date, were cancelled and in
exchange, holders of such interests received distributions pursuant to the terms of the Plan. As of
June 22, 2012, the authorized capital stock of the Company consists of (i) 190,000,000 shares of
common stock, of which 69,958,989 shares of common stock are issued and outstanding at
December 31, 2012, 3,684,211 shares of common stock which are reserved for issuance upon
exercise of warrants, and 8,187,135 shares of common stock which are reserved for issuance upon
exercise of certain other warrants and awards to be issued by the Company under the MIP (defined
below) and (ii) 10,000,000 shares of preferred stock, $0.01 par value per share, of which no shares
are issued and outstanding. There are no other outstanding obligations, warrants, options, or other
rights to subscribe for or purchase from the Company any class of capital stock of the Company.
On June 22, 2012, the Company issued an aggregate of 70,000,000 post-emergence shares of
new common stock pursuant to the final Plan on a pro rata basis to the holders of the then-existing
first lien term loan (the “Term Loan”), of which 41,011 are treasury shares as of December 31,
2012, the then-existing first lien revolving loan facility (the “Revolving Loan”), and 10.5% Senior
Notes as of the Petition Date. The Company relied on Section 1145(a)(1) of the Bankruptcy Code
to exempt from the registration requirements of the Securities Act of 1933, the issuance of such
new common stock.
A new Management Incentive Plan (“MIP”) became effective upon emergence. The MIP provides
for grants of options and restricted stock at a strike price equal to or greater than the fair market
value per share of common stock as of the date of the grant and reserved for management and
employees up to 10% of the new common stock of the Company. During 2012, the Company
granted to certain employees, including executive officers, stock options totaling 4,912,281 shares
of the Company’s common stock. Each of the stock options granted have an exercise price equal
to the fair market value and generally vest over a three or four year period. During 2012, the
Company granted 22,200 restricted stock units to independent directors which generally vest over a
61
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
one year period. As of December 31, 2012, there are 3,252,654 shares reserved for issuance
under the MIP.
In accordance with the Plan, each existing common stockholder received its pro rata share of
warrants to purchase 5% of the common stock of the Company, subject to dilution for equity awards
issued in connection with the MIP. The exercise price for the warrants is based upon a $3.1 billion
enterprise valuation of the Company, and the warrants have a term of seven years. All of the then-
existing common stock was extinguished on the effective date of the Plan. As of December 31,
2012, there are 3,684,211 shares reserved for issuance upon the exercise of such warrants. These
warrants are referred to as the “New Warrants.”
Debt Transactions
On June 22, 2012, the Company’s creditors converted the First Lien Credit Agreement consisting of
the Term Loan with an aggregate outstanding principal balance of $2.6 billion and the Revolving
Loan with an aggregate outstanding principal balance of $235.8 million, and the outstanding $300.0
million principal amount of 10.5% Senior Notes to 100 percent pro rata ownership of the Company’s
common stock, subject to dilution pursuant to the MIP and the exercise of the New Warrants
(described previously), and received $30.3 million in cash.
In connection with the Chapter 11 filing on May 22, 2012, the Company entered into a new $500.0
million senior secured credit facility (DIP facility), which converted into an exit facility on the
effective date of the emergence from Chapter 11. This exit facility consists of a $250.0 million
revolving credit facility, which is secured by the Company’s accounts receivable and inventory, and
a $250.0 million term loan credit facility. The proceeds of the exit facility were used to fund the
costs of the reorganization and are providing working capital to the Company since its emergence
from Chapter 11.
A summary of the transactions affecting the Company’s debt balances is as follows:
Debt balance prior to emergence from bankruptcy (including accrued interest)
Exchange of debt for new common shares
Elimination of debt discount and deferred financing fees
Adequate protection payments
Conversion fees
Professional fees
(Gain) loss on extinguishment
$
$
(3,142,234)
1,750,000
98,352
69,701
30,299
21,726
(1,172,156)
Reorganization Items
Reorganization items represent expense or income amounts that were recorded in the
consolidated financial statements as a result of the bankruptcy proceedings. Reorganization items
were incurred starting with the date of the bankruptcy filing through the date of bankruptcy
emergence. The gain from reorganization items for the year ended December 31, 2012 were as
follows:
62
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Adjusted to
Capital in excess
of par value
Reorganization
items, net
Total
$
$
Debt to equity conversion
Elimination of debt discount and deferred financing fees
Adequate protection payments
Conversion fees
Professional fees
(Gain) loss on extinguishment
Stock compensation
Issuance of warrants
Reorganization items, net
(1,392,234)
98,352
69,701
30,299
21,726
(1,172,156)
2,027
10,747
(1,159,382)
$
(1,199,549)
84,740
60,054
26,106
18,381
(1,010,268)
-
-
$
(1,010,268)
$
$
(192,685)
13,612
9,647
4,193
3,345
(161,888)
2,027
10,747
(149,114)
Liabilities Subject to Compromise
Certain pre-petition liabilities and indebtedness were subject to compromise under the Plan and
were reported at amounts allowed or expected to be allowed by the Court. A summary of liabilities
subject to compromise reflected in the consolidated balance sheet as of May 21, 2012 is as
follows:
May 21,
2012
$2,668,690 Term Loan due June 12, 2014
$235,751 Revolving Loan due December 12, 2013
$300,000 10.5% senior secured notes due June 1, 2019
Accrued interest
Total
$
$
2,570,815
235,751
300,000
35,668
3,142,234
As of December 31, 2012, there were no liabilities subject to compromise.
All pre-petition claims were considered liabilities subject to compromise at May 21, 2012. As
discussed above, the Term Loan, the Revolving Loan, the 10.5% Senior Notes, and the associated
accrued interest were exchanged for new common stock in the Company. There were no other
liabilities subject to compromise as of May 21, 2012. We honored other prepetition obligations,
including employee wages and trade payables in the ordinary course of business.
3.
Significant Accounting Policies
Principles of Consolidation
Our accompanying consolidated financial statements include the results of operations of the
Company and our wholly-owned subsidiaries. All material intercompany accounts and transactions
are eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires the use of estimates, assumptions and judgments by
management that affect the reported amounts of assets, liabilities, revenues, expenses, and
related disclosure of contingent assets and liabilities in the amounts reported in the financial
statements and accompanying notes. On an ongoing basis, we evaluate our estimates and
assumptions including, but not limited to, book returns, allowance for bad debts, recoverability of
advances to authors, valuation of inventory, depreciation and amortization periods, recoverability of
63
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
long-term assets such as property, plant, and equipment, capitalized pre-publication costs, other
identified intangibles, goodwill, deferred revenue, income taxes, pensions and other postretirement
benefits, contingencies, and litigation. We base our estimates on historical experience and on
various other assumptions that we believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying value of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from those estimates.
Revenue Recognition
We derive revenue primarily from the sale of print and digital textbooks and instructional materials,
trade books, reference materials, multimedia instructional programs, license fees for book rights,
content, software and services that include test development, test scoring, consulting and training.
Revenue from print and digital textbooks and instructional materials, trade books, reference
materials, assessment materials and multimedia instructional programs is recognized in the period
when persuasive evidence of an arrangement with the customer exists, the products are shipped,
title and risk of loss have transferred to the customer, all significant obligations have been
performed and collection is reasonably assured.
We enter into certain contractual arrangements that have multiple elements, one or more of which
may be delivered subsequent to the initial sale. These multiple deliverable arrangements may
include print and digital media, professional development, training services, software, software as a
service (SaaS), and various services related to the software including but not limited to hosting,
maintenance and support, and implementation. At the inception of these arrangements,
consideration is allocated using the Relative Sales Value (RSV) method. For each element, we
determine whether the element falls under the accounting guidance within multiple element
arrangements or software revenue recognition. For elements which fall under the accounting
guidance for multiple element arrangements, we apply the highest applicable relative selling price
guidance available, Vendor Specific Objective Evidence (VSOE), Third Party Evidence (TPE), or
Best Estimate of Selling Price (BESP). For elements which fall under the accounting guidance for
software revenue recognition, we apply VSOE and the residual method. If we are not able to
establish VSOE, we estimate relative selling price based on TPE or BESP for purposes of
allocation of total project discount, and defer until all such elements are fulfilled assuming all other
revenue recognition criteria have been met. For multiple deliverable arrangements, fair value is
determined for all elements and the relative sales value of revenue for items to be delivered after
the initial sale is deferred until such time as the items are delivered. A significant component of
revenue that is deferred relates to gratis items delivered in connection with sales to customers
within adoption states. As our business model shifts to more digital and on-line learning
components, additional revenue could be deferred. As products are shipped with right of return, a
provision for estimated returns on these sales is made at the time of sale based on historical
experience.
License fees for software products without future obligations are recognized upon delivery. Certain
contracts include software and on-going fees for maintenance and other support. If VSOE of the
fair value of each element of the arrangement exists, the elements of the contract are unbundled
and the revenue is recognized for each element when or as delivered. Revenue for test delivery,
test scoring and training are recognized when the services have been completed, the fee is fixed or
determinable and collection is reasonably assured. Revenue for test development is recognized as
the services are provided. Differences between what has been billed and what has been
recognized as revenue is recorded as deferred revenue. We enter into agreements to license
certain book publishing rights and content. We recognize revenue on such arrangements when all
materials have been delivered to the customer and collection is reasonably assured.
Advertising Costs and Sample Expenses
Advertising costs are charged to selling and administrative expenses as incurred. Advertising
costs were $6.7 million and $7.4 million for the years ended December 31, 2012 and 2011,
respectively. For the period January 1, 2010 to March 9, 2010, advertising costs were $1.1 million
64
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
and for the period March 10, 2010 to December 31, 2010 advertising costs were $5.1 million.
Sample expenses are charged to selling and administrative expenses when the samples are
shipped.
Cash and Cash Equivalents
Cash and cash equivalents consist primarily of cash in banks and highly liquid investment
securities that have maturities of three months or less when purchased. The carrying amount of
cash equivalents approximates fair value because of the short term maturity of these investments.
Restricted Cash
Restricted cash consists primarily of cash collateral for irrevocable standby letters of credit in
connection with property that we currently lease and performance and surety bonds.
Short-term Investments
Short-term investments typically consist of marketable securities with maturities between three and
twelve months at the balance sheet date. We have classified all of our short-term investments as
available-for-sale at December 31, 2012. The investments are reported at fair value, with any
unrealized gains or losses excluded from earnings and reported as a separate component of
stockholders’ equity as other comprehensive income (loss).
Accounts Receivable
Accounts receivable are recorded net of allowances for doubtful accounts and reserves for book
returns. In the normal course of business, we extend credit to customers that satisfy predefined
criteria. We estimate the collectability of our receivables. Allowances for doubtful accounts are
established through the evaluation of accounts receivable aging and prior collection experience to
estimate the ultimate collectability of these receivables. Reserves for book returns are based on
historical return rates and sales patterns.
Inventories
Inventories are stated at the lower of weighted average cost or net realizable value. The level of
obsolete and excess inventory is estimated on a program or title level-basis by comparing the
number of units in stock with the expected future demand. The expected future demand of a
program or title is determined by the copyright year, the previous years’ sales history, the
subsequent year’s sales forecast, known forward-looking trends including our development cycle to
replace the title or program and competing titles or programs.
Property, Plant, and Equipment
Property, plant, and equipment are stated at cost, or in the case of assets acquired in business
combinations, at fair value as of the acquisition date, less accumulated depreciation. Equipment
under capital lease is stated at fair value at inception of the lease, less accumulated depreciation.
Maintenance and repair costs are charged to expense as incurred, and renewals and
improvements that extend the useful life of the assets are capitalized.
Depreciation on property, plant, and equipment is calculated using the straight-line method over the
estimated useful lives of the assets or, in the case of assets acquired in business combinations,
over their remaining lives. Equipment held under capital leases and leasehold improvements are
amortized using the straight-line method over the shorter of the lease term or estimated useful life
of the asset. Estimated useful lives of property, plant, and equipment are as follows:
65
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Building and building equipment
Machinery and equipment
Capitalized software
Leasehold improvements
Estimated
Useful Life
10 to 35 years
2 to 15 years
3 to 5 years
Lesser of useful life or lease term
Capitalized Internal-Use and External-Use Software
Capitalized internal-use and external-use software is included in property, plant and equipment on
the consolidated balance sheets.
We capitalize certain costs related to obtaining or developing computer software for internal use.
Costs incurred during the application development stage, including external direct costs of
materials and services, and payroll and payroll related costs for employees who are directly
associated with the internal-use software project, are capitalized and amortized on a straight-line
basis over the expected useful life of the related software. The application development stage
includes design, software configuration and integration, coding, hardware installation and testing.
Costs incurred during the preliminary stage, as well as maintenance, training and upgrades that do
not result in additional functionality are expensed as incurred.
Certain computer software development costs for software that is to be sold or marketed are
capitalized in the consolidated balance sheets. Capitalization of computer software development
costs begins upon the establishment of technological feasibility. We define the establishment of
technological feasibility as a working model. Amortization of capitalized computer software
development costs is provided on a product-by-product basis using the straight-line method,
beginning upon commercial release of the product, and continuing over the remaining estimated
economic life of the product. The carrying amounts of computer software development costs are
periodically compared to net realizable value and impairment charges are recorded, as appropriate,
when amounts expected to be realized are lower.
66
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
We review internal and external software development costs for impairment. For the year ended
December 31, 2012 and 2011, software development costs of $2.6 million and $5.6 million,
respectively, were impaired. For the period January 1, 2010 to March 9, 2010 software
development costs of $4.0 million were impaired. There were no software development cost
impairments for the period March 10, 2010 to December 31, 2010. All impairments were included
as a charge to the statement of operations in the impairment charge for goodwill, intangible assets,
pre-publication costs and fixed assets caption.
Pre-publication costs
We capitalize the art, prepress, manuscript and other costs incurred in the creation of the master
copy of a book or other media (the “pre-publication costs”). Pre-publication costs are primarily
amortized from the year of copyright, or sale if earlier, over five years using the sum-of-the-years-
digits method. This policy is used throughout the Company, except for the Trade Publishing
consumer books, which expenses such costs as incurred, and the assessment products, which
uses the straight-line amortization method. The amortization methods and periods chosen best
reflect the pattern of expected sales generated from individual titles or programs. We periodically
evaluate the remaining lives and recoverability of capitalized pre-publication costs, which are often
dependent upon program acceptance by state adoption authorities.
Amortization expense related to pre-publication costs for the years ended December 31, 2012 and
2011 were $137.7 million and $176.8 million, respectively. For the period January 1, 2010 to
March 9, 2010 amortization expense related to pre-publication costs was $37.9 million and for the
period March 10, 2010 to December 31, 2010 amortization expense related to pre-publication costs
was $181.5 million
Pre-publication costs recorded on the balance sheet are periodically reviewed for impairment by
comparing the unamortized capitalized costs of the assets to the fair value of those assets. For the
years ended December 31, 2012 and 2011, the period January 1, 2010 to March 9, 2010, and the
period March 10, 2010 to December 31, 2010, pre-publication costs of $0.4 million, $33.5 million,
zero and $16.9 million, respectively, were deemed to be impaired. The impairment was included
as a charge to the statement of operations in the impairment charge for goodwill, intangible assets,
pre-publication costs and fixed assets caption.
Goodwill and indefinite-lived intangible assets
Goodwill is the excess of the purchase price paid over the fair value of the net assets of the
business acquired. Other intangible assets principally consist of branded trademarks and trade
names, acquired publishing rights and customer relationships. Goodwill and indefinite-lived
intangible assets (certain trade names) are not amortized but are reviewed at least annually for
impairment or earlier, if an indication of impairment exists. Recoverability of goodwill and indefinite
lived intangibles is evaluated using a two-step process. In the first step, the fair value of a reporting
unit is compared to its carrying value. If the fair value of a reporting unit exceeds the carrying value
of the net assets assigned to a reporting unit, goodwill is considered not impaired and no further
testing is required. If the carrying value of the net assets assigned to a reporting unit exceeds the
fair value of a reporting unit, the second step of the impairment test is performed in order to
determine the implied fair value of a reporting unit’s goodwill. Determining the implied fair value of
goodwill requires valuation of a reporting unit’s tangible and intangible assets and liabilities in a
manner similar to the allocation of purchase price in a business combination. If the carrying value
of a reporting unit’s goodwill exceeds its implied fair value, goodwill is deemed impaired and is
written down to the extent of the difference. We estimate total fair value of each reporting unit
using discounted cash flow analysis, and make assumptions regarding future revenue, gross
margins, working capital levels, investments in new products, capital spending, tax, cash flows and
the terminal value of the reporting unit. With regard to other intangibles with indefinite lives, we
67
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
determine the fair value by asset, which is then compared to its carrying value to determine if the
assets are impaired.
Goodwill is allocated entirely to our Education reporting unit. Determining the fair value of a
reporting unit is judgmental in nature, and involves the use of significant estimates and
assumptions. These estimates and assumptions may include revenue growth rates and operating
margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic
and market conditions, the determination of appropriate market comparables as well as the fair
value of individual assets and liabilities. Consistent with prior years, we used an income approach
to establish the fair value of the reporting unit as of October 1, 2012. As in prior years, we used the
most recent five year strategic plan as the initial basis of our analysis.
We completed our annual goodwill and indefinite-lived intangible asset impairment tests as of
October 1, 2012, 2011, and 2010 and recorded a noncash impairment charge of $5.0 million for the
year ended December 31, 2012, $1,635.1 million for the year ended December 31, 2011 and $87.0
million for the period March 10, 2010 to December 31, 2010. There was no impairment for the
period January 1, 2010 to March 9, 2010. The impairments principally related to one specific
tradename within the Education business in 2012, goodwill and tradenames within the Education
business in 2011, and related to tradenames within the Education business and Trade Division in
2010. The impairment charges resulted primarily from a decline in revenue from previously
projected amounts as a result of the economic downturn and reduced educational spending by
states and school districts.
Publishing Rights
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. We determine the fair
market value of the publishing rights arising from business combinations by discounting the after-
tax cash flows projected to be derived from the publishing rights and titles to their net present value
using a rate of return that accounts for the time value of money and the appropriate degree of risk.
The useful life of the publishing rights is based on the lives of the various copyrights involved. We
calculate amortization using the percentage of the projected operating income before taxes derived
from the titles in the current year as a percentage of the total estimated operating income before
taxes over the remaining useful life. Acquired publication rights, as well as customer-related
intangibles with definitive lives, are primarily amortized on an accelerated basis over periods
ranging from three to 20 years.
Impairment of other long-lived assets
We review our other long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be fully recoverable. If the
future undiscounted cash flows are less than their book value, impairment exists. The impairment
is measured as the difference between the book value and the fair value of the underlying asset.
Fair value is normally determined using a discounted cash flow model.
Severance
We accrue postemployment benefits if the obligation is attributable to services already rendered,
rights to those benefits accumulate, payment of benefits is probable, and amount of benefit is
reasonably estimated. Postemployment benefits include severance benefits.
Subsequent to recording such accrued severance liabilities, changes in market or other conditions
may result in changes to assumptions upon which the original liabilities were recorded that could
result in an adjustment to the liabilities.
68
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Royalty advances
Royalty advances to authors are capitalized and represent amounts paid in advance of the sale of
an author’s product and are recovered as earned. As advances are recorded, a partial reserve
may be recorded immediately based primarily upon historical sales experience. Advances are
evaluated periodically to determine if they are expected to be recovered. Any portion of a royalty
advance that is not expected to be recovered is fully reserved.
Income taxes
We record income taxes using the asset and liability method. Deferred income tax assets and
liabilities are recognized for future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective income
tax basis, and operating loss and tax credit carryforwards. Our consolidated financial statements
contain certain deferred tax assets which have arisen primarily as a result of interest expense
limitations, as well as other temporary differences between financial and tax accounting. We
establish a valuation allowance if the likelihood of realization of the deferred tax assets is reduced
based on an evaluation of objective verifiable evidence. Significant management judgment is
required in determining our provision for income taxes, our deferred tax assets and liabilities and
any valuation allowance recorded against those deferred tax assets. We evaluate the weight of all
available evidence to determine whether it is more likely than not that some portion or all of the
deferred income tax assets will not be realized.
We also evaluate any uncertain tax positions and only recognize the tax benefit from an uncertain
tax position if it is more likely than not that the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax benefits recognized in the
financial statements from such positions are then measured based on the largest benefit that has a
greater than 50 percent likelihood of being realized upon settlement. We record a liability for
unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a
tax return. Any change in judgment related to the expected ultimate resolution of uncertain tax
positions is recognized in earnings in the period in which such change occurs. Interest and
penalties, if any, related to unrecognized tax benefits are recorded in income tax expense.
Share-Based Compensation
Certain employees and or directors have been granted stock options and restricted stock awards in
both the predecessor and successor companys’ common stock. Stock based compensation
expense reflects the fair value of stock-based awards measured at the grant date and recognized
over the relevant service period. We estimate the fair value of each stock-based award on the
measurement date using either the current market price or the Black-Scholes option valuation
model. The Black-Scholes option valuation model incorporates assumptions as to stock volatility,
the expected life of the options, risk-free interest rate and dividend yield for time-vested stock
options and restricted stock. We recognize compensation cost on a straight-line basis over the
awards' vesting periods.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as changes in the equity of an enterprise except those
resulting from stockholder transactions. The amounts shown on the consolidated statements of
stockholders’ equity (deficit) and comprehensive income (loss) relate to the cumulative effect of
changes in pension liabilities, foreign currency translation gain and loss adjustments, and
unrealized gains and losses on short-term investments.
Foreign Currency Translation
The functional currency for each of our subsidiaries is the currency of the primary economic
environment in which the subsidiary operates, generally defined as the currency in which the entity
generates and expends cash. Foreign currency denominated assets and liabilities are translated
69
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
into United States dollars at current rates as of the balance sheet date and the revenue, costs and
expenses are translated at the average rates established during each reporting period. Cumulative
translation gains or losses are recorded in equity as an element of accumulated other
comprehensive income.
Financial instruments
Derivative financial instruments are employed to manage risks associated with interest rate
exposures and are not used for trading or speculative purposes. We recognize all derivative
instruments, such as interest rate swap agreements, in our consolidated balance sheets at fair
value. Changes in the fair value of derivatives are recognized periodically either in earnings or in
stockholders’ equity (deficit) as a component of accumulated other comprehensive income (loss),
depending on whether the derivative financial instrument qualifies for hedge accounting and, if so,
whether it qualifies as a fair value hedge or a cash flow hedge. Gains and losses on derivatives
designated as hedges, to the extent they are effective, are recorded in other comprehensive
income, and subsequently reclassified to earnings to offset the impact of the hedged items when
they occur. Changes in the fair value of derivatives not qualifying as hedges are reported in
earnings. Our interest rate swap agreements that existed during 2010 and terminated upon
expiration did not qualify for hedge accounting because we did not contemporaneously document
our hedging strategy upon entering into the hedging arrangements. The net interest paid or
received on interest rate swaps is recognized within net interest expense in the consolidated
statement of operations. There were no derivative instruments that qualified for hedge accounting
during 2011 and 2012.
Treasury Stock
We account for treasury stock under the cost method. When shares are reissued or retired from
treasury stock they are accounted for at an average price. Upon retirement the excess over par
value is charged against capital in excess of par value.
Recent Accounting Pronouncements
Recent accounting pronouncements, not included below, are not expected to have a material
impact on our consolidated financial position and results of operations.
In May 2011, the FASB issued new guidance for fair value measurements intended to achieve
common fair value measurement and disclosure requirements in U.S. GAAP and International
Financial Reporting Standards. The amended guidance provides a consistent definition of fair
value to ensure that the fair value measurement and disclosure requirements are similar between
U.S. GAAP and International Financial Reporting Standards. The amended guidance changes
certain fair value measurement principles and enhances the disclosure requirements, particularly
for Level 3 fair value measurements. On January 1, 2012, we adopted the amended guidance for
fair value measurements. The changes did not have a significant impact on our financial position,
results of operations or cash flows.
In June 2011, the FASB issued guidance that modified how comprehensive income is presented in
an entity’s financial statements. The guidance issued requires an entity to present the total of
comprehensive income, the components of net income, and the components of other
comprehensive income either in a single continuous statement of comprehensive income or in two
separate but consecutive statements and eliminates the option to present the components of other
comprehensive income as part of the statement of equity. On January 1, 2012, we adopted the
comprehensive income guidance and disclosed the components of comprehensive income in a
separate statement.
In September 2011, the FASB issued new guidance to simplify how entities test goodwill for
impairment. The amended guidance permits an entity to first assess qualitative factors to
determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the
70
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
fair value of a reporting unit is less than its carrying amount. If this is the case, companies will
need to perform a more detailed two-step goodwill impairment test which is used to identify
potential goodwill impairments and to measure the amount of goodwill impairment losses to be
recognized, if any. The amended guidance was effective for us beginning January 1, 2012. The
adoption of this update did not have a material impact on our financial statements.
In July 2012, the FASB issued an accounting standard update that amends the accounting
guidance on testing indefinite-lived intangible assets for impairment. The amendments in this
accounting standard update are intended to reduce complexity and costs by allowing an entity the
option to make a qualitative evaluation about the likelihood that an indefinite-lived intangible asset
is impaired to determine whether it should perform a quantitative impairment test. The
amendments also enhance the consistency of impairment testing guidance among long-lived asset
categories by permitting an entity to assess qualitative factors to determine whether it is necessary
to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment,
which is equivalent to the impairment testing requirements for other long-lived assets. The
amendments in this accounting standard update are effective for interim and annual impairment
tests performed for fiscal years beginning after September 15, 2012. We test indefinite-lived
intangible assets for impairment annually on October 1 or more frequently when events or changes
in circumstances indicate that impairment may have occurred. The accounting standard update will
be effective for us beginning in 2013. We believe the adoption of this update will not have a
material impact on our financial statements.
4.
Acquisitions
On November 5, 2012, we acquired certain asset product lines from a third party for a total
purchase price of approximately $11.0 million, which was paid in cash at closing. The acquisition
provides us with the copyrights, trademarks and intellectual property of the acquired product lines
for our Trade Publishing business. In connection with the acquisition, we entered into a transition
services agreement whereby the third party will provide certain transitional services to us for the
acquired product lines. Since the fair value assigned to the net assets acquired exceeded the
consideration paid, we recorded a $30.8 million gain on bargain purchase on the transaction in
2012. Intangible assets, author advances, and other assets recorded as part of the acquisition
totaled approximately $30.4 million, $6.2 million, and $5.1 million, respectively.
Prior Year Acquisitions
During 2011, we reduced the accrued contingent consideration recorded for one of our 2010
acquisitions by $6.3 million, as we determined we would not able to achieve certain EBITDA growth
targets and the projections for future growth were much lower than originally anticipated. In
accordance with the accounting guidance relating to the subsequent remeasurement of contingent
consideration, the amount was recorded as a decrease to the selling and administrative expenses
caption in our statement of operations for the year ended December 31, 2011.
During 2011, we completed two acquisitions for a total purchase price of approximately $6.5 million,
which is net of cash acquired. The purchase price consisted of approximately $5.6 million of cash
at closing and $0.9 million of accrued contingent consideration. The acquisitions provide us with
English as a second language course material for the international markets.
During 2010, we completed two acquisitions for a total purchase price of approximately $28.3
million, which is net of cash acquired. The purchase price consisted of approximately $12.9 million
of cash at closing, installment payments due over 5 years with a net present value of approximately
$4.1 million, and approximately $11.6 million of accrued contingent consideration. The acquisitions
provided us with a suite of educational technology software for students along with consulting
services to school districts throughout the United States.
71
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
The 2011 and 2010 transactions were accounted for under the acquisition method of accounting.
We allocated the purchase price to each company’s assets and liabilities assumed at estimated fair
values as of the acquisition dates. The excess of the purchase price over the net amounts
assigned to the fair value of the assets acquired and liabilities assumed was recorded as goodwill.
Goodwill and intangible assets recorded as part of the acquisitions totaled approximately $6.5
million and $0 in 2011 and $20.1 million and $6.9 million in 2010, respectively. The financial results
of each company acquired were included within our financial statements from their respective dates
of acquisition. The acquisitions were not considered to be material for purposes of additional
disclosure.
5.
Balance Sheet Information
Short-term Investments
The estimated fair value of our short-term investments classified as available for sale, is as follows:
Short-term investments:
U.S. Government and agency securities
December 31, 2012
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Estimated
Fair Value
$
$
146,029
146,029
$
$
12
12
$
-
$
-
$
$
146,041
146,041
The contractual maturities of our short-term investments are one year or less.
Account Receivable
Accounts receivable at December 31, 2012 and 2011 consisted of the following:
Accounts receivable
Allowance for bad debt
Reserve for returns
2012
2011
$
265,477
$
300,181
(10,575)
(25,784)
(18,296)
(25,614)
$
229,118
$
256,271
72
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Inventories
Inventories at December 31, 2012 and 2011 consisted of the following:
Finished goods
Raw materials
Inventory
2012
2011
$
192,382
$
236,350
5,231
5,812
$
197,613
$
242,162
Property, Plant, and Equipment
Balances of major classes of assets and accumulated depreciation and amortization at
December 31, 2012 and 2011 were as follows:
Land and land improvements
Building and building equipment
Machinery and equipment
Capitalized software
Leasehold improvements
2012
2011
$
6,629
$
6,629
16,512
44,384
222,799
23,831
314,155
16,322
37,452
176,276
22,131
258,810
Less: Accumulated depreciation and amortization
(164,928)
(106,598)
Property, plant, and equipment, net
$
149,227
$
152,212
For the year ended December 31, 2012 and 2011, depreciation and amortization expense related
to property, plant, and equipment were $58.1 million and $58.4 million, respectively. Depreciation
and amortization expense for the period January 1, 2010 to March 9, 2010 was $10.9 million and
for the period March 10, 2010 to December 31, 2010 was $48.6 million.
Property, plant, and equipment at December 31, 2012 include approximately $5.3 million acquired
under capital lease agreements of which the majority is included in machinery and equipment. The
future minimum lease payments required under non-cancelable capital leases as of December 31,
2012 is as follows: $1.7 million in 2013, $1.7 million in 2014, $1.6 million in 2015, and $0.9 million
in 2016.
Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) consisted of the following at December 31, 2012
and 2011:
Net change in pension and benefit plan liability
$
(18,664)
$
(21,042)
2012
2011
Foreign currency translation adjustments
Unrealized gain on short-term investments
(2,877)
13
(2,412)
1
$
(21,528)
$
(23,453)
73
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
6.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets consisted of the following:
December 31, 2012
December 31, 2011
Cost
Accumulated
Amortization
Cost
Accumulated
Amortization
Goodwill
Trademarks and tradenames
Publishing rights
Customer related and other
$
520,088
440,505
1,180,000
271,150
2,411,743
$
-
$
-
(644,348)
(180,255)
(824,603)
$
$
520,088
440,805
1,180,000
245,470
2,386,363
$
-
$
-
(466,601)
(125,461)
(592,062)
$
The changes in the carrying amount of goodwill for the years ended December 31, 2012 and 2011
are as follows:
Balance at December 31, 2010
Acquisitions
Impairment losses
Balance at December 31, 2011
Goodwill
Accumulated impairment losses
Balance at December 31, 2011
Goodwill
Accumulated impairment losses
Balance at December 31, 2012
$
1,956,071
6,517
(1,442,500)
520,088
1,962,588
(1,442,500)
520,088
1,962,588
(1,442,500)
520,088
$
We had goodwill of $520.1 million at December 31, 2012 and 2011. The additions to goodwill
relate to our acquisitions described in Note 4 of approximately $6.5 million for the year ended
December 31, 2011. The decrease in goodwill of $1,442.5 million for the year ended December
31, 2011 was due to goodwill impairment charges. There was no goodwill impairment charge for
the year ended December 31, 2012, for the period January 1, 2010 to March 9, 2010, or for the
period March 10, 2010 to December 31, 2010.
In accordance with the provisions of the accounting standard for goodwill and other intangible
assets, goodwill and certain indefinite-lived tradenames are not amortized. We recorded an
impairment charge of approximately $5.0 million, $192.6 million, and $87.0 million for certain of our
intangible assets at October 1, 2012, 2011, and 2010, respectively. Amortization expense for
publishing rights and customer related and other intangibles were $232.6 and $298.0 million for the
year ended December 31, 2012 and 2011, respectively. Amortization expense for publishing rights
and customer related and other intangibles were $50.3 million for the period January 1, 2010 to
March 9, 2010, and $293.6 million for the period March 10, 2010 to December 31, 2010.
On October 5, 2011, we entered into an agreement with EMPG International Limited (“EMPGI”), a
former related party, to terminate the 2008 license agreement between us and EMPGI. The
license agreement had provided EMPGI the rights to translate and prepare localized versions of
substantially all of our products, as well as change or create derivative versions and redistribute
such products in territories outside of our current presence. As a result of entering into the
agreement, certain international intellectual property rights were obtained for consideration of a
one-time payment of $30.0 million. This amount has been capitalized within other intangible assets
and is being amortized over a 20 year life.
74
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Estimated aggregate amortization expense expected for each of the next five years related to
intangibles subject to amortization is as follows:
2013
2014
2015
2016
2017
Thereafter
7.
Debt
Other
Publishing
Intangible
Rights
Assets
$
139,588
$
18,421
105,624
81,007
61,350
46,238
101,845
10,044
10,267
9,372
8,765
34,026
As described in Note 2, pursuant to the Plan, the holders of the Company’s debt converted the First
Lien Credit Agreement consisting of the Term Loan with an aggregate outstanding principal
balance of $2.6 billion and the Revolving Loan with an aggregate outstanding principal balance of
$235.8 million, and the outstanding $300.0 million principal amount of 10.5% Senior Notes to 100
percent pro rata ownership of the Company’s common stock. As described in Note 1, we
completed a Restructuring on March 9, 2010 converting $1,983.7 million of our then-existing Term
Loan and the entire balance of our then-existing Mezzanine Loan to equity.
Long-term debt at December 31, 2012 and 2011 consisted of the following:
$250,000 Term Loan due May 21, 2018
interest payable monthly
$2,668,690 Term Loan due June 12, 2014
$235,751 Revolving Loan due December 12, 2013
$300,000 10.5% Secured Notes due June 1, 2019,
interest payable semiannually
Less: Current portion of long-term debt
2012
2011
$
248,125
$
-
-
-
-
248,125
2,500
2,475,837
235,751
300,000
3,011,588
43,500
Total long-term debt, net of discount
$
245,625
$
2,968,088
75
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Long-term debt repayments due (at face value) in each of the next five years and thereafter is as
follows:
Year
2013
2014
2015
2016
2017
Thereafter
$
2,500
2,500
2,500
2,500
2,500
235,625
$
248,125
On May 26, 2011, we issued $300.0 million aggregate principal amount of our 10.5% Senior Notes,
which matured on June 1, 2019. The 10.5% Senior Notes accrued interest at 10.5% and interest
was paid semi-annually on June 1 and December 1. The 10.5% Senior Notes were pari passu to
our existing Term Loan. The proceeds from the 10.5% Senior Notes were used to provide for
working capital needs and to repay borrowings under the accounts receivable securitization facility.
We incurred approximately $8.2 million of professional fees to issue the 10.5% Senior Notes which
were capitalized in accordance with the applicable accounting guidance for debt issuance costs,
and were being amortized over the term of the debt.
On May 22, 2012, we entered into a new $500.0 million DIP facility which was converted into an
exit facility upon emergence from Chapter 11. This exit facility consists of a $250.0 million revolving
credit facility (“Revolving Credit Facility”), which is secured by the Company’s accounts receivable
and inventory, and a $250.0 million term loan credit facility (“Term Loan”). The Revolving Credit
Facility has a term of five years and the interest rate is determined by a combination of LIBOR rate
and average daily availability. No funds have been drawn on the Revolving Credit Facility as of
December 31, 2012. The Term Loan has a term of six years and the interest rate is based on the
LIBOR plus 6.0%. The actual LIBOR is subject to a minimum “floor” of 1.25%. As of December 31,
2012, the interest rate of the Term Loan is 7.25%. The proceeds of the Term Loan were used to
fund the costs of the reorganization and provide post-closing working capital to the Company.
On June 11, 2012 and June 20, 2012, respectively, we entered into Amendment No. 1 and
Amendment No. 2 to the Term Loan. Amendment No. 1 modified definitions by reducing LIBOR
from 1.50% to 1.25% along with a reduction in the interest rate from 6.25% to 6.0%. Amendment
No. 2 related to administrative matters modifying the notice requirement, which enabled the
Company to move from a DIP facility to an exit facility upon emergence from bankruptcy.
On June 20, 2012, we entered into Amendment No. 1 and Amendment No. 2 to our Revolving
Credit Facility. Amendment No. 1 modified definitions relating to administrative matters releasing
our restricted cash of $26.5 million, which was collateralizing our letters of credit. Amendment No.
2 modified certain provisions of the agreement with regard to same day borrowing.
The $2.6 billion Term Loan and $235.8 million Revolving Loan were all issued with a discount
equal to 4% of the borrowing commitment of each instrument. As of December 31, 2011, the
effective interest rates were 8.1% and 6.4% for the $2.6 billion Term Loan and $235.8 million
Revolving Loan, respectively. We have written off the remaining balance of deferred financing fees
as of March 10, 2010 relating to the issuance of the $2.6 billion Term Loan, then-existing
Mezzanine Loan and $235.8 million Revolving Loan. The discounts were being amortized over the
life of each debt arrangement as additional interest expense.
76
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Loan Covenants
We are required to meet certain restrictive financial covenants as defined under our Term Loan and
Revolving Credit Facility. We have financial covenants pertaining to interest coverage, maximum
leverage, and fixed charge ratios. The interest coverage ratios are set forth as follows: 7.0 to 1.0
for fiscal quarters ending during 2012, 8.0 to 1.0 for fiscal quarters ending during 2013, and 9.0 to
1.0 for fiscal quarters ending thereafter. The maximum leverage ratios are set forth as follows:
2.25 to 1.0 for fiscal quarters ending through September 30, 2013 and 2.0 to 1.0 for fiscal quarters
ending December 31, 2013 and thereafter. The fixed charge ratio, which only pertains to the
revolving credit facility and is only tested in limited situations, is 1.0 to 1.0 through the end of the
facility. As of December 31, 2012, we were in compliance with all of our debt covenants.
Receivables Funding Agreement
On August 4, 2010, HM Receivables Co. II, LLC (“HMRC II”), a subsidiary of us, entered into a
Receivables Funding and Administration Agreement (the “New Funding Agreement’), which
established a $250.0 million revolving credit facility, with a maturity date of August 4, 2013. The
interest rate was LIBOR based. All accounts receivables were held in a subsidiary of HMH, HMRC
II, which had entered into the aforementioned New Funding Agreement and amendments thereto.
Total HMRCII receivables on December 31, 2011 were $302.1 million. As of December 31, 2011,
$156.3 million of eligible receivables were pledged as collateral on the revolving credit facility, and
the receivables have been sold by originating subsidiaries to HMRC II. The assets of HMRC II
were not available to satisfy the obligations of our other subsidiaries. No LIBOR based rate was
elected as of December 31, 2011 insofar as the HMRCII facility had no borrowings. In connection
with the 2012 Chapter 11 Reorganization, HMRC II was terminated.
8.
Interest Swap Arrangements
We entered into interest rate swap agreements to manage our exposure to interest rate changes
as required under our First Lien Credit Agreement which had required, prior to the March 9, 2010
amendment, that at least 50% of the aggregate principal amount of our debt being effectively
subject to a fixed or maximum interest. The swaps effectively converted a portion of our variable
rate debt to a fixed rate, without exchanging the notional principal amounts.
We had entered into the following interest rate swap agreements with various financial institutions.
Effective date of swap
3/30/2007
12/31/2007
Expiration
Date
Notional
Amount
Interest
Rates
3/31/2010
$
814,370
4.999%–5.12%
12/31/2010
1,875,000
3.00%–4.715%
Our interest rate swaps were not designated as hedges and therefore did not qualify for hedge
accounting under the accounting standards for derivative instruments and hedging activities. Our
interest rate swaps expired in 2010. We had no other interest rate swaps outstanding as of
December 31, 2012 and 2011. We recorded an unrealized loss of $7.4 million for the period
January 1, 2010 to March 9, 2010, and a gain of $90.3 million for the period March 10, 2010 to
December 31, 2010 in our statement of operations to account for the changes in fair value of the
derivatives. Interest rate swap arrangements expensed and recorded in interest expense for the
period January 1, 2010 to March 9, 2010 were $23.3 million and for the period March 10, 2010 to
December 31, 2010 were $69.8 million.
77
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
9.
Severance and Other Charges
2012
During the year ended December 31, 2012, $19.2 million of severance payments were made to
employees whose employment ended in 2012 and prior years and $7.6 million of net payments for
office space no longer utilized by the Company. Further, we recorded an expense in the amount of
$9.4 million to reflect additional costs for severance and revised estimates for office space no
longer utilized in connection to our continuing strategic alignment of the business.
2011
On November 8, 2011, our Board of Directors approved a restructuring plan that was substantially
implemented in the fourth quarter of 2011. The plan included workforce reductions of up to
approximately 10% of the current workforce as part of an organizational realignment and a
reduction of operating costs. Accordingly, a severance charge of $28.8 million was recorded in
2011 to reflect the workforce reductions due to our organizational realignment. For the year ended
December 31, 2011, $18.3 million of severance payments were made to employees whose
employment ended in 2011 and prior years.
In the year ended December 31, 2011, the vacant space accrual was increased $4.0 million
primarily as a result of our exiting certain space. Additionally, during 2011, we paid $9.9 million of
payments for excess space where our committed payment obligations exceeded the sublease
income received.
2010
We recorded a reduction in severance expense for the period March 10, 2010 to December 31,
2010 of approximately $0.3 million in connection with revised cost estimates in relation to workforce
reductions of employees. These reductions were part of our continuing strategic integration of the
former Houghton and Harcourt businesses. During 2010, approximately $11.1 million of severance
payments were made to employees whose employment ended in 2010 and prior years.
As part of purchase accounting, we established a $48.0 million accrual for ongoing obligations to
pay rent for vacant space that could not be sublet or space that is expected to be sublet at rates
lower than the committed lease arrangements. The length of these obligations varies by lease with
the longest extending through 2019. Subsequently, we sublet vacant space more quickly and at
higher rates than previously estimated. Accordingly, the reserve initially established was reduced
by $11.5 million in the period ended December 31, 2010 to reflect the more recent positive sublet
experience.
A summary of the significant components of the severance/restructuring and other charges is as
follows:
78
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Successor Company
2012
Severance/
restructuring
accrual at
Severance/
restructuring
Severance/
restructuring
accrual at
December 31, 2011
expense
Cash payments
December 31, 2012
Severance cos ts
$
16,071
$
5,284
$
(19,213)
$
2,142
Other accruals
19,679
4,091
(7,622)
16,148
$
35,750
$
9,375
$
(26,835)
$
18,290
Successor Company
2011
Severance/
restructuring
accrual at
Severance/
restructuring
Severance/
restructuring
accrual at
December 31, 2010
expense
Cash payments
December 31, 2011
Severance cos ts
$
5,587
$
28,801
$
(18,317)
$
16,071
Other accruals
25,593
4,000
(9,914)
19,679
$
31,180
$
32,801
$
(28,231)
$
35,750
Successor Company
2010
Severance/
restructuring
accrual at
Severance/
restructuring
Severance/
restructuring
accrual at
March 10, 2010
expense
Cash payments
December 31, 2010
Severance cos ts
$
14,392
$
282
$
(9,087)
$
5,587
Other accruals
47,765
(11,525)
(10,647)
25,593
$
62,157
$
(11,243)
$
(19,734)
$
31,180
Predecessor Company
2010
Severance/
restructuring
accrual at
Severance/
restructuring
Severance/
restructuring
accrual at
December 31, 2009
expense
Cash payments
March 9, 2010
Severance cos ts
$
16,414
$
-
$
(2,022)
$
14,392
Other accruals
50,000
-
(2,235)
47,765
$
66,414
$
-
$
(4,257)
$
62,157
79
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
10.
Income Taxes
The components of loss before taxes by jurisdiction are as follows:
Successor
Company
For the Year
For the Year
Ended
Ended
For the Period
March 10, 2010
Predecessor
Company
For the Period
January 1, 2010 to
December 31, 2012
December 31, 2011
December 31, 2010
March 9, 2010
U.S.
Foreign
$
(47,755)
$
(2,187,025)
$
(406,627)
$
(292,665)
(45,327)
(95,498)
(89,171)
(19,331)
Loss before taxes
$
(93,082)
$
(2,282,523)
$
(495,798)
$
(311,996)
Total income taxes by jurisdiction are as follows:
Successor
Company
Predecessor
Company
For the Year
For the Year
For the Period
For the Period
Ended
Ended
March 10, 2010
January 1, 2010 to
December 31, 2012 December 31, 2011
December 31, 2010
March 9, 2010
Income tax expense (benefit)
U.S.
Foreign
$
(7,045)
$
(101,698)
$
18,477
$
499
1,102
1,545
(6,548)
(719)
$
(5,943)
$
(100,153)
$
11,929
$
(220)
Significant components of the expense (benefit) for income taxes attributable to loss from
continuing operations consist of the following:
Successor
Company
Predecessor
Company
For the Year
For the Year
For the Period
For the Period
Ended
Ended
March 10, 2010 to
January 1, 2010 to
December 31, 2012 December 31, 2011
December 31, 2010
March 9, 2010
Current
Foreign
U.S. - Federal
U.S. - State and other
Total current
Deferred
Foreign
U.S. - Federal
U.S. - State and other
Total deferred
$
1,102
$
3,958
$
-
$
-
-
3,031
4,133
-
(9,201)
(875)
(10,076)
-
13,506
17,464
(2,413)
(98,655)
(16,549)
(117,617)
(2,775)
4,207
1,432
(6,548)
15,465
1,580
10,497
-
499
499
(719)
-
-
(719)
Income tax expense (benefit)
$
(5,943)
$
(100,153)
$
11,929
$
(220)
80
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
The reconciliation of the income tax rate computed at the statutory tax rate to the reported income
tax expense (benefit) attributable to continuing operations is as follows:
Successor
Company
Predecessor
Company
For the Year
For the Year
For the Period
For the Period
Ended
Ended
March 10, 2010 to
January 1, 2010 to
December 31, 2012
December 31, 2011
December 31, 2010
March 9, 2010
Statutory rate
Permanent items
Goodwill impairment
Transfer pricing adjustments
Reorganization expense
Bargain purchase gain
Foreign rate differential
State and local taxes
Alternative Minimum Tax Credit
Increase in valuation allowance
Effective tax rate
(35.0)%
3.7
-
(0.1)
5.9
(11.6)
10.3
0.0
-
20.4
(6.4)%
(35.0)%
0.1
12.0
-
-
-
1.0
(0.4)
-
17.9
(4.4)%
(35.0)%
0.1
-
-
-
-
2.4
(2.5)
(0.6)
38.0
2.4 %
(12.5)%
0.1
-
-
-
-
(21.8)
-
-
34.1
(0.1)%
The significant components of the net deferred tax assets and liabilities are shown in the following
table:
Tax asset related to
Net operating loss and other carryforwards
$
40,358
$
111,185
2012
2011
Returns reserve/inventory expense
Pension and postretirement benefits
Interest
Deferred revenue
Deferred compensation
Other, net
Valuation allowance
Tax liability related to
Intangible assets
Depreciation and amortization expense
Other, net
74,523
19,968
537,624
105,714
13,601
18,927
(512,234)
298,481
(260,428)
(118,573)
(1,210)
(380,211)
86,235
26,291
507,741
130,803
30,392
17,943
(822,485)
88,105
(34,330)
(70,667)
(1,028)
(106,025)
Net deferred tax liabilities
$
(81,730)
$
(17,920)
The net deferred tax liability balance is stated at prevailing statutory income tax rates. Deferred tax
assets and liabilities are reflected on our consolidated balance sheets as follows:
81
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Current deferred tax assets
Noncurrent deferred tax liability
2012
2011
$
42,858
$
14,152
(124,588)
(32,072)
$
(81,730)
$
(17,920)
A reconciliation of the gross amount of unrecognized tax benefits, excluding accrued interest and
penalties, is as follows:
Predecessor Company
Balance at January 1, 2010
Additions based on tax positions related to the prior year
Additions based on tax positions related to the current year
Balance at March 9, 2010
Successor Company
Balance at March 10, 2010
Additions based on tax positions related to the prior year
Additions based on tax positions related to the current year
Reductions based on tax positions related to the prior year
Balance at December 31, 2010
Additions based on tax positions related to the prior year
Additions based on tax positions related to the current year
Balance at December 31, 2011
Reductions based on tax positions related to the prior year
Additions based on tax positions related to the current year
Balance at December 31, 2012
$
64,655
-
-
$
64,655
$
64,655
-
-
(243)
$
64,412
-
-
$
64,412
(105)
-
$
64,307
At December 31, 2012, we had $64.3 million of gross unrecognized tax benefits (excluding interest
and penalties), of which $52.1 million, if recognized, would reduce the Company's effective tax
rate. We expect the amount of unrecognized tax benefit disclosed above not to change
significantly over the next 12 months.
With a few exceptions, we are currently open for audit under the statute of limitation for Federal,
state and foreign jurisdictions for years 2009 to 2012. However, carryforward attributes from prior
years may still be adjusted upon examination by tax authorities if they are used in a future period.
We report penalties and tax-related interest expense as a component of the provision for income
taxes in the accompanying consolidated statement of operations. At December 31, 2012 and
2011, we had $5.9 million and $3.7 million, respectively, of accrued interest and penalties in the
accompanying consolidated balance sheet.
As part of the 2012 Chapter 11 Reorganization, we realized approximately $1.3 billion of
cancellation of debt income. We will be able to exclude this cancellation of debt income of $1.3
billion from taxable income since HMH was insolvent (liabilities greater than the fair value of its
assets) by this amount at the time of the exchange. Although we will not have to pay current cash
taxes from this transaction, we will need to reduce our tax attributes, such as net operating loss
carryovers and tax credit carryovers and also reduce our tax basis of our assets to offset the $1.3
82
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
billion of taxable income that did not have to be recognized due to insolvency. As a result, our net
operating losses and credit carryforwards will be reduced on January 1, 2013, and a portion of our
tax basis in our assets will also be reduced at that time.
As of December 31, 2012, we have approximately $390.7 million of Federal tax loss carryforwards,
which will expire through 2032. In addition, we have foreign tax credit carryforwards of $5.3 million,
which will expire through 2022. As noted above, these tax attributes will be reduced on January 1,
2013 as a result of the 2012 Chapter 11 Reorganization.
Based on the our assessment of historical pre-tax losses and the fact that we did not anticipate
sufficient future taxable income in the near term to assure utilization of certain deferred tax assets,
the Company recorded a valuation allowance at December 31, 2012 and 2011 of $512.2 million
and $822.5 million, respectively. We have decreased our valuation allowance by $310.3 million in
2012, and increased our valuation allowance by $388.0 million, and $317.9 million, respectively, for
2011 and 2010.
11. Retirement and Postretirement Benefit Plans
Retirement Plan
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
covers employees who earn over the qualified pay limit as determined by the Internal Revenue
Service. The nonqualified plan accrues benefits for the executive officers based on service and
pay. Benefits for all other employees accrue 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 also had a foreign defined benefit plan. On July 20, 2011, we entered into a bulk annuity policy
with a third party which effectively terminated the foreign defined benefit plan. This policy covers
all known plan beneficiaries and liabilities and represents a full transfer of the plan’s financial and
longevity risk to the third party. The policy is held in the name of the plan trustees. This
termination did not constitute a settlement of liability under applicable accounting guidance for
pension plans. Following a full plan data cleansing, the bulk annuity policy is expected to be
converted into individual annuity policies at which point the plan will be discharged of all future
liability with respect to the plan beneficiaries. We anticipate the conversion to individual annuity
policies along with the liability discharge to occur in the first half of 2013. The foreign defined
benefit plan had benefit obligations of $16.4 million and $14.3 million as of December 31, 2012 and
2011, respectively. The plan had assets of $16.6 million and $14.6 million December 31, 2012 and
2011, respectively. Further, the plan had a net pension benefit asset of $0.2 million and $0.2
million, at December 31, 2012 and 2011, respectively. The foreign defined benefit plan is included
in the accompanying table for all years presented.
During 2012, we amended the postretirement medical benefits plan resulting in the benefit
contributions for certain participants to remain at the current year level for all future years. The
result of the plan change was to reduce our accrued postretirement benefits liability by
approximately $8.7 million with the offset to other comprehensive income in accordance with the
accounting guidance for other postretirement defined benefit plans.
83
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
We are required to recognize the funded status of defined benefit pension and other postretirement
plans as an asset or liability in the balance sheet and are required to recognize actuarial gains and
losses and prior service costs and credits in other comprehensive income and subsequently
amortize those items in the statement of operations. Further, we are required to use a
measurement date equal to the fiscal year end.
The following table summarizes the Accumulated Benefit Obligations ("ABO"), the change in
Projected Benefit Obligation ("PBO"), and the funded status of our plans as of and for the financial
statement period ended December 31, 2012 and 2011:
ABO at end of period
Change in PBO
PBO at beginning of period
Service cost
Interest cost on PBO
Actuarial (gain) loss
Benefits paid
Exchange rates
2012
2011
$
204,420
$
196,898
$
196,898
$
186,169
-
8,288
8,860
(10,136)
510
-
9,120
10,497
(9,045)
157
PBO at end of period
$
204,420
$
196,898
Change in plan assets
Fair market value at beginning of period
$
132,408
$
126,196
Actual return (loss)
Company contribution
Benefits paid
Exchange rates
15,669
17,168
(10,136)
597
3,628
11,460
(9,045)
169
Fair market value at end of period
$
155,706
$
132,408
Funded status
$
(48,714)
$
(64,490)
Amounts recognized in the consolidated balance sheets at December 31, 2012 and 2011 consist
of:
2012
2011
Noncurrent liabilities
$
(48,714)
$
(64,490)
Additional year-end information for pension plans with ABO in excess of plan assets at
December 31, 2012 and 2011 consist of:
PBO
ABO
Fair value of plan assets
2012
2011
$
187,998
$
182,549
187,998
138,987
182,549
117,843
84
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Amounts not yet reflected in net periodic benefit cost and recognized in accumulated other
comprehensive income at December 31, 2012 and 2011 consist of:
2012
2011
Net gain (loss)
$
(2,204)
$
(14,954)
Accumulated other comprehensive income (loss)
$
(2,204)
$
(14,954)
Weighted average assumptions used to determine the benefit obligations (both PBO and ABO) at
December 31, 2012 and 2011 are:
Discount rate
Increase in future compensation
Net periodic pension cost includes the following components:
2012
3.8%
N/A
2011
4.4%
N/A
For the Year
For the Year
For the Period
For the Period
Sucessor Company
Predecessor Company
Ended December Ended December March 10, 2010 to
31, 2011
December 31, 2010
31, 2012
January 1, 2010 to
March 9, 2010
Service cost
$
-
$
-
$
-
$
-
Interest cost on projected benefit obligation
Expected return on plan assets
Amortization of net (gain) loss
Net pension expense
Loss (gain) due to settlement
8,288
(9,047)
13
(746)
84
9,120
(8,175)
-
945
20
7,816
(5,443)
-
2,373
-
1,580
(1,318)
2
264
-
Net cost (gain) recognized for the period
$
(662)
$
965
$
2,373
$
264
Significant actuarial assumptions used to determine net periodic pension cost at December 31,
2012, 2011 and 2010 are:
2012
2011
2010
Discount rate
Increase in future compensation
Expected long-term rate of return on assets
4.4 %
N/A
6.7 %
5.1 %
N/A
6.7 %
5.6 %
N/A
7.0 %
Assumptions on Expected Long-Term Rate of Return as Investment Strategies
We employ a building block approach in determining the long-term rate of return for plan assets.
Historical markets are studied and long-term relationships between equities and fixed income are
preserved congruent with the widely accepted capital market principle that assets with higher
volatility generate a greater return over the long run. Current market factors such as inflation and
85
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
interest rates are evaluated before long-term capital market assumptions are determined. The
long-term portfolio return is established via a building block approach and proper consideration of
diversification and rebalancing. Peer data and historical returns are reviewed for reasonability and
appropriateness. We regularly review the actual asset allocation and periodically rebalances
investments to a targeted allocation when appropriate. The current targeted asset allocation is
50% with equity managers and 50% with fixed income managers. For 2013, we will use a 7.0%
long-term rate of return for the Retirement Plan. We will continue to evaluate the expected rate of
return assumption, at least annually, and will adjust as necessary.
Plan Assets
Plan assets for the U.S. tax qualified plans consist of a diversified portfolio of fixed income
securities, equity securities, real estate, and cash equivalents. Plan assets do not include any of
our securities. The U.S. pension plan assets are invested in a variety of funds within a Collective
Trust (“Trust”). The Trust is a group trust designed to permit qualified trusts to comingle their
assets for investment purposes on tax-exempt basis. The U.K pension plan assets are invested in
a single bulk annuity policy with a third party.
Investment Policy and Investment Targets
The tax qualified plans consist of the U.S. pension plan and the U.K. pension scheme. It is our
practice to fund amounts for our qualified pension plans at least sufficient to meet minimum
requirements of local benefit and tax laws. The investment objectives of our pension plan asset
investments is to provide long-term total growth and return, which includes capital appreciation and
current income. The nonqualified noncontributory defined benefit pension plan is generally not
funded. Assets were invested among several asset classes.
The percentage of assets invested in each asset class at December 31, 2012 and 2011 is shown
below.
2012
Asset Class
Equity
Fixed income
Real estate investment trust
Annuity policies
Other
2011
Asset Class
Equity
Fixed income
Annuity policies
Other
Percentage
in Each
Asset Class
40.7 %
41.0
4.1
10.6
3.6
100.0 %
Percentage
in Each
Asset Class
44.0 %
43.0
10.8
2.2
100.0 %
86
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Fair Value Measurements
The fair value of our pension plan assets by asset category and by level at December 31 were as
follows:
Quoted Prices
Significant
For the
in Active
Other
Year ended
Markets for
Observable
December 31,
Identical Assets
Inputs
2012
(Level 1)
(Level 2)
Cash and cash equivalents
$
1,123
$
1,123
$
-
Equity securities
U.S. large cap growth
U.S. large cap value
U.S. large cap passive
U.S. small / mid cap growth
U.S. small / mid cap value
Non-U.S. equities
Government bonds
Corporate bonds
Mortgage-backed securities
Asset-backed securities
Commercial Mortgage-Backed Securities
Real Estate
Annuity policies
Other
5,096
5,152
17,442
4,328
4,325
27,006
19,877
34,567
8,551
506
425
6,355
16,423
4,530
-
-
-
-
-
-
-
-
-
-
-
-
-
-
5,096
5,152
17,442
4,328
4,325
27,006
19,877
34,567
8,551
506
425
6,355
16,423
4,530
$
155,706
$
1,123
$
154,583
Quoted Prices
Significant
For the
in Active
Other
Year ended
Markets for
Observable
December 31,
Identical Assets
Inputs
2011
(Level 1)
(Level 2)
Cash and cash equivalents
$
1,005
$
1,005
$
-
Equity securities
U.S. large cap growth
U.S. large cap value
U.S. large cap passive
U.S. small / mid cap growth
U.S. small / mid cap value
Non-U.S. equities
Government bonds
Corporate bonds
Mortgage-backed securities
Asset-backed securities
Commercial Mortgage-Backed Securities
Annuity policies
Other
8,944
9,333
13,034
3,877
3,983
19,102
17,535
29,249
9,239
472
424
14,349
1,862
-
-
-
-
-
-
-
-
-
-
-
-
-
8,944
9,333
13,034
3,877
3,983
19,102
17,535
29,249
9,239
472
424
14,349
1,862
$
132,408
$
1,005
$
131,403
87
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
We recognize that risk and volatility are present to some degree with all types of investments.
However, high levels of risk are minimized through diversification by asset class, by style of each
fund.
Estimated Future Benefit Payments
The following benefit payments are expected to be paid.
Fiscal Year Ended
2013
2014
2015
2016
2017
2018–2021
Total
Pension
13,530
19,526
18,944
19,819
10,514
50,238
Expected Contributions
We expect to contribute approximately $11.2 million in 2013; however, the actual funding decision
will be made after the 2013 valuation is completed.
Postretirement Benefit Plan
We also provide postretirement medical benefits to retired full-time, nonunion employees hired
before April 1, 1992, who have provided a minimum of five years of service and attained age 55.
88
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
The following table summarizes the Accumulated Postretirement Benefit Obligation ("APBO"), the
changes in plan assets, and the funded status of our plan as of and for the financial statement
periods ended December 31, 2012 and 2011.
Change in APBO
APBO at beginning of period
Service cost (benefits earned during the period)
Interest cost on APBO
Plan Amendments
Employee contributions
Actuarial (gain) loss
Benefits paid
2012
2011
$
35,970
$
36,546
250
1,087
(8,674)
646
3,042
(2,748)
372
1,840
-
716
(540)
(2,964)
APBO at end of period
$
29,573
$
35,970
Change in plan assets
Fair market value at beginning of period
Company contributions
Employee contributions
Benefits paid
$
-
$
-
2,102
646
(2,748)
2,248
716
(2,964)
Fair market value at end of period
$
-
$
-
Funded status
$
29,573
$
35,970
Amounts for postretirement benefits accrued in the consolidated balance sheets at December 31,
2012 and 2011 consist of:
Current liabilities
Noncurrent liabilities
2012
2011
$
(2,342)
$
(2,252)
(27,231)
(33,718)
Net amount recognized
$
(29,573)
$
(35,970)
Amounts not yet reflected in net periodic benefit cost and recognized in accumulated other
comprehensive income at December 31, 2012 and 2011 consist of:
Net gain (loss)
Prior service cost
2012
2011
$
(5,298)
$
(2,256)
7,638
-
Accumulated other comprehensive income (loss)
$
2,340
$
(2,256)
89
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Weighted average actuarial assumptions used to determine APBO at year-end December 31, 2012
and 2011 are:
2012
2011
Discount rate
Health care cost trend rate assumed for next year
Rate to which the cost trend rate is assumed to decline
(ultimate trend rate)
Year that the rate reaches the ultimate trend rate
3.8 %
7.4 %
4.5 %
2027
4.5 %
7.6 %
4.5 %
2027
Net periodic postretirement benefit cost included the following components:
Successor Company
Predecessor
Company
For the Period
For the Period
For the
For the
Year Ended
Year Ended
March 10,
2010 to
December 31,
December 31,
December 31,
2012
2011
2010
January 1,
2010 to
March 9,
2010
Service cost
Interest cost on APBO
Amortization of unrecognized prior service cost
Amortization of net (gain) loss
$
250
$
372
$
300
$
57
1,269
(1,035)
-
1,840
1,583
-
-
-
-
319
(15)
(226)
Net periodic postretirement benefit expense
$
484
$
2,212
$
1,883
$
135
Significant actuarial assumptions used to determine postretirement benefit cost at December 31,
2012, 2011 and 2010 are:
2012
2011
2010
Discount rate
Health care cost trend rate assumed for next year
Rate to which the cost trend rate is assumed to decline
(ultimate trend rate)
Year that the rate reaches the ultimate trend rate
4.5 %
7.6%
4.5%
2027
5.2 %
7.8%
4.5%
2027
5.8 %
8.1%
4.5%
2027
Assumed health care trend rates have a significant effect on the amounts reported for the health
care plans. A one-percentage-point change in assumed health care cost trend rates would have
the following effects on the expense recorded in 2012 and 2011 for the postretirement medical
plan:
90
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
2012
2011
One-percentage-point increase
Effect on total of service and interest cost components
$
23
$
47
Effect on postretirement benefit obligation
One-percentage-point decrease
Effect on total of service and interest cost components
Effect on postretirement benefit obligation
303
(25)
(276)
1,076
(55)
(1,278)
The following table presents the change in other comprehensive income, net of tax expense of $85,
for the year ended December 31, 2012 related to our pension and postretirement obligations.
Postretirement
Pension
Plans
Benefit
Plan
Total
Sources of change in accumulated other
comprehensive income (loss)
New prior service cost
Net loss (gain) arising during the period
Amortization of prior service credit
Total accumulated other comprehensive
$
-
$
8,588
$
8,588
(2,129)
-
(3,045)
(1,036)
(5,174)
(1,036)
Income (loss) recognized during the period
$
(2,129)
$
4,507
$
2,378
Estimated amounts that will be amortized from accumulated other comprehensive income (loss)
over the next fiscal year.
Prior service credit (cost)
Net gain (loss)
Total
Total
Pension
Postretirement
Plans
Plan
$
-
$
1,381
(337)
(309)
$
(337)
$
1,072
91
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, are expected to be paid:
Fiscal Year Ended
2013
2014
2015
2016
2017
2018-2022
Expected Contribution
Postretirement
Plan
$
2,342
2,274
2,193
2,107
2,057
9,445
We expect to contribute approximately $2.3 million in 2013.
Defined Contribution Retirement Plan
We maintain a defined contribution retirement plan, the Houghton Mifflin 401(k) Savings Plan,
which conforms to Section 401(k) of the Internal Revenue Code, and covers substantially all of our
eligible employees. Participants may elect to contribute up to 50.0% of their compensation subject
to an annual limit. We provided a matching contribution in amounts up to 4.5% of employee
compensation until March 1, 2009 when the employer contribution was suspended. The
contribution was reinstated on July 1, 2010, where we provided a matching contribution in amounts
up to 1.5% of employee compensation and further increased to 3.0% of employee contribution
effective May 2011. The 401(k) contribution expense amounted to $4.9 million and $4.0 million for
the years ended December 31, 2012 and 2011, respectively. For the period March 10, 2010
through December 31, 2010 the contribution expense was $1.0 million. We did not make any
discretionary contribution in 2012, 2011 and 2010.
12. Share-Based Compensation
Certain employees participate or participated in various equity plans of the Predecessor and
Successor Company which provide for the grant of stock options and restricted stock to certain
executive employees and independent members of the Board of Directors. The stock underlying
such plans for the Predecessor Company was held in trust for the equity recipients. The stock
related to award forfeitures remains outstanding and may be reallocated to new recipients. After
the date of the March 2010 Restructuring, the equity awards pertaining to the Predecessor
Company were no longer charged to our financial results as the employees were no longer related
to the Predecessor Company.
The vesting terms for equity awards generally range from 1 to 4 years over equal annual
installments and generally expire seven years after the date of grant. Restricted stock is common
stock that is subject to a risk of forfeiture only upon voluntary termination or termination for cause,
as defined. Total compensation expense related to stock option grants and restricted stock
issuances recorded in the year ended December 31, 2012 was approximately $6.3 million of which
approximately $4.3 million was recorded in selling and administrative expense and approximately
$2.0 million was recorded in reorganization items, net. Total compensation expense related to
stock option grants and restricted stock issuances recorded in the year ended December 31, 2011,
for the period January 1, 2010 to March 9, 2010, and for the period March 10, 2010 to December
92
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
31, 2010 was approximately $8.6 million, $0.9 million, and $4.3 million, respectively, and was
recorded in selling and administrative expense.
Stock Options
The following tables summarize option activity for HMH employees in stock options for the periods
ended December 31, 2012 and 2011:
Successor Company
Number of
Shares
Weighted
Average
Exercise
Price
Balance at December 31, 2010
26,976,957
$
9.54
Granted
Forfeited
Cancelled
468,224
(14,522,175)
(9,213,225)
5.37
8.58
8.67
Balance at December 31, 2011
3,709,781
$
5.90
Granted
Forfeited
Cancelled
Balance at December 31, 2012
Options Exercisable at end of year
4,912,281
(749,159)
(2,960,622)
25.00
5.37
6.03
4,912,281
$
25.00
460,526
$
25.00
The intrinsic value of a stock option is the amount by which the current market value of the
underlying stock exceeds the exercise price of the option as of the balance sheet date. There was
no intrinsic value of options outstanding and exercisable at December 31, 2012, 2011 and 2010.
We estimate the fair value of stock options using the Black-Scholes valuation model. Key input
assumptions used to estimate the fair value of stock options include the exercise price of the
award, the expected volatility of our stock over the option's expected term, the risk-free interest rate
over the option's expected term, and our expected annual dividend yield.
The fair value of each option granted was estimated on the grant date using the Black-Scholes
valuation model with the following assumptions:
Successor Company
For the
For the
For the Period
Year Ended
Year Ended
March 10 2010 to
December 31,
December 31,
December 31,
2012
2011
2010
Expected term (years) (a)
Expected dividend yield
Expected volatility (b)
Risk-free interest rate (c)
4.0
0.00%
24.21%-26.54%
0.67%-0.76%
7.0
0.00%
7.0
0.00%
25.88% 22.68%-24.12%
2.40%
1.77%-3.11%
93
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
(a) The expected term is the number of years that we estimate that options will be outstanding
prior to exercise.
(b) We have estimated volatility for options granted based on the historical volatility for a group of
companies believed to be a representative peer group, selected based on industry and
market capitalization.
(c) The risk-free interest rate is based on the U.S. Treasury yield for a period commensurate with
the expected life of the option.
The accounting standard for stock-based compensation requires companies to estimate forfeitures
at the time of grant and periodically revise those estimates in subsequent periods if actual
forfeitures differ from those estimates. Stock-based compensation expense is recorded only for
those awards expected to vest using an estimated forfeiture rate based on historical forfeiture data
coupled with and estimated derived forfeiture rate of peers.
As of December 31, 2012, there remained approximately $16.0 million of unearned compensation
expense related to unvested stock options to be recognized over a weighted average term of 3.5
years.
The weighted average grant date fair value was $25.00, $4.54 and $7.01 for options granted in
2012, 2011 and 2010 (Successor Period), respectively.
The following tables summarize information about stock options outstanding and exercisable under
the plan at December 31, 2012:
Successor Company
Options Outstanding
Options
Weighted
Options Exercisable
Options
Range of
Outstanding at
Average
Weighted
Exercisable at
Weighted
Exercise
December 31,
Remaining
Average
December 31,
Average
Price
2012
Contractual life Exercise Price
2012
Exercise Price
$
25.00
4,912,281
4,912,281
3.5
3.5
$
25.00
$
25.00
460,526
$
25.00
460,526
$
25.00
Restricted Stock (Successor Company)
The following table summarizes restricted stock activity for grants to HMH employees and directors
in our restricted stock units from March 10, 2010 to December 31, 2012:
94
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Numbers of
Units
Weighted
Average
Grant Date
Fair Value
-
$
-
138,354
4.54
-
-
-
-
Balance at December 31, 2010
Granted
Vested
Forfeited
Balance at December 31, 2011
138,354
$
4.54
Granted
Vested
Cancelled
22,200
-
(138,354)
25.00
-
4.54
Balance at December 31, 2012
22,200
$
25.00
13. 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
Level 2
Level 3
Observable input such as quoted prices in active markets for identical assets or
liabilities;
Observable inputs, other than the quoted prices in active markets, that are observable
either directly or indirectly; and
Unobservable inputs in which there is little or no market data, which require the
reporting entity to develop its own assumptions.
Assets and liabilities measured at fair value are based on one or more of three valuation
techniques identified in the tables below. Where more than one technique is noted, individual
assets or liabilities were valued using one or more of the noted techniques. The valuation
techniques are as follows:
(a) Market approach: Prices and other relevant information generated by market transactions
involving identical or comparable assets or liabilities;
(b)
(c)
Cost approach: Amount that would be currently required to replace the service capacity of an
asset (current replacement cost); and
Income approach: Valuation techniques to convert future amounts to a single present amount
based on market expectations (including present value techniques).
On a recurring basis, we measure certain financial assets and liabilities at fair value, including our
money market funds, short-term investments which consist of U.S. treasury securities and U.S.
agency securities, and foreign exchange forward 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
95
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
transfer a liability in an orderly transaction between market participants at the measurement date.
As such, fair value is a market-based measurement that should be determined based on
assumptions that market participants would use in pricing an asset or liability. In determining fair
value, we utilize valuation techniques that maximize the use of observable inputs and minimize the
use of unobservable inputs to the extent possible as well as consider counterparty and its credit
risk in its assessment of fair value.
The following tables present our financial assets and liabilities measured at fair value on a recurring
basis at December 31, 2012 and December 31, 2011:
Quoted Prices
Significant
in Active
Other
Successor
Markets for
Observable
Company
Identical Assets
Inputs
2012
(Level 1)
(Level 2)
Valuation
Technique
Financial assets
Money market funds
U.S. treasury securities
U.S. agency securities
Foreign exchange forward contracts
$
299,918
$
299,918
$
-
97,134
48,907
475
97,134
-
-
-
48,907
475
$
446,434
$
397,052
$
49,382
(a)
(a)
(a)
(a)
Quoted Prices
Significant
in Active
Other
Successor
Markets for
Observable
Company
Identical Assets
Inputs
2011
(Level 1)
(Level 2)
Valuation
Technique
$
368,701
$
368,701
$
-
(a)
$
368,701
$
368,701
$
-
Financial assets
Money market funds
Financial liabilities
Foreign exchange forward contracts
$
1,113
$
-
$
1,113
(a)
$
1,113
$
-
$
1,113
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 $299.9 million and $368.7
million invested in money market funds as of December 31, 2012 and December 31, 2011,
respectively, we had $29.2 million and $44.9 million of cash invested in bank accounts as of
December 31, 2012 and December 31, 2011, respectively.
Our foreign exchange forward contracts consist of Euro 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.
96
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
The following table presents our nonfinancial assets and liabilities measured at fair value on a
nonrecurring basis during 2012 and 2011:
Significant
Successor
Unobservable
Company
Inputs
Total
Valuation
2012
(Level 3)
Impairment
Technique
Nonfinancial assets
Property, plant, and equipment
$
-
$
-
$
2,590
Pre-publication costs
Other intangible assets
7,160
-
7,160
-
413
5,000
$
7,160
$
7,160
$
8,003
(b)
(b)
(a) (c)
Nonfinancial liabilities
Other accruals
$
16,148
$
16,148
$
-
(c)
$
16,148
$
16,148
$
-
Significant
Successor
Unobservable
Company
Inputs
Total
Valuation
2011
(Level 3)
Impairment
Technique
Nonfinancial assets
Property, plant, and equipment
$
-
$
-
$
5,640
320
520,088
373,030
320
520,088
373,030
33,424
1,442,500
192,600
$
893,438
$
893,438
$
1,674,164
(b)
(b)
(a) (c)
(a) (c)
Pre-publication costs
Goodwill
Other intangible assets
Nonfinancial liabilities
Other accruals
$
19,679
$
19,679
$
-
(c)
$
19,679
$
19,679
$
-
Our nonfinancial assets, which include goodwill, other intangible assets, property, plant, and
equipment, and pre-publication costs, are not required to be measured at fair value on a recurring
basis. However, if certain trigger events occur, or if an annual impairment test is required, we
evaluate the nonfinancial assets for impairment. If an impairment did occur, the asset is required to
be recorded at the estimated fair value.
We review internal and external software development costs, included within property, plant, and
equipment, for impairment. The carrying amounts of software development costs are periodically
compared to net realizable value and impairment charges are recorded, as appropriate, when
amounts expected to be realized are lower. For the year ended December 31, 2012 and 2011,
software development costs of $2.6 million and $5.6 million, respectively, were impaired as the
products will not be sold in the marketplace.
Pre-publication costs recorded on the balance sheet are periodically reviewed for impairment by
comparing the unamortized capitalized costs of the assets to the fair value of those assets. For the
years ended December 31, 2012 and 2011, pre-publication costs of $0.4 million and $33.4 million,
respectively, were impaired as the programs will not be sold in the marketplace.
97
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
In evaluating goodwill for impairment, we first compare our reporting unit's fair value to its carrying
value. We estimate the fair values of our reporting units by considering market multiple and recent
transaction values of peer companies, where available, and projected discounted cash flows, if
reasonably estimable. There was no impairment recorded for goodwill for the year ended
December 31, 2012. Impairment recorded for goodwill for the year ended December 31, 2011 was
$1,442.5 million. There was no impairment recorded for the periods January 1, 2010 to March 9,
2010, and March 10, 2010 to December 31, 2010.
We perform an impairment test for our other intangible assets by comparing the assets fair value to
its carrying value. Fair value is estimated based on recent market transactions, where available,
and projected discounted cash flows, if reasonably estimable. There was a $5.0 million impairment
recorded for the year ended December 31, 2012 relating to one specific tradename intangible asset
that was fully impaired. Certain tradename intangible assets and other intangible assets were
written down to their fair value of $373.0 million resulting in an impairment charge of $192.6 million
which was included in earnings for the year ended December 31, 2011. There was no impairment
recorded for the period January 1, 2010 to March 9, 2010. Impairment charges were $87.0 million
for the period March 10, 2010 to December 31, 2010. The fair value of goodwill and other
intangible assets are estimates, which are inherently subject to significant uncertainties, and actual
results could vary significantly from these estimates.
Other accruals include restructuring charges which were valued using our internal estimates using
a discounted cash flow model, and we have classified the other accruals as Level 3 in the fair value
hierarchy.
Fair Value of Debt
The following table presents the carrying amounts and estimated fair market values of our debt at
December 31, 2012 and December 31, 2011. 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.
Successor Company
December 31, 2012
Successor Company
December 31, 2011
Carrying
Amount
Estimated
Fair Value
Carrying
Amount
Estimated
Fair Value
Debt
$250,000 Term loan
$2,668,690 Term loan
Revolving loan
10.5% notes
$
248,125
-
-
-
$
249,986
-
-
-
-
$
2,581,690
235,751
300,000
$
-
1,484,472
135,557
189,000
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 December 31, 2012 and December 31, 2011. 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.
98
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
14. Commitments and Contingencies
Lease Obligations
We have operating leases for various real property, office facilities, and warehouse equipment that
expire at various dates through 2019. Certain leases contain renewal and escalation clauses for a
proportionate share of operating expenses.
The future minimum rental commitments under all noncancelable leases (with initial or remaining
lease terms in excess of one year) for real estate and equipment are payable as follows:
2013
2014
2015
2016
2017
Thereafter
Operating
Leases
$
43,818
41,434
41,208
33,441
14,947
18,082
Total minimum lease payments
Total future minimal rentals under subleases
$
192,930
$
41,905
For the year ended December 31, 2012 and 2011 rent expense, net of sublease income, was
$38.0 million and $39.3 million, respectively. The rent expense, net of sublease income, for the
period January 1, 2010 to March 9, 2010 was $6.3 million and for the period March 10, 2010 to
December 31, 2010 was $18.4 million. On March 10, 2010, in connection with purchase
accounting, the accrual estimate was revised and the estimate was adjusted to fair value. In the
period March 10, 2010 to December 31, 2010, the accrual for the vacant space was reduced by
$11.5 million; thus, lowering rent expense, to reflect the subleasing of space sooner and at higher
rates than originally assumed. For the year ended December 31, 2012 and 2011, the rent expense
included a $4.1 million and $3.5 million charge as additional real estate was vacated.
Purchase Commitments
During 2008, we entered into a print services agreement with a third party for a term of five years
commencing January 1, 2009 whereby the third party will provide platemaking, printing, binding
and disposition services for the Company. The agreement expands the previous relationship
between the two companies. We are obligated to purchase $175.0 million per contract year for a
total of $875.0 million over the five-year term. Effective January 1, 2012, the print service
agreement was amended to extend the agreement for two years and modify some of the aggregate
spend and savings covenants. As of December 31, 2012, our remaining purchase commitment
was approximately $171.0 million.
Contingencies
We are involved in ordinary and routine litigation and matters incidental to our business. Litigation
alleging infringement of copyrights and other intellectual property rights has become extensive in
the educational publishing industry. Specifically, there have been various settled, pending and
threatened litigation that allege we exceeded the print run limitation or other restrictions in licenses
granted to us to reproduce photographs in our textbooks. While management believes that there is
a reasonable possibility we may incur a loss associated with the pending and threatened litigation,
we are not able to estimate such amount, but we do not expect any of these matters to have a
material adverse effect on our results of operations, financial position or cash flows. We have
99
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
insurance over such amounts and with coverage and deductibles as management believes is
reasonable. There can be no assurance that our liability insurance will cover all events or that the
limits of coverage will be sufficient to fully cover all liabilities. We were contingently liable for $11.7
million and $11.6 million of performance related surety bonds for our operating activities as of
December 31, 2012 and 2011, respectively. An aggregate of $26.2 million of letters of credit
existed each year at December 31, 2012 and 2011 of which $6.4 million backed the
aforementioned performance related surety bonds each year in 2012 and 2011.
We routinely enter into standard indemnification provisions as part of license agreements involving
use of our intellectual property. These provisions typically require us to indemnify and hold
harmless licensees in connection with any infringement claim by a third party relating to the
intellectual property covered by the license agreement. The assessment business routinely enters
into contracts with customers that contain provisions requiring us to indemnify the customer against
a broad array of potential liabilities resulting from any breach of the contract or the invalidity of the
test. Although the term of these provisions and the maximum potential amounts of future payments
we could be required to make is not limited, we have never incurred any costs to defend or settle
claims related to these types of indemnification provisions. We therefore believe the estimated fair
value of these provisions is inconsequential, and have no liabilities recorded for them as of
December 31, 2012 and December 31, 2011.
15. Related Party Transactions
Debt-for-Equity Exchange
As discussed in Note 2, upon the Company’s emergence from Chapter 11 bankruptcy proceedings,
holders of the Term Loan, Revolving Loan, and 10.5% Senior Notes were issued post-emergence
shares of new common stock pursuant to the final Plan on a pro rata basis. Certain of these
holders of the Term Loan, Revolving Loan, and 10.5% Senior Notes were also equity holders prior
to the consummation of the Plan. The amount of the gain attributable to the debt to equity
conversion, net of elimination of fees and other charges, of $1,010.3 million, which is associated to
the holders of the Term Loan, Revolving Loan, and 10.5% Senior Notes that were also equity
holders prior to the consummation of the Plan, was charged to capital in excess of par value.
Transactions with Former Officer:
Officer Loan
On March 9, 2010, we entered into a credit agreement with an entity controlled by an
executive of the Company at that time, whereby the entity was granted a loan in the
aggregate principal amount of $20.0 million for the sole purpose of satisfying certain
obligations of that officer with regards to the acquisition of equity of the Predecessor
Company. The loan bore interest at a rate per annum equal to 2.69% and had a maturity
date of March 9, 2015.
On November 16, 2010, we entered into an amended and restated credit agreement
whereby the loan of $20.0 million was divided into a tranche A loan with an aggregate
principal amount of $12.2 million and a tranche B loan with an aggregate principal amount of
$7.8 million. Both tranches of the loan continued to bear interest at a rate per annum equal
to 2.69%. The tranche A loan had a maturity date of March 9, 2015 and the tranche B loan
has a maturity date of September 30, 2030. There are no required principal or interest
payments during the term of the loan with the interest accruing to the outstanding balance.
While the officer was employed by the Company, the loan entity earned a fee equal to
approximately $0.1 million per month (“Earned Fee”) that was used to repay the amount
outstanding under the loan. The Earned Fee was approximately $1.1 million which was
100
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
recorded as professional fees which is a component of administrative expenses in our
statement of operations for the period March 10, 2010 to December 31, 2010.
We fully reserved the remaining balance of the loan due to the long term nature of the
maturity date and uncertainty of collectability. The total amount of $18.9 million was
recorded in selling and administrative expenses in our statement of operations for the period
March 10, 2010 to December 31, 2010.
Officer Separation Agreement
On May 7, 2011, the Company entered into a separation agreement with an executive of the
Company. Under the terms on the agreement, the former executive agreed to act as a
senior advisor to the Company for a year. For these services, the former executive received
a consulting fee of $2.0 million and the potential to receive an additional $3.0 million in
success fees predicated upon certain criteria. The success fee was fully earned and paid in
October 2011.
Other Transactions
We paid $10.0 million to an entity controlled by a former executive of the Company at that
time for consulting services rendered in connection with the March 9, 2010 financial
restructuring. The $10.0 million payment has been recorded as professional fees, which is a
component of administrative expenses, in our statement of operations for the period
March 10, 2010 to December 31, 2010.
16. Segment Reporting
As of December 31, 2012, we had two reportable segments (Education and Trade Publishing). We
measure and evaluate our reportable segments based on segment net sales and segment
Adjusted EBITDA. We exclude from segment Adjusted EBITDA certain corporate related
expenses, as our corporate functions do not meet the definition of a segment, as defined in the
accounting guidance relating to segment reporting. In addition, certain transactions or adjustments
that our Chief Operating Decision Maker considers to be non-recurring and/or non-operational,
such as amounts related to goodwill and other intangible asset impairment charges and
restructuring related charges, as well as amortization expenses, are excluded from segment
Adjusted EBITDA. Although we exclude these amounts from segment Adjusted EBITDA, they are
included in reported consolidated operating income (loss) and are included in the reconciliation
below.
101
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
(in thousands)
2012
Net sales
Adjusted EBITDA
2011
Net sales
Adjusted EBITDA
Education
Year Ended December 31,
Trade Publishing
Corporate/Other
Total
$
1,128,591
329,723
$
157,050
28,774
-
$
(38,685)
$
1,285,641
319,812
$
1,169,645
278,930
$
125,650
12,888
-
$
(53,620)
$
1,295,295
238,198
For the period March 10, 2010
to December 31, 2010
Net sales
Adjusted EBITDA
$
1,290,429
510,871
$
106,713
15,161
-
$
(53,281)
$
1,397,142
472,751
For the period January 1, 2010
to March 9, 2010
Net sales
Adjusted EBITDA
$
92,718
(20,609)
$
17,187
(2,431)
-
$
(8,974)
$
109,905
(32,014)
Reconciliation of Adjusted EBITDA to the consolidated statements of operations is as follows:
(in tho usands)
To tal A djusted EB ITDA
Co nso lidated interest expense
P ro visio n (benefit) fo r inco me taxes
Depreciatio n expenses
A mo rtizatio n expenses (including capitalized permissio n settlements)
No n-cash charges - sto ck co mpensatio n
No n-cash charges - gain (lo ss) o n fo reign currency and interest hedge
No n-cash charges - asset impairment charges
P urchase acco unting adjustments (a)
Fees, expenses o r charges fo r equity o fferings, debt o r acquisitio ns
No n-recurring debt restructuring (b)
No n-recurring restructuring (c)
Severance, separatio n co sts and facility clo sures (d)
Reo rganziatio n items, net (e)
Net lo ss
S uc c e s s o r
P re de c e s s o r
Y e a r E nde d
D e c e m be r 3 1,
2 0 12
Y e a r E nde d
D e c e m be r 3 1,
2 0 11
F o r t he P e rio d
M a rc h 10 , 2 0 10 t o
D e c e m be r 3 1,
2 0 10
F o r t he P e rio d
M a rc h 10 , 2 0 10 t o
D e c e m be r 3 1,
2 0 10
$
$
$
319,812
(123,197)
5,943
(58,131)
(370,291)
(4,227)
1,688
(8,003)
16,511
(267)
-
(6,716)
(9,375)
149,114
(87,139)
$
238,198
(244,582)
100,153
(58,392)
(474,825)
(8,558)
(811)
(1,674,164)
(22,732)
(3,839)
-
-
(32,818)
-
$
(2,182,370)
472,751
(258,174)
(11,929)
(48,649)
(475,099)
(4,274)
90,250
(103,933)
(113,182)
(1,513)
(30,000)
-
(23,975)
-
(507,727)
(32,014)
(157,947)
220
(10,900)
(88,265)
(925)
(7,361)
(4,028)
-
-
(9,564)
-
(992)
-
(311,776)
$
$
$
(a) Represents certain non-cash accounting adjustments, most significantly relating to deferred revenue, and inventory costs , that we were
required to record as a direct result of the March 9, 2010 Restructuring and the acquisitions for the years ended 2012, 2011 and 2010.
(b) Represents fees paid and charged to operations relating to the March 9, 2010 Restructuring.
(c) Represents non-recurring restructuring costs (other than severance and real estate) such as consulting and realignment.
(d) Represents costs associated with the restructuring. Included in such costs are severance, facility integration and vacancy of excess
facilities. 2010 costs also includes program integration and related inventory obsolescence and consulting costs.
(e) Represents net gain associated with the Chapter 11 Reorganization.
102
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
Segment information as of December 31, 2012 and 2011 is as follows:
(in thousands)
Goodwill - Education
Goodwill - Trade Publishing
Other intangible assets, net - Education
Other intangible assets, net - Trade Publishing
2012
$
520,088
2011
$
520,088
-
-
$
520,088
$
520,088
$
$
937,531
129,521
1,067,052
$
$
1,158,994
115,219
1,274,213
The following is a schedule of net sales by geographic region:
$
$
1,223,852
61,789
1,285,641
$
$
1,240,807
54,488
1,295,295
$
$
105,312
4,593
109,905
$
$
1,301,143
95,999
1,397,142
(in thousands)
Year Ended December 31, 2012
Net sales - U.S.
Net sales - International
Total net sales
Year Ended December 31, 2011
Net sales - U.S.
Net sales - International
Total net sales
For the period January 1, 2010 to March 9, 2010
Net sales - U.S.
Net sales - International
Total net sales
For the period March 10, 2010 to December 31, 2010
Net sales - U.S.
Net sales - International
Total net sales
103
HMH Holdings (Delaware), Inc.
Notes to Consolidated Financial Statements
December 31, 2012
17. Quarterly Results of Operations (Unaudited)
Three Months Ended
2012:
March 31,
June 30,
Net sales
Gross profit
Operating income (loss)
Reorganization items, net
Net income (loss)
$
165,229
731
(152,349)
-
(225,347)
$
344,204
135,320
(21,897)
(156,894)
105,474
$
September 30, December 31,
282,195
$
81,864
(27,933)
7,780
(34,204)
494,013
236,302
81,492
-
66,938
2011:
Net sales
Gross profit
Operating income (loss)
Net income (loss)
$
152,465
(24,095)
(194,706)
(274,267)
$
328,605
107,877
(73,735)
(138,501)
$
574,509
279,632
64,588
20,642
$
239,716
11,816
(1,833,277)
(1,790,244)
Reorganization items, net for the year ended December 31, 2012 was $149.1 million. The amount
represents expense and income amounts that were recorded to the statement of operations as a result of
the bankruptcy proceedings. Reorganization items were incurred starting with the date of the bankruptcy
filing through the date of bankruptcy emergence.
104
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Our management is responsible for the integrity and objectivity of all information presented in this report.
The Financial Statements were prepared in conformity with accounting principles generally accepted in
the United States of America and include amounts based on our best estimates and judgments. We
believe that the Financial Statements fairly reflect the form and substance of transactions and that the
Financial Statements fairly represent our financial condition and results of operations.
As of the end of the period covered by this report, we were not subject to, and have never been subject
to, the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as
amended. Since this report is not filed with the Securities Exchange Commission, we are not required to
conduct an evaluation (as required under Rules 13a-15(b) and 15d-15(b) under the Securities Exchange
Act of 1934, as amended (the “Exchange Act”)), under the supervision and with the participation of the
principal executive officer and principal financial officer, of our “disclosure controls and procedures” (as
such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).
None.
Item 9B. Other Information
Item 10. Directors, Executive Officers and Corporate Governance
As of March 15, 2013, the executive officers and directors of HMH Holdings were as follows:
Age
Name
Executive Officers
Linda K. Zecher . . . . . . . . . . . . . . . . . .59 President, Chief Executive Officer and Director
Eric L. Shuman . . . . . . . . . . . . . . . . . . 58 Executive Vice President and Chief Financial Officer
William F. Bayers . . . . . . . . . . . . . . . . 58 Executive Vice President, Secretary and General
Position
Counsel
Timothy L. Cannon . . . . . . . . . . . . . . . 58 Executive Vice President, Strategy and Alliances
Mary J. Cullinane. . . . . . . . . . . . . . . . . 46 Chief Content Officer and Executive Vice President, Corporate
Affairs
Lee R. Ramsayer. . . . . . . . . . . . . . . . .48 Executive Vice President, U.S. Sales
John K. Dragoon . . . . . . . . . . . . . . . . . 52 Executive Vice President and Chief Marketing Officer
Gary L. Gentel . . . . . . . . . . . . . . . . . . . 60 President, HMH Trade Publishing
Joanne M. Karimi . . . . . . . . . . . . . . . . . 54 Executive Vice President, Human Resources
Brook Colangelo . . . . . . . . . . . . . . . . . .35 Senior Vice President and Chief Information Officer
Mark P. Short . . . . . . . . . . . . . . . . . . . . 48 Senior Vice President, International Markets
Directors
Lawrence K. Fish . . . . . . . . . . . . . . . . . 68 Chairman of the Board
John R. McKernan, Jr. . . . . . . . . . . . . . 64 Director and Chair of Compensation Committee
John F. Killian . . . . . . . . . . . . . . . . . . . .58 Director and Chair of Audit Committee
L. Gordon Crovitz . . . . . . . . . . . . . . . . 54 Director
Sheru Chowdhry. . . . . . . . . . . . . . . . . . 39 Director
Jill A. Greenthal. . . . . . . . . . . . . . . . … 56 Director and Chair of Nominating, Ethics and
Governance Committee
105
E. Rogers Novak, Jr.. . . . . . . . . . . . . .64 Director
Linda K. Zecher . . . . . . . . . . . . . . . . . 59 Director
The following information provides a brief description of the business experience of each
executive officer and director.
Executive Officers
Linda K. Zecher, President, Chief Executive Officer and Director
Linda joined Houghton Mifflin Harcourt in September 2011 as President, Chief Executive Officer
and Director. Previously, she served as Corporate Vice President of Microsoft's Worldwide
Public Sector organization since 2009. She also served as Microsoft’s Vice President Public
Sector, Americas and Asia Pacific from 2008 to 2009, and as Vice President, US Public Sector
from 2003 to 2008. Prior to joining Microsoft in 2003, Linda held leadership positions with Texas
Instruments, Bank of America, PeopleSoft, Oracle and Evolve Corp. She currently serves on the
U.S. State Department’s Board for Overseas Schools, the Focused Ultrasound Surgery
Foundation Advisory Council, and the Emily Couric Leadership Forum. Linda is also a former
member of the Intelligence National Security Association, the Virginia Piedmont Technology
Council, and James Madison University’s Board of Visitors. Linda’s extensive sales, marketing
and technology experience enables her to provide the Company with effective leadership in the
conduct of its rapidly changing business.
Eric L. Shuman, Executive Vice President, Chief Financial Officer
Eric joined the Company in October 2009 as Executive Vice President and K-12 Chief Operating
Officer. From November 2011 to January 2012, he served as Executive Vice President and K-12
Chief Operating Officer and Interim Chief Financial Officer. He began his current role with the
Company in January 2012. Prior to joining Houghton Mifflin Harcourt, Eric was with Thomson
Lifelong Learning Group, a division of Thomson Corporation, where he served as Chief Executive
Officer from September 2005 to December 2007. Previously, Eric was Senior Vice President and
Chief Financial Officer from June 1994 to September 2005 for Thomson Reuters, and Vice
President and Corporate Controller for Thomson Newspapers.
William F. Bayers, Executive Vice President, Secretary and General Counsel
Bill joined Houghton Mifflin Harcourt in May of 2007 as Senior Vice President, Secretary and
General Counsel and was made Executive Vice President, Secretary and General Counsel in
March 2008. Previously, he served as Vice President and General Counsel of Harcourt
Education Group. Bill oversees all legal, regulatory and corporate matters for the Company. He
is a graduate of Harvard College and Harvard Law School.
Timothy L. Cannon, Executive Vice President, Strategy and Alliances
Before joining HMH in November 2011, Tim was Senior Director of Business Strategy for
Microsoft’s Worldwide Public Sector organization from September 2008 to November 2011,
where he oversaw the development and execution of business strategies to better serve
Government, Education and Health customers and partners worldwide. Prior to that role, Tim
was Senior Director of Business Strategy for Microsoft’s U.S Public Sector from October 2006 to
September 2008. He has also held leadership roles at companies like Digital Equipment
Corporation and Oracle. Tim serves on the board of the Center for Entrepreneurship and
Innovation at the University of Florida and on the advisory board for the School of Engineering at
George Mason University.
106
Mary J. Cullinane, Chief Content Officer and Executive Vice President, Corporate Affairs
Mary joined HMH in February 2012. Prior to joining HMH, Mary served as Worldwide Senior
Director, Innovation and Education Policy for Microsoft from May 2010 to December 2011.
Prior to that role, Mary served as Director, Innovation and Business Development for Microsoft
from July 2008 until May 2010 and as Director, U.S. Partners In Learning for Microsoft from
February 2006 to July 2008. Mary holds a Master of Public Policy and Administration from
Columbia University and a Bachelor of Arts from The College of New Jersey.
Lee R. Ramsayer, Executive Vice President, U.S. Sales
Before joining Houghton Mifflin Harcourt in February 2012, Lee served as Senior Vice President
of Sales for Monster Worldwide, Inc.’s Government Solutions sector. Prior to his role at Monster,
Lee served as Manager, Government Sales and Consulting Services for Microsoft from January
2004 to February 2005. Lee currently serves on the board of Innovate Education, a national
organization focused on STEM education.
John K. Dragoon, Executive Vice President and Chief Marketing Officer
John joined Houghton Mifflin Harcourt in April 2012. Previously, he served as Chief Marketing
Officer and Channel Chief of Novell from October 2003 to April 2011, where he led the company’s
Marketing and Partner programs for over seven years. Prior to joining Novell, John served as
Senior Vice President, Marketing and Product Management at Art Technology Group (ATG) from
2002 to 2003. Before ATG, John served as Vice President, Operations at Internet Capital Group
from 2000 to 2002. John also spent more than 16 years at IBM, where he held a number of
marketing and sales positions. He holds an MBA from Cornell University and a BS from Union
College.
Gary L. Gentel, President, HMH Trade Publishing
Gary joined Houghton Mifflin Harcourt in October 2003 as Corporate Vice President and Director
of Trade Sales and was promoted to Interim President of the combined Trade Group in July 2007.
He was given the permanent position in December of that year. Previously, he served as
President of Candlewick Press—a children’s publisher based in Cambridge, SVP of Trade Sales
at Scholastic Books, and SVP and Publisher of The Grosset and Dunlap Group at GP Putnam’s
Sons—now a division of Penguin Books. Gary started his publishing career as a Sales
Representative at Random House in 1980, rising to VP of Children’s Sales by 1990.
Joanne M. Karimi, Executive Vice President, Human Resources
Joanne joined Houghton Mifflin Harcourt in February of 2011. From June 2010 to November
2010, Joanne served as Leader of Human Capital for PacifiCord, the U.S. subsidiary of a Taiwan-
based Biomedical company called Health Banks that specializes in biotechnology, stem cell
therapy, and cord blood processing and storage. Prior to her role at Pacificord, Joanne worked
as an independent consultant from January 2008 until June 2010 and as Executive Vice
President, Human Resources for CCI Valve, a company focused on design and manufacture of
severe service control and isolation valves for the severe service applications of the power, oil
and gas and nuclear industries, from July 2007 to September 2008. She also worked at Faro
Technologies from August 1998 to April 2007.
Brook Colangelo, Senior Vice President and Chief Information Officer
Brook joined HMH from the White House where he held the role of Chief Information Officer from
January 2009 to January 2013. In November 2008 he joined President-Elect Obama’s team as
Deputy Technology Team Leader to lead the technology effort for the Obama-Biden transition
107
project. From June 2007 to November 2008 he was the CIO for the Democratic National
Convention Committee. He also held senior IT leadership roles with The American Red Cross’
Hurricane Recovery Program and QRS Newmedia. Brook holds an honors degree in Political
Communications from The George Washington University.
Mark P. Short, Senior Vice President, International Markets
Mark joined HMH in December 2012 from Pearson Education where he served as Senior Vice
President, Sales and Marketing, English Language Training from August 2008 to October 2012.
He had served as Vice President, Sales and Marketing for Pearson Education from February
2007 to August 2008. Prior to that, he held a number of senior regional management, sales and
marketing roles across Asia Pacific, Latin America, and Europe as part of Pearson’s global
education business. As head of the International Markets division, Mark leads a sales, marketing
and business development team responsible for extending the HMH’s global footprint across key
markets in Asia Pacific, Latin America and the Middle East.
Directors
Lawrence K. Fish, Director and Chairman of the Board
Lawrence K. Fish has served as a member of the board of directors since August 2010 and
Chairman of the Board since January 2011. Mr. Fish served as Chairman and Chief Executive
Officer of Citizens Financial Group, Inc. (“Citizens”) from 2005 to 2008 and before as Chairman,
President and Chief Executive Officer, from 1992, of Citizens. Mr. Fish is a member of the Board
of Trustees of Massachusetts Institute of Technology. He serves on the boards of Textron Inc.,
Tiffany & Co., and NBH Holdings Corp. He is also an Honorary Trustee of the Brookings
Institution in Washington D.C. Mr. Fish’s extensive experience in the areas of finance, marketing,
general management and corporate governance enables him to provide the Company with
effective leadership on the board of directors.
John R. McKernan, Jr., Director and Chair of Compensation Committee
John R. McKernan, Jr. served as a member of the board of directors from August 2010 through
June 2012 and rejoined the board in September 2012. Mr. McKernan is currently Chairman and
Chief Executive Officer of McKernan Enterprises, Inc., in Portland, Maine. He is the former
Chairman of Education Management Corporation, a provider of post-secondary education in
North America, where he served as Chief Executive Officer from September 2003 until February
2007 and continues to serve as a director. Mr. McKernan is a director of BorgWarner Inc. and
served as Governor of the State of Maine from 1987 to 1995. Mr. McKernan is currently
Chairman of the Board of Directors of The Foundation for Maine’s Community Colleges and
serves on the board of the U.S. Chamber of Commerce’s Institute for a Competitive Workforce.
Mr. McKernan brings to the board superior leadership capabilities, knowledge of the legal and
legislative processes and significant prior experience as a director.
John F. Killian, Director and Chair of Audit Committee
John F. Killian has served as a member of the board of directors since January 2011. Mr. Killian
was Executive Vice President for Verizon and served as Verizon’s Chief Financial Officer from
March 2009 through October 2010. Prior to becoming CFO, Mr. Killian was President of Verizon
Business from October 2005 until March 2009, the Senior Vice President and Chief Financial
Officer of Verizon Telecom from June 2003 until October 2005, and the Senior Vice President
and Controller of Verizon Telecom from April 2002 until June 2003. Mr. Killian serves on the
board of directors at ConEdison Inc. and is a Chairman of the Board of Providence College. Mr.
Killian brings extensive financial expertise to the board, as well as significant management and
leadership experience.
108
L. Gordon Crovitz, Director
L. Gordon Crovitz has served as a member of the board of directors since August 2012. From
1980-2007 Mr. Crovitz held a number of positions with Dow Jones and the Wall Street Journal
culminating in his role as Executive Vice President for Dow Jones and Publisher of The Wall
Street Journal. He was co-founder of e-commerce software company Press+ in 2009. Mr. Crovitz
serves on the Board of Directors at Minneapolis Star Tribune, Business Insider, Blurb and Marin
Software. He is on the board of the American Association of Rhodes Scholars. Mr. Crovitz’s
management roles in the publishing industry and extensive experience as a director enables him
to provide the Company with valuable guidance.
Sheru Chowdhry, Director
Sheru Chowdhry served as a member of the board of directors from March 2010 through March
2012 and rejoined the board in June 2012. Mr. Chowdhry joined Paulson & Co. Inc., a hedge
fund, in 2004 as a Senior Vice President and has been a Managing Director and Head of
Distressed & Bankruptcy Research since 2008. Previously, he was a research analyst at
DebtTraders Inc., covering distressed and bankrupt securities, and an investment banker in the
Mergers & Acquisitions Group at JP Morgan Securities. Mr. Chowdhry’s financial expertise and
significant experience with debt and equity capital markets render him a valuable member of the
board.
Jill A. Greenthal, Director and Chair of Nominating, Ethics, and Governance Committee
Jill A. Greenthal has served as a member of the board of directors since June 2012. Ms.
Greenthal has been a Senior Advisor in Private Equity at the Blackstone Group since 2007,
working closely with the company’s global media and technology teams to assist in investments
in those sectors. She also currently serves as a director of Akamai Technologies, Orbitz
Worldwide, Michaels Stores and The Weather Channel Companies. Prior to 2007, Ms. Greenthal
was an investment banker and partner at Blackstone and Credit Suisse First Boston. Ms.
Greenthal has extensive experience in the media industry and in advising technology and media
companies, which enables her to provide valuable guidance to the Company.
E. Rogers Novak, Jr., Director
E. Rogers Novak, Jr. has served as a member of the board of directors since November 2012.
He is a founder and managing member of Novak Biddle Venture Partners, an early-stage venture
fund focused on investment opportunities in businesses focused on education, security, big data
analytics, and business-to-business-to-consumer. Roger formerly served as Lead Director of
Blackboard which was acquired by Providence Equity Partners. Roger currently serves on
several private company boards and is a member of the External Relations Council for the
Department of Homeland Security’s Predict project. He also serves on the Board of Trustees for
Kenyon College where he sits on the Budget, Financial and Audit Committee and the Information
Resources Committee. From 2008 to 2011, Roger held a seat on the Board of the National
Venture Capital Association and was their Treasurer and a member of their Executive Committee
from 2009 to 2011. Mr. Novak’s significant prior experience as a director, especially in the
education technology sector, render him a valuable member of the board.
Board of Directors
HMH Holdings’ board of directors is currently composed of eight individuals, one of whom is the Chief
Executive Officer. A majority of the Directors, including the Chairperson, must be “independent” under
NYSE standards. The independent directors are Lawrence K. Fish, John R. McKernan, Jr., John F.
Killian, L. Gordon Crovitz, Jill A. Greenthal, and E. Rogers Novak, Jr.
109
Nomination Agreement
Paulson & Co., Inc. (“Paulson”) and HMH have entered into a nomination agreement which provides that
Paulson has the right to nominate two Directors, one of whom must be an “independent” Director under
NYSE standards (the “Independent Director”) and the other nominated by Paulson (the “Holder Director”).
The initial Holder Director is Sheru Chowdhry and the Independent Director is John McKernan. Any
vacancy in the Independent Director position shall be nominated by Paulson in consultation with the
nominating committee of the Board of Directors and shall be subject to approval by the majority of the
Board of Directors; any vacancy in the Holder Director shall be nominated by Paulson and (i) filled with a
full-time Paulson employee or (ii) selected in consultation with the nominating committee and approved by
a majority of the Board of Directors (excluding the Independent Director). The right to nominate the
Independent Director terminates if Paulson holds less than 20% of the issued and outstanding New
Common Stock and the right to nominate the Holder Director terminates if Paulson holds less than 15%
of the issued and outstanding common stock. All nominating rights terminate upon an IPO. If Paulson
transfers at least 20% of the issued and outstanding common stock to a Transferee, the nominating rights
with respect to only the Holder Director (and any successor in the event of a vacancy) may be assigned
to the Transferee (subject to the same termination events – 15% ownership threshold or an initial public
offering). In the event that any other shareholder acquires 20% or more of the issued and outstanding
common stock (a “Nominating Holder”), such Nominating Holder will also be entitled to nominate one
director to the Board of Directors immediately pursuant to a nomination agreement (which HMH shall be
required to enter into if the Nominating Holder so elects) in form and substance substantially similar to the
Paulson nomination agreement. If the Nominating Holder became a Nominating Holder other than by
acquiring the stock of an existing 20% shareholder, the size of the Board of Directors will be increased in
order to elect the director chosen by such Nominating Holder. As with the Paulson nomination
agreement, the Nominating Holder nomination agreement will terminate upon an IPO or if the Nominating
Holder owns less than 15% of the outstanding common stock. As long as Paulson or a Nominating
Holder does not hold less than 20% of the issued and outstanding common stock, respectively, the
directors nominated by Paulson or such Holder, respectively, will be eligible for re-election at each annual
meeting until an initial public offering.
Board of Directors Committees
HMH Holdings’ board of directors has three committees: the audit committee, the compensation
committee and the nominating, ethics, and governance committee. Messrs. Killian, Chowdhry, Fish, and
Mses. Greenthal serve on the audit committee, which oversees and meets with management, the internal
auditors and the independent auditors to review internal accounting controls and accounting, auditing,
and financial reporting matters. Mr. Killian is the audit committee financial expert. Messrs. McKernan,
Chowdhry, Crovitz, Fish, and Killian serve on the compensation committee, which reviews the
compensation of HMH’s executive officers, executive bonus allocations and other compensation matters.
Ms. Greenthal, Messrs. Crovitz, Fish, and Novak serve on the nominating, ethics and governance
committee, which identifies individuals qualified to become members of the board of directors, develops
and recommends corporate governance guidelines and oversees the evaluation of the board of directors
and management.
Code of Ethics
We have adopted a Code of Conduct policy which applies to all officers and employees of the Company.
The Code Conduct is the foundation of our ethics and compliance program and covers a wide range of
areas. Many of our policies are summarized in the Code of Conduct, including our policies regarding
conflict of interest, honest and ethical conduct, discrimination and harassment, confidentiality and
compliance with laws and regulations applicable to the conduct of our business. All employees are
required to comply with the Code of Conduct and are subject to disciplinary action, including termination,
for violations. The Code of Conduct is published on our website at www.hmhco.com under the heading
“Investor Relations” and is also available in print to any person who requests it by writing to: Houghton
Mifflin Harcourt, Investor Relations, 222 Berkeley Street, Boston, Massachusetts 02116. Any
amendments to the Code of Conduct or the grant of a waiver from a provision of the Code Conduct
requiring disclosure under applicable SEC rules will be disclosed on our website. Under our Code of
110
Conduct all employees have a duty to report any violation or suspected violation of the policy or the law to
the appropriate personnel as identified in the policy.
Item 11. Executive Compensation
Compensation Discussion and Analysis
Compensation Program Philosophy and Objectives
Following the Company’s emergence from bankruptcy in June 2012, we implemented a compensation
program designed to help us attract and retain a management team capable of implementing our plan of
reorganization. To be successful, our employees needed to overcome uncertain economic conditions.
Therefore, we structured a compensation program designed to protect our assets in the near-term and
position us for future growth. Now that the Company has successfully emerged from bankruptcy, the
current Compensation Committee plans to do a thorough review of the Company’s compensation goals
and policies, and overall compensation objectives in 2013 for 2014 to ensure that its compensation
programs continue to align executive compensation of key employees with the best interests of
stockholders by rewarding performance based upon the attainment of annual financial and strategic
goals.
The goal of the Company’s compensation program for its named executive officers is the same as for the
entire Company, which is to foster compensation policies and practices that attract, engage, and motivate
high caliber talent by offering a competitive pay and benefits program. The Company is committed to a
total compensation philosophy and structure that provides flexibility in responding to market factors;
rewards and recognizes superior performance; attracts highly skilled, experienced, and capable
employees; and is fair and fiscally responsible. Most of the Company’s compensation elements
simultaneously fulfill one or more of our performance, alignment, or retention objectives.
The Process of Setting Executive Compensation
Our Compensation Committee meets throughout the year to evaluate the performance of our named
executive officers, to determine their bonuses for the prior fiscal year, to establish the individual and
corporate performance objectives for each executive for the current fiscal year, and to consider and
approve any grants of equity incentive compensation. Our Compensation Committee also reviews the
appropriateness of the financial measures used in our incentive plans and the degree of difficulty in
achieving specific performance targets. Our Compensation Committee engages in an active dialogue
with our Chief Executive Officer concerning strategic objectives and performance targets. All
Compensation Committee decisions are recommended to the Board of Directors and the Board of
Directors ultimately makes the final determination.
In making compensation decisions, the Compensation Committee considers the following:
• Company Performance. The Compensation Committee reviews the Company’s operational
performance and the achievement of its pre-established goals for the fiscal year.
• Executives’ Performance. The Compensation Committee evaluates an executive’s
performance during the year including leadership qualities, responsibilities, and contribution
to the Company’s performance. The relative importance of each factor varies among the
Company’s named executive officers depending on their positions and the particular
operations or functions for which they are responsible.
• Recommendations of the Chief Executive Officer. The Compensation Committee considers
the recommendations of the Company’s Chief Executive Officer, who assesses the
performance of the other named executive officers and adjustments to their base salary and
other elements of compensation.
111
Management’s Role in the Compensation-Setting Process
Our Chief Executive Officer, Ms. Zecher, plays a significant role in the compensation-setting process. Ms.
Zecher evaluates the performance of the other named executive officers, recommends business
performance targets and objectives for the other named executive officers, and recommends salary and
bonus levels and option awards for other executive officers. All recommendations of Ms. Zecher are
subject to Compensation Committee approval. Ms. Zecher’s compensation, performance targets, and
objectives are reviewed by the Compensation Committee and upon approval are recommended to the
Board of Directors. The Board of Directors sets Ms. Zecher’s compensation.
Elements of Executive Compensation
Base Salary
Base pay provides executives with a base level of regular income. In determining a named executive
officer’s base salary, we consider the executive’s qualifications, experience, and industry knowledge, the
quality and effectiveness of their leadership at our Company, the scope of their responsibilities and future
potential, the goals and objectives established for the executive, the executive’s past performance,
internal pay equity, and other factors as deemed appropriate. In addition, we consider the other
components of executive compensation and the mix of performance pay to total compensation. The
Compensation Committee does not apply any specific weighting to these factors. The minimum salaries
for the named executive offers are as reflected in applicable employment agreements.
The 2012 annual base salaries for our named executive officers were as follows:
Named Executive Officer
Linda Zecher
Eric Shuman
John Dragoon
Bethlam Forsa
William Bayers
Salary
$750,000
$500,000
$400,000
$400,000
$400,000
Annual Cash Bonus
Our bonus program is intended to motivate and reward performance by providing incentive bonuses
based upon meeting and exceeding individual and Company performance goals. Other than for our Chief
Executive Officer, we award annual incentive bonuses under a bonus plan (the Bonus Plan). Each
named executive officer has a specified payout target as a percentage of base salary based on the
executive’s position and level of responsibility. The named executive officers had the following bonus
targets (as a percentage of base salary) for 2012:
Named Executive Officer
Linda Zecher
Eric Shuman
John Dragoon
Bethlam Forsa
William Bayers
Bonus Target
Percentages
125%
100%
100%
100%
100%
Under the Bonus Plan, the total maximum bonus for each executive is allocated between two bonus
objectives – individual performance (25%) and EBITDA (75%) as established in the Company’s annual
budget. The relative weight or percentage of the maximum available bonus for each objective is based
on the importance of the objective for the year and the ability of the executive to influence the result. The
payout based on the applicable financial metrics is determined in accordance with the following schedule:
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% Achievement of EBITDA
Target
0% - 89.79%
89.8% - 92.99%
93.0% - 96.49%
96.5% - 99.99%
100% - 101.79%
101.8% - 103.49%
103.5% and up
Payout as a Percentage of
EBITDA Component of
Total Maximum Bonus
Opportunity
0.0%
25.0%
50.0%
75.0%
100.0%
120.0%
140.0%
For 2012, the Company’s Operating EBITDA target was $301 million. The Bonus Plan is meant to be
self-funding and although the Company achieved its’ $301 million operating EBITDA target, there was not
sufficient funding to pay 100% of the bonus level. Therefore, the EBITDA component of the bonus was
paid at the 75% level subject to adjustments made by the Chief Executive Officer and approved by the
Board.
With respect to our named executive officers other than Ms. Zecher, Ms. Zecher recommends to the
Board of Directors the size of an award by considering his or her individual performance as measured
against pre-set individual performance targets and objectives. Each named executive officer receives his
or her bonus amount based on the assessment of individual performance relative to such predetermined
specific performance goals. With respect to our Chief Executive Officer, the Compensation Committee
reviews and evaluates her performance against pre-set performance goals determined by the
Compensation Committee.
Ms. Zecher’s performance objectives included an EBITDA target and personal objectives. Based on its
review of Ms. Zecher’s 2012 performance, the Compensation Committee determined that Ms. Zecher
achieved substantially all of her goals, and awarded a bonus equal to 96% of her target bonus.
The personal objectives for each of Messrs. Shuman, Dragoon and Bayers, which comprised 25% of his
respective target bonus, were substantially consistent with Ms. Zecher’s personal objectives, and were
deemed by the Compensation Committee to have been achieved after taking into account each named
executive officer’s respective efforts in connection with the Company’s emergence from bankruptcy, and
pro-rating the amount for Mr. Dragoon to reflect the portion of the fiscal year he was actually employed by
us. Our Chief Executive Officer recommended that Messrs. Shuman, Dragoon and Bayers be paid an
annual bonus in an amount equal to 96%, 62.5% and 100%, respectively, of each officer’s target bonus,
and such awards were approved by the Compensation Committee.
Ms. Forsa’s employment with us terminated on January 3, 2013. As part of the negotiation of her
separation agreement with us, Ms. Forsa was awarded 100% of her target bonus.
Equity Incentives
Equity awards are a significant component of our executive officer compensation. In connection with our
emergence from bankruptcy all awards granted prior to our emergence from bankruptcy were cancelled.
All equity awards are now granted under our 2012 Management Incentive Plan (the “MIP”), which is
designed to align the interests of our stockholders and executive officers by increasing the proprietary
interest of our executive officers in our growth and success, to advance our interests by attracting and
retaining key employees, and motivating such executives to act in our long-term best interests. We grant
equity awards to promote the success and enhance the value of the Company by providing participants
with an incentive for outstanding performance. Equity-based awards also provide the Company with the
flexibility to motivate, attract, and retain the services of employees upon whose judgment, interest, and
special effort the successful conduct of our operation is largely dependent. We believe that equity awards
113
provide long-term incentives to executive officers because they tie the executive officers’ financial
interests to those of our shareholders.
As part of the negotiations with creditors in connection with our emergence from bankruptcy, we
established the overall size of the option pool (10% of the fully-diluted outstanding shares) as well as the
allocation of initial grants under the MIP to executive officers, which are set forth below:
Named Executive Officer
Linda Zecher
Eric Shuman
John Dragoon
Bethlam Forsa
William Bayers
Stock Options Granted
(#)
1,842,105
818,714
614,035
491,228
327,485
Percentage of Fully-Diluted
Outstanding Shares
2.25%
1.00%
.75%
.60%
.40%
The exercise price of all stock options granted by the Board of Directors cannot be less than 100% of the
fair market value (as determined under the MIP) of the common stock on the date of the grant. The stock
options granted in fiscal 2012 have an exercise price of $25.00 per share, which is equal to the value of
our common stock established in the Plan of Reorganization as of the date of emergence from
bankruptcy. Stock options generally are subject to a four-year vesting schedule and expire seven years
after the date of grant.
Employee Benefits
Executive officers participate in other employee benefit plans generally available to all employees on the
same terms, such as a 401(k) plan with a Company matching contribution. In addition, certain executive
officers participate in an executive life insurance plan. We also provide parking, tax preparation, moving
expenses, and tax gross-ups for moving expenses to certain of our named executive officers. These
plans are designed to enable us to attract and retain our workforce in a competitive marketplace.
Change in Control Severance Plan
We believe that companies should provide reasonable severance benefits to executive officers due to the
greater level of difficulty they face in finding comparable employment in a short period of time and greater
risk of job loss or modification as a result of a change-in-control transaction than other employees. In
recognition of the need to retain key personnel during a period of significant change and uncertainty, we
adopted a Change in Control Severance Plan in December 2012. The Change in Control Severance
Plan is designed (i) to retain our executives and (ii) to align their interests with our stockholders’ interests
so that they can consider transactions that are in the best interests of our stockholders and maintain their
focus without concern regarding how any such transaction might personally affect them. The Change in
Control Severance Plan provides for “double trigger” severance payments, which means that both a
change in control and a termination of employment must occur in order for a named executive officer’s
severance benefits to be triggered in connection with a change in control.
See “Potential Post-Employment Payments Upon Termination or Change in Control” for a more detailed
description of the benefits payable under the Change in Control Severance Plan.
Reasonableness of Compensation
The Compensation Committee does not adhere to rigid formulas when determining the amount and mix
of compensation elements. Compensation elements for each executive are reviewed in a manner that
optimizes the executive’s contribution to the Company and reflects an evaluation of the compensation
paid by the Company’s competitors. The Compensation Committee reviews both current pay and the
opportunity for future compensation to achieve an appropriate mix between equity incentive awards and
cash payments in order to meet its objectives. The mix of compensation elements is designed to reward
recent results and motivate long-term performance through a combination of cash and equity incentive
awards.
114
Compensation Committee Report
The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis
with management and, based on such review and discussions, the Compensation Committee
recommended to the Board of Directors that the Compensation Discussion and Analysis be included in
this Annual Report.
Members of the Compensation Committee:
John R. McKernan, Jr. (chair)
Sheru Chowdhry
L. Gordon Crovitz
Lawrence K. Fish
John F. Killian
E. Rogers Novak, Jr.
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Summary Compensation Table For Fiscal Year 2012
The following table sets forth the cash and non-cash compensation paid by us or incurred on our
behalf to our named executive officers during 2012, our last completed fiscal year.
Name and
Principal
Position
Linda Zecher
Chief Executive
Officer
Year
2012
Salary
($)
Bonus
($)
Stock
Awards
($)
Option
Awards
($)(1)
Non-Equity
Incentive Plan
Compensation
($)(2)
All Other
Compensation
($)(3)
Total
($)
750,000
__
__
10,205,262
900,000
67,409
11,922,671
Eric Shuman
2012
500,000
__
__
4,535,676
480,000
17,075
5,532,751
Executive Vice
President/
Chief Financial
Officer
John Dragoon (4)
2012
284,615
__
__
3,401,754
250,000
3,915
3,940,284
Executive Vice
President/
Chief Marketing
Officer
Bethlam Forsa (5)
2012
400,000
__
__
2,721,403
400,000
7,350
3,528,753
Executive Vice
President/
K-12 Product
Development
William Bayers
2012
400,000
__
__
1,814,267
400,000
26,420
2,640,687
Executive Vice
President/
General
Counsel,
Secretary
(1)
(2)
(3)
Represents the aggregate grant date fair value of stock options granted during the year in
accordance with the Financial Accounting Standards Board Accounting Standards Codification
(“FASB ASC”) Topic 718, Stock Compensation (disregarding any forfeiture assumptions). See
Note 12 to our consolidated financial for the assumptions made in determining these values.
These values do not correspond to the actual values that may be realized by our named executive
officers for these awards.
Represents awards made pursuant to the Bonus Plan in respect of the year indicated, although
the awards were actually paid in the following year.
For Ms. Zecher, this amount represents Company-paid life insurance premiums ($12,564); parking
($5,220); moving expenses ($29,843); and tax gross-ups for moving ($19,782). For Mr. Shuman,
this amount represents employer matching contributions to our 401(k) plan ($7,350); parking
($5,220) and Company-paid life insurance premiums ($4,505). For Mr. Dragoon, this amount
represents parking ($3,915). For Ms. Forsa, this amount represents employer matching
contributions to our 401(k) plan ($7,350). For Mr. Bayers, this amount represents employer
matching contributions to our 401(k) plan ($7,350); parking ($5,220); tax preparation assistance
($1,571) and Company-paid life insurance premiums ($12,279).
(4) Mr. Dragoon was hired on April 9, 2012.
(5) Ms. Forsa’s employment terminated effective January 3, 2013.
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Grants of Plan-Based Awards For Fiscal Year 2012
The following table details grants to our named executive officers during 2012:
Estimated Future Payouts
Under Non-Equity
Incentive Plan Awards(1)
Grant
Date
Threshold
($)
Target
($)
Maximum
($)
All Other
Option Awards:
Number of
Securities
Underlying
Options(#) (3)
Exercise Price of
Option Awards($)
Grant Date
Fair Value of
Option
Awards($)(2)
6/22/12
937,500
1,842,105
25.00
10,205,262
6/22/12
218,750 500,000
650,000
818,717
25.00
4,535,676
6/22/12
175,000 400,000
520,000
614,035
25.00
3,401,754
6/22/12
175,000 400,000
520,000
491,228
6/22/12
175,000 400,000
520,000
327,485
25.00
25.00
2,721,403
1,814,267
For a description of the material terms of these awards, please see the “Compensation
Discussion and Analysis—Elements of Executive Compensation—Annual Cash Bonus Plans.”
We estimated the fair value of option awards on the grant date using the Black-Scholes option-
pricing model and in accordance with the FASB ASC Topic 718. See Note 12 to our consolidated
financial statements for the assumptions made in determining these values.
For Ms. Zecher, the options vested 25% on the date of grant and vest 25% on June 22, 2013,
June 22, 2014 and June 22, 2015. For all other executives, the options vest over four years with
25% vesting on June 22, 2013, June 22, 2014, June 22, 2015 and June 22, 2016.
Linda
Zecher
Eric
Shuman
John
Dragoon
Bethlam
Forsa
William
Bayers
(1)
(2)
(3)
Employment Agreements
We have entered into an employment agreement with each of our named executive officers. For a
description of the severance benefits each executive is entitled to receive upon a termination of
employment pursuant to the terms of his or her employment agreement, please see “Potential Post-
Employment Payments Upon Termination or Change in Control”.
Linda Zecher
Ms. Zecher’s employment agreement provides that Ms. Zecher will continue to serve as our President
and Chief Executive Officer until her employment is terminated by us or by Ms. Zecher, which may be at
any time, with or without cause, subject to the provisions of her employment agreement. In consideration
for her receipt of stock options, the agreement contains a covenant not to engage in any business that
competes with us or to solicit employees or customers during the term of her employment and for a period
of one year thereafter, as well as non-disparagement, confidentiality, and intellectual property provisions.
The provisions of Ms. Zecher’s employment agreement that relate to equity grants are no longer effective
following our emergence from bankruptcy.
Ms. Zecher is entitled to receive an annual base salary of $750,000 and is eligible for an annual target
bonus of 125% of her base salary based on the achievement of performance goals established by our
Board of Directors for such fiscal year. Ms. Zecher is entitled to four weeks of vacation per year.
117
Eric Shuman
Mr. Shuman’s employment agreement provides that Mr. Shuman will continue to serve as our Executive
Vice President/Chief Financial Officer until his employment is terminated by us or by Mr. Shuman, which
may be at any time, with or without cause, subject to the provisions of his employment agreement. In
consideration for his receipt of stock options, the agreement contains a covenant not to engage in any
business that competes with us or to solicit employees or customers during the term of his employment
and for a period of one year thereafter, as well as non-disparagement and intellectual property provisions.
Mr. Shuman is entitled to receive an annual base salary of $500,000, and in accordance with the terms of
his employment agreement, the Bonus Plan, and our benefit policies, is eligible for an annual target
bonus of 100% of his base salary. Mr. Shuman is entitled to four weeks of vacation per year.
John Dragoon
We entered into an employment agreement on March 27, 2012, with John Dragoon with an effective date
of April 9, 2012. Mr. Dragoon’s employment agreement provides that Mr. Dragoon will continue to serve
as our Executive Vice President and Chief Marketing Officer until his employment is terminated by us or
by Mr. Dragoon, which may be at any time, with or without cause, subject to the provisions of his
employment agreement. In consideration for his receipt of stock options, the agreement contains a
covenant not to engage in any business that competes with us or to solicit employees or customers
during the term of his employment and for a period of one year thereafter, as well as non-disparagement,
confidentiality, and intellectual property provisions.
Mr. Dragoon is entitled to receive an annual base salary of $400,000, and in accordance with the terms of
his employment agreement, the Bonus Plan, and our benefit policies, is eligible for an annual target
bonus of 100% of his base salary. Mr. Dragoon is entitled to four weeks of vacation per year.
Bethlam Forsa
Ms. Forsa’s employment terminated effective January 3, 2013, and we subsequently entered into a
separation agreement with her dated January 10, 2013.
Prior to the termination of her employment, Ms. Forsa’s employment agreement provided that Ms. Forsa
would serve as our Executive Vice President – Publishing Operations until December 31, 2013, subject to
automatic one-year extensions unless either we or Ms. Forsa provided ninety days’ notice not to extend
the term or until her employment is terminated by us or Ms. Forsa, which may be at any time, with or
without cause, subject to the provisions of her employment agreement. The agreement contained a
covenant not to engage in any business that competes with us or to solicit employees or customers
during the term of her employment and for a period of one year thereafter, as well as non-disparagement,
confidentiality, and intellectual property provisions.
During 2012, Ms. Forsa was entitled to receive an annual base salary of $400,000, and in accordance
with the terms of her employment agreement, the Bonus Plan, and our benefit policies, was eligible for an
annual target bonus of 100% of her base salary. Ms. Forsa was entitled to four weeks of vacation per
year.
William Bayers
Mr. Bayers’ employment agreement provides that Mr. Bayers will continue to serve as our Executive Vice
President, General Counsel and Secretary until his employment is terminated by us or by Mr. Bayers,
which may be at any time, with or without cause, subject to the provisions of his employment agreement.
The employment agreement also contains confidentiality and intellectual property provisions.
Mr. Bayers is entitled to receive an annual base salary of $400,000, and in accordance with the terms of
his employment agreement, the Bonus Plan and our benefit policies, is eligible for an annual target bonus
of 100% of his base salary. Mr. Bayers’ is entitled to four weeks of vacation per year. He also is entitled
to prior service credit for purposes of eligibility under the Company’s post-retirement medical plan.
118
Outstanding Equity Awards at Fiscal Year-End 2012
Option Awards
Number of Securities
Underlying Unexercised
Options
Exercisable
(#)(1)
Unexercisable
(#)(2)
460,526.25 1,381,578.75
Option
Exercise
Price ($)
25.00
Option
Expiration
Date
6/21/19
Name
Linda Zecher
Eric Shuman
—
818,714
25.00
6/21/19
John Dragoon
—
614,035
25.00
6/21/19
Bethlam Forsa
—
491,228
25.00
6/21/19
William Bayers
—
327,485 25.00
6/21/19
(1)
(2)
For Ms. Zecher, the options vested 25% on the date of grant and vest 25% on June 22, 2013,
June 22, 2014 and June 22, 2015. For all other executives, the options vest over four years with
25% vesting on June 22, 2013, June 22, 2014, June 22, 2015 and June 22, 2016.
Upon a change of control, all option awards will become immediately vested and exercisable.
Potential Post-Employment Payments Upon Termination or Change in Control
Change in Control Severance Plan
We maintain the HMH Holdings (Delaware), Inc. Change in Control Severance Plan to help retain key
executives by reducing personal uncertainty that may arise from the possibility of a change in control, and
to promote their objectivity and neutrality in evaluating transactions that may be in the best interest of the
Company and our shareholders. The plan establishes objective criteria to determine whether a change in
control has occurred, and provides for severance payments and benefits only on a “double trigger” basis.
The “double trigger” design is intended to further our goals to retain key executives upon a change in
control.
Each named executive officer participates in the Change in Control Severance Plan. Under this plan, if
the executive’s employment is terminated by us other than for “cause” (as defined in the MIP as
described below under “Equity Award Provisions”), death or disability, or if the executive resigns for “good
reason” within two years after a “change in control” or the period commencing on the date of entry into a
definitive agreement or following a public announcement by the Company of a transaction or transactions
that would result in a change in control (but not earlier than six months preceding the change in control),
then HMH or its successor will be obligated to pay or provide the following benefits upon the employee’s
execution of a release of claims:
• A lump sum payment equal to two times annual base salary; plus
• A lump sum payment equal to 200% (in the case of Ms. Zecher and Mr. Shuman) or
100% (for other named executive officers) of the officer’s target annual bonus; plus
• A lump sum payment equal to a pro-rata portion of the target annual bonus.
119
The plan provides for a cutback of severance payments to the safe harbor amount if the payments would
be subject to the excise tax imposed by Section 4999 of the Code but only if such reduction would result
in a greater net payment to the executive than he or she would have received without such reduction but
after paying the excise tax.
The term “good reason” generally means (a) material adverse change in duties or reporting relationship,
(b) reduction in salary or annual bonus opportunity not in connection with an across-the-board reduction
for other senior executives of the Company, or (c) forced relocation to a place of employment more than
fifty miles from the employee’s place of employment immediately prior to the change in control; provided,
however, that no termination of an employee’s employment will constitute a termination for good reason
unless (i) the executive has first provided the Company with written notice specifically identifying the acts
or omissions constituting the grounds for good reason within thirty days after the executive has or should
reasonably be expected to have had knowledge of the occurrence thereof, (ii) the Company has not
cured such acts or omissions within thirty days of its actual receipt of such notice, and (iii) the effective
date of the employee’s termination for good reason occurs no later than ninety days after the initial
existence of the facts or circumstances constituting good reason.
The term “change in control” generally means, unless otherwise provided in any employment agreement
between the Company and the applicable employee, the occurrence of any one of the following
events:
(i)
any person (as such term is used in Section 13(d) of the Exchange Act) (other than a
“permitted holder” (as defined in the Change in Control Severance Plan)), together with its affiliates (other
than a permitted holder), is or becomes the beneficial owner, directly or indirectly, of more than 50% of
the outstanding common stock or voting power of the Company by merger, consolidation, reorganization,
or otherwise;
(ii)
the sale of all or substantially all of the Company’s assets, determined on a consolidated
basis, to any person or group (as such term is used in Section 13(d) of the Exchange Act) of persons
(other than any permitted holder or their affiliates); or
(iii)
the Company combines with another company if, immediately after such combination, the
shareholders of the Company immediately prior to the combination hold, directly or indirectly, less than
50% of the capital stock (of any class or classes) having general voting power under ordinary
circumstances, in the absence of contingencies, to elect the directors of the Company of the combined
entity; provided, however, that for purposes of this definition, no group will be deemed to have been
formed solely by virtue of the execution and delivery of the Restructuring Support Agreement and the
Investor Rights Agreement (each as defined in the Change in Control Severance Plan). In addition, the
Board of Directors may specifically provide that an event or transaction that would not otherwise qualify
as a Change in Control be treated as a Change in Control for purposes of the Plan.
Equity Award Provisions
According to the terms of our MIP, if a named executive officer’s employment is terminated due to their
death or disability or for any other reason except by us for “cause” (as defined below), the unvested
portion of their equity awards will expire on the date they are terminated. The vested portion of stock
option awards will remain exercisable until the earlier of either the expiration of the option period or 12
months after such termination in the case of termination due to death or disability, 30 days in the case of
a voluntary resignation, or 90 days (180 days for Ms. Zecher) after any other termination other than
termination by us for cause.
If we terminate any named executive officer’s employment for cause, both the unvested equity awards
and vested portions of the stock options will terminate on the same date their employment is terminated.
Upon a change in control (as defined as in the Change in Control Severance Plan, except that the Board
of Directors does not have an explicit right to provide that an event or transaction that would not otherwise
qualify as a change in control be treated as a change in control for purposes of the MIP), and unless
otherwise determined by the Compensation Committee and specified in the applicable award notice, all
120
stock options outstanding under the MIP will vest and become exercisable with respect to 100% of the
shares of our common stock covered by such stock option.
As a condition to the receipt of a stock option grant, the executive signs a restrictive covenant agreement,
which restricts competition and solicitation during employment and for one year thereafter, as well as
customary confidentiality and non-disparagement provisions.
For purposes of the MIP, the term “cause” generally means, unless an award notice under the MIP states
otherwise, (i) commission or guilty plea or plea of no contest to a felony (or its equivalent under applicable
law) or any crime that involves moral turpitude, (ii) conduct that constitutes fraud or embezzlement or any
acts of dishonesty in relation to his or her duties with the Company or our affiliates, (iii) engaging in gross
negligence, bad faith, or intentional misconduct which causes either reputational or economic harm to the
Company or our affiliates, (iv) continued refusal to substantially perform his or her essential duties with
respect to the Company or our affiliates, which refusal is not remedied within ten days after written notice
from the Board of Directors, or (v) breach of obligations under any service contract with the Company or
our affiliates or any written Company employment policy, including any code of conduct, which is not
cured, if curable, within ten days after Company notification of such breach.
Employment Agreement for Linda Zecher
If Ms. Zecher’s employment is terminated by us without “cause” (as defined above in the MIP) or by her
for “good reason” (as defined below), subject to her execution of a release of claims, she will be entitled
to (i) severance payment over twelve months equal to two times base salary; (ii) twelve months of
COBRA payments; and (iii) a pro rata bonus for the year in which her employment terminates, based on
the actual performance results for the year of termination and payable at such time as bonuses are
generally paid.
For purposes of Ms. Zecher’s employment agreement, “good reason” includes a resignation by her during
the 30-day period commencing six months after either (i) a “change in control” (as defined in the MIP as
described above), or (ii) the date that a majority (but not less than five) members of the Board of Directors
is replaced during any twelve-month period by directors whose appointment or election is not endorsed
by a majority of the members of the Board of Directors before the date of the appointment or election.
As noted above, the provisions of Ms. Zecher’s employment agreement that relate to equity grants are no
longer effective following our emergence from bankruptcy. If Ms. Zecher becomes eligible for payments
under both the Change in Control Severance Plan and her employment agreement, she would be entitled
to the cash payments as dictated by the Severance Plan and any benefits continuation provided by her
employment agreement.
Employment Agreement for Eric Shuman
If Mr. Shuman’s employment is terminated by us without cause prior to a change in control, we will
provide him with severance consideration equal to continued salary for twelve months.
Employment Agreement for John Dragoon
If Mr. Dragoon’s employment is terminated by us without “cause” (as that term is commonly understood in
connection with executive actions or inactions) prior to a change of control, he will be entitled to receive,
subject to his execution of a release of claims in favor of the Company, (i) severance payments equal to
one year’s base salary, (ii) six months of COBRA payments if he elects COBRA; and (iii) a pro rata bonus
for the year in which his employment terminates, based on the actual performance results for the year of
termination, payable at such time as executive bonuses are generally paid.
Separation Agreement for Bethlam Forsa
Ms. Forsa separated from the Company, effective January 3, 2013. We entered into a separation
agreement with her dated January 10, 2013, providing for severance in the amount of $400,000, monthly
COBRA costs totaling $21,984.60, each payable over a twelve-month period, and her 2012 bonus equal
to $400,000, paid on the first payroll date following her execution and non-revocation of the separation
121
agreement. As a condition to the receipt of any severance payments, Ms. Forsa executed a release of
claims against the Company. Additionally, she continues to be subject to the restrictive covenant
agreement of her employment agreement and confidentiality and intellectual property agreement, which
subjects her to a noncompete for one year following termination, as well as non-disparagement,
confidentiality, and intellectual property provisions.
Employment Agreement for William Bayers
If Mr. Bayers’ employment is terminated by us for any reason other than for cause prior to a change in
control, we will provide him with a severance payment equal to one year of continued base salary upon
his execution of a separation and release agreement.
Termination Payments
The following table sets forth the payments each of our named executive officers would have received if
their employment had been terminated by us without cause or by the executive for good reason on
December 31, 2012 and there was no change of control.
Death,
Disability,
Voluntary
Resignation,
Termination
for Cause
($)
__
__
__
__
__
__
__
__
Name
Linda Zecher (1) Cash Severance
Benefit
COBRA
Payments
Eric Shuman (2) Cash Severance
John Dragoon (3) Cash Severance
COBRA
Payments
Bethlam Forsa (4) Cash Severance
COBRA
Payments
William Bayers (5) Cash Severance
Amount Payable
Termination By Us
Without Cause
($)
Resignation for
Good Reason
($)
2,400,000
17,433
500,000
525,000
4,182
400,000
21,985
400,000
__
__
__
__
__
400,000
21,985
__
(1)
(2)
(3)
(4)
Upon a termination by us without cause or a resignation for good reason, Ms. Zecher would be
entitled to two times base salary, a prorated bonus (which for this purpose is assumed to be the
actual bonus payable for fiscal year 2012), and 12 months of COBRA payments.
Upon a termination by us without cause, Mr. Shuman would be entitled to continued base salary
for twelve months.
Upon a termination by us without cause, Mr. Dragoon would be entitled to base salary, a prorated
bonus (which for this purpose is assumed to be the actual bonus payable for fiscal year 2012), and
six months of COBRA payments.
Represent the amounts Ms. Forsa would have received under her employment agreement if her
employment had been terminated on December 31, 2012 and does not reflect additional amounts
122
provided by her separation agreement.
(5)
Upon a termination by us without cause, Mr. Bayers would be entitled to continued base salary for
twelve months
Change of Control Termination
The following table sets forth the payments each of our named executive officers would have received if a
change of control occurred, and, following a change of control, their employment had been terminated by
us without cause or by the named executive officer for good reason, in each case on December 31, 2012.
Although outstanding unvested stock options would become vested in connection with a change of
control, the value of such acceleration is deemed to be $0 as of December 31, 2012 because as of such
date the fair market value of the common stock did not exceed the exercise price of the stock options.
Amounts Payable Upon a Change in Control
($)
Termination
Without Cause
Resignation for
Good Reason
Death, Disability,
Termination for
Cause
Name
Benefit
Linda
Zecher (1) Cash Severance
COBRA
Payments
Option
Acceleration
Value
Eric
Shuman (1)
Cash Severance
Option
Acceleration
Value
John
Dragoon (2)
Bethlam
Forsa (3)
Cash Severance
Option
Acceleration
Value
Cash Severance
Option
Acceleration
Value
4,275,000
4,275,000
__
__
17,433
__
2,480,000
2,480,000
__
__
1,462,500
1,462,500
__
__
400,000
400,000
__
__
William
Bayers (2) Cash Severance
1,600,000
1,600,000
Option
Acceleration
Value
__
__
123
__
__
__
__
__
__
__
__
__
__
__
(1) Ms. Zecher’s and Mr. Shuman’s cash severance amounts upon a termination without cause or
resignation for good reason consist of two times the sum of base salary and target bonus plus a
prorated bonus for the year of termination (which for this purpose is assumed to be the actual
bonus payable for fiscal year 2012). Under certain circumstances, if Ms. Zecher resigns for good
reason, pursuant to her employment agreement, she would be entitled to benefits continuation.
(2) Mr. Dragoon’s and Mr. Bayers’ cash severance amounts upon a termination without cause or
resignation for good reason consist of two times base salary plus target bonus and a prorated
bonus for the year of termination (which for this purpose is assumed to be the actual bonus
payable for fiscal year 2012).
(3) Represent the amounts Ms. Forsa would have received under her employment agreement if her
employment had been terminated on December 31, 2012.
Board Compensation
The Nominating, Ethics and Governance committee of our Board of Directors is responsible for reviewing
and recommending non-employee director compensation to the full board for its approval. We pay our
non-employee directors a mix of cash and equity-based compensation. We do not provide any
perquisites or retirement benefits to our non-employee directors. We do not provide any additional
compensation to our employee directors.
The cash compensation paid to our non-employee directors consists of an annual retainer for board and
committee service, plus an annual retainer for service as chair of certain committees with respect to the
full board. Our non-employee directors (other than the Chairman of the Board) receive annual
compensation of $165,000, of which $80,000 is payable in cash and $85,000 is payable in the form of
restricted stock units (RSUs) described below. Our Chairman receives annual compensation of
$250,000, of which $120,000 is payable in cash and $130,000 is payable in RSUs. The Company also
reimburses all of its directors for expenses they incur in connection with attending Board meetings and
committee meetings.
In addition, each non-employee director will earn a fee for service on a committee and service as a
committee chairperson, as applicable. Each member of the Audit Committee (other than the
Chairperson) receives an annual retainer of $10,000, and the Chairperson of the Audit Committee
receives an annual retainer of $25,000. Each member of the Compensation Committee (other than the
Chairperson) receives an annual retainer of $10,000, and the Chairperson of the Compensation
Committee receives an annual retainer of $25,000. Each member of the Nominating, Ethics and
Governance Committee (other than the Chairperson) receives an annual retainer of $5,000, and the
Chairperson of the Nominating, Ethics and Governance Committee receives an annual retainer of
$12,500. Cash compensation is payable quarterly. The schedule of retainers paid to our non-employee
directors in effect as of December 31, 2012 is as follows:
Position
Board of Directors
Audit Committee
Compensation Committee
Nominating, Ethics and Governance Committee
Annual Retainer
for Membership
$165,000
$10,000
$10,000
$5,000
Additional Retainer for
Chair role
$85,000
$15,000
$15,000
$7,500
The grants of RSUs in fiscal 2012 were valued based on the $25 per share value established in our Plan
of Reorganization in connection with our emergence from bankruptcy. All subsequent grants of restricted
stock units will be granted at the fair market value of the common stock at the time of grant. The RSUs
generally vest on the first anniversary of the date of grant, subject to continued service as a member of
the Board.
124
Prior to June 22, 2012, The cash compensation paid to our non-employee directors consisted of an
annual retainer for board and committee service. Our non-employee directors (other than the Chairman
of the Board) receive annual cash compensation of $144,000. Our Chairman received annual cash
compensation of $216,000. The Company also reimbursed all of its directors for expenses they incur in
connection with attending Board meetings and committee meetings.
Director Compensation Table – Fiscal 2012
Name
Lawerence K. Fish
John F. Killian
Jill A. Greenthal
L. Gordan Crovitz
John R. McKernan, Jr.
E. Rogers Novak, Jr.
Sheru Chowdhry (4)
William Hagerty
Robert Schmitz
William Campbell
Todd Boehly (4)
Anthony Salcito (5)
Fees Earned or
Paid in Cash ($)(1)
188,000
139,500
53,228
33,750
103,630
9,130
-
79,500
72,000
72,000
-
-
Stock Awards ($) (2) Other ($) (3)
Total
130,000
85,000
85,000
85,000
85,000
85,000
-
-
-
-
-
-
78,170
-
-
-
-
-
-
-
-
-
-
-
396,170
224,500
138,228
118,750
188,630
94,130
-
79,500
72,000
72,000
-
-
(1) Represents the aggregate cash retainers for board and committee service.
(2) Represents the aggregate grant date fair value of stock options granted during the year in
accordance with the FASB ASC Topic 718 (disregarding any forfeiture assumptions. See Note
12 to our consolidated financial statements for the assumptions made in determining these
values. These values do not correspond to the actual value that may be realized by our non-
employee directors for these awards. As of December 31, 2012, each of Messrs. Killian,
Greenthal, Crovitz, McKernan and Novak held 3,400 RSUs, and Mr. Fish held 5,200 RSUs. No
other non-employee directors held any stock awards.
(3) Represents portion of salary and benefits paid to Mr. Fish’s executive assistant not attributed to
services rendered to the Company
(4) Mr. Chowdhry and Mr. Boehly are not considered independent directors and did not receive
any director compensation.
(5) Mr. Salcito resigned from the Board of Directors on February 3, 2012 and did not receive any
director compensation in 2012.
Stock Plans
The board of directors of HMH Holdings administers the HMH Management Incentive Plan (the “Plan”)
pursuant to which the board, or a committee designated by the board may, from time to time, grant option
and stock awards to employees and employees of our subsidiaries who, in the opinion of the board, are in
a position to make a significant contribution to our success. The board of directors may grant options that
vest over time or options that vest based on the attainment of performance goals specified by the board
of directors. The stock related to award forfeitures remains outstanding and may be reallocated to new
recipients.
125
Item 12. Security Ownership of Certain Beneficial Owner’s and Management and Related
Stockholders Matters
As of February 28, 2013, common stock was the only class of HMH Holdings’ capital stock that was
outstanding, and there were 69,958,989 shares of common stock outstanding as of that date. The table
below sets forth certain information regarding the beneficial ownership of the outstanding shares of
common stock of HMH Holdings as of February 28, 2013 by:
• each person who is known to be the beneficial owner of more than 5% of HMH Holdings’
common stock;
• each member of HMH Holdings’ board of directors and each of our executive officers
individually; and
• all members of HMH Holdings’ board of directors and executive officers as a group.
Beneficial ownership has been determined under rules promulgated by the SEC. The information does
not necessarily indicate beneficial ownership for any other purpose. Shares of common stock subject to
options currently exercisable and convertible securities currently convertible, or exercisable or convertible
within 60 days after the dates of this report, are deemed outstanding for purposes of computing the
percentage beneficially owned by the person or entity holding such securities but are not deemed
outstanding for purposes of computing the percentage beneficially owned by any other person or entity.
Each individual or entity shown on the table has furnished information with respect to beneficial
ownership. Except as otherwise indicated below, the address of each executive officer and director listed
below is c/o HMH Holdings (Delaware), Inc., 222 Berkeley Street, Boston, Massachusetts 02116.
Name of beneficial owner
Percentage
Shares of
common stock
beneficially
owned
Affiliates of Paulson & Co. Inc.(1) ......................................................
18,183,856
26.0%
Affiliates of Anchorage Advisors L.L.C.(2) .......................................
Affiliates of Blackrock Financial Management, Inc.(3) ....................
Affiliates of Avenue Investments L.P.(4) ...........................................
Affiliates of Q Investments L.P.(5) .....................................................
Affiliates of Oak Hill Advisors L.P.(6) ................................................
Lehman Commercial Paper Inc.(7) ....................................................
Lawrence K. Fish ...............................................................................
John R. McKernan, Jr. .......................................................................
L. Gordon Crovitz...............................................................................
Jill A. Greenthal ..................................................................................
John F. Killian ....................................................................................
Sheru Chowdry ..................................................................................
E. Rogers Novak, Jr. ..........................................................................
126
6,833,320
6,161,679
6,053,596
5,253,801
4,304,296
4,247,858
-
-
-
-
-
-
-
9.8%
8.8%
8.7%
7.5%
6.2%
6.1%
*
*
*
*
*
*
*
Linda K. Zecher(8) ...............................................................................
460,526
Eric L. Shuman ...................................................................................
John K. Dragoon ................................................................................
Bethlam Forsa ....................................................................................
William F. Bayers ...............................................................................
-
-
-
-
All Directors and Executive Officers as a group (16 persons)…..
460,526
*
*
*
*
*
*
*
Less than 1%.
The information with respect to the affiliates of Paulson & Co. Inc. includes the shares of common
stock held by funds affiliated with Paulson & Co., Inc. including Paulson Advantage Master LTD
which owns 5.6%, Paulson Advantage Plus Master LTD which owns 12.5%, and Paulson Credit
Opportunities Master LTD which owns 7.7%. Address is 1251 Avenue of the Americas, New York,
New York 10020.
The information with respect to the affiliates of Anchorage Advisors L.L.C. includes the shares of
common stock held by funds affiliated with Anchorage Advisors L.L.C. including Anchorage Capital
Master Offshore LTD which owns 6.4%. Address is 610 Broadway, New York, New York 10012.
The information with respect to the affiliates of Blackrock Financial Management, Inc. includes the
shares of common stock held by funds affiliated with Blackrock Financial Management, Inc.
including Blackrock Credit Investors Master Fund LP which owns 5.2%. Address is c/o Blackrock,
Inc., 55 East 52nd St., New York, New York 10055.
The information with respect to the affiliates of Avenue Investments L.P. includes the shares of
common stock held by funds affiliated with Avenue Investments L.P. including Avenue Investments
L.P. which owns 6.7%. Address is 399 Park Avenue, New York, New York 10022.
The information with respect to the affiliates of Q Investments, L.P. includes the shares of common
stock held by funds affiliated with Q Investments L.P. including R2 Top Hat LTD which owns 5.9%.
Address is 301 Commerce Street, Fort Worth, Texas 76102.
The information with respect to the affiliates of Oak Hill Advisors, L.P. includes the shares of
common stock held by funds affiliated with Oak Hill Advisors L.P. Address is 1114 Avenue of the
Americas, New York, New York 10036.
The information with respect to Lehman Commercial Paper Inc. includes the shares of common
stock held by Lehman Commercial Paper Inc. which owns 6.1%. Address is 1271 Avenue of the
Americas, New York, New York 10020.
Includes 460,526 shares issuable with respect to options exercisable within 60 days of February
28, 2013.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
.
127
The following table provides information with respect to our equity compensation plans under which our
equity securities were authorized for issuance as of December 31, 2012.
Equity Compensation Plan Information
Number of securities to
be issued upon
exercise of outstanding
options, warrants and
restricted stock units
Weighted-average
exercise price of
outstanding options,
warrants and restricted
stock units
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(a)
(b)
(c)
8,618,692
$25.00
3,252,654
-
-
-
Plan Category
Equity
compensation
plans approved
by security
holders
Equity
compensation
plans not
approved by
security holders
Total
128
Item 13. Certain Relationships and Related Transactions
Investor Rights Agreement
In connection with our restructuring, on June 22, 2012, we entered into an Investor Rights Agreement (the
“Investor Rights Agreement”) with our new shareholders. The Investor Rights Agreements contains,
among others, provisions granting our shareholders party thereto from time to time certain registration
rights as described in further detail below and provisions related to confidentiality, holdback agreements,
our public reporting obligations and our obligation to register our common stock under the Exchange Act
after October 1, 2013 in certain circumstances.
Registration Rights
The Investor Rights Agreement provides our shareholders party thereto from time to time with certain
registration rights.
Any holder or holders who own at least 25% of our outstanding common stock may require us to
consummate an underwritten initial public offering after April 1, 2013 pursuant to the exercise of demand
registration rights on a secondary basis so long as the total proposed offering size is at least $150 million
(an “IPO Demand Right”). If an IPO Demand Right is exercised and the initial public offering price
equates to a total equity value of our Company of not less than $1.5 billion, the holders exercising the IPO
Demand Right may also, at their option, require all other stockholders to sell in such initial public offering
their pro rata share of the common stock being sold, not to exceed 15% of the shares held by such holder
(an “IPO Drag Right”).
Any time after we become an Exchange Act public reporting company, we are required to use
commercially reasonable efforts to file and cause to become effective a shelf registration statement (on
Form S-3 if permitted) for the benefit of all holders party to the Investor Rights Agreement, and any
individual holder of 15% or more of our outstanding common stock can demand an unlimited number of
“shelf takedowns” so long as the total offering size exceeds $100 million.
Each holder or holders who own at least 15% of our outstanding common stock will have, after our initial
public offering (i) one Form S-1 demand registration right per annum, which may be conducted in an
underwritten offering as long as the total offering price is at least $100 million; and (ii) unlimited Form S-3
registration rights, which may be conducted in underwritten offerings as long as the total offering price is
at least $100 million, each subject to customary cutback provisions.
Each holder party to the Investor Rights Agreement has unlimited piggyback registration rights with
respect to underwritten offerings, subject to certain exceptions and limitations.
The foregoing registration rights are subject to certain cutback provisions and customary
suspension/blackout provisions. We have agreed to pay all registration expenses under the Investor
Rights Agreement, and, in limited circumstances, the underwriting fees and commissions for certain
holders.
Indebtedness
Affiliates of certain of our stockholders, including the stockholders holding 5% or more of HMH Holdings’
common stock listed in “Security ownership of certain beneficial owners and management,” also currently
own a portion of our indebtedness, including indebtedness outstanding under our Term Loan.
Debt-for-Equity Exchange
Upon the Company’s emergence from Chapter 11 bankruptcy proceedings, holders of the Term Loan,
Revolving Loan, and 10.5% Senior Notes were issued post-emergence shares of new common stock
pursuant to the final Plan on a pro rata basis. Certain of these holders of the Term Loan, Revolving Loan,
and 10.5% Senior Notes were also equity holders prior to the consummation of the Plan. The amount of
129
the gain attributable to the debt to equity conversion, net of elimination of fees and other charges, of
$1,010.3 million, which is associated to the holders of the Term Loan, Revolving Loan, and 10.5% Senior
Notes that were also equity holders prior to the consummation of the Plan, was charged to capital in
excess of par value.
Item 14. Principal Accountant’s Fees and Services
The table below provides a summary of the fees paid by us to our auditors, PricewaterhouseCoopers
LLP, for the following periods:
Audit fees
Audit-related fees
Tax fees
All other fees
Total
Years Ended December 31,
2012
2011
$
1,857,139
$
2,034,749
6,592
27,867
1,800
214,000
94,663
-
$
1,893,398
$
2,343,412
Audit fees consist of fees for professional services necessary to perform an audit of the financial
statements, review of the quarterly and annual reports and statutory audits and other services required to
be performed by our independent auditors.
Audit-related fees consist of fees for services that are reasonably related to the performance of the audit
or review of our financial statements including the support of business acquisition and divestiture
activities.
Tax fees consist of fees for professional services rendered for assistance with federal, state, local and
international tax compliance, tax planning, and tax advice.
All other fees include licenses to technical accounting research software.
The Audit Committee approves in advance all audit and non-audit services to be provided by the
independent auditors. Under the Audit Committee’s pre-approval policy for 2012, the Chairman of the
Audit Committee has the delegated authority from the Committee to pre-approve services with fees up to
$200,000. Any such pre-approvals are to be reviewed and ratified by the Audit Committee at its next
meeting. The Audit Committee requires the independent auditors and management to report on actual
fees charged for each category of service periodically throughout the year.
Item 15. Exhibits, Financial Statement Schedules
Financial Statements – the response to this portion is set forth in Financial Statements and
Supplementary Data.
Financial Statement Schedules – the response to this portion is set forth in Financial Statements and
Supplementary Data. All other financial statement schedules are not required under the related
instructions or are inapplicable and therefore have been omitted.
Exhibits – see below.
130
Exhibit No. Title
2.1
3.1
3.2
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
10.1
10.2
10.3
10.4
14.1
21.1
Prepackaged Joint Plan of Reorganization of the Debtors Under Chapter 11 of the
Bankruptcy Code 5.11.2012
Restated Certificate of Incorporation 6.21.2012
Amended and Restated By-laws 6.22.2012
Superpriority Senior Secured Debtor-in-Possession and Exit Term Loan Credit Agreement
5.22.2012
First Amendment to DIP/Exit Term Loan Credit Agreement 6.11.2012
Letter Waiver and Amendment No. 2 to Credit Agreement 6.20.2012
Term Facility Guarantee and Collateral Agreement 5.22.2012
Superpriority Senior Secured Debtor-in-Possession and Exit Revolving Loan Credit
Agreement 5.22.2012
First Amendment to DIP/Exit Revolving Loan Credit Agreement 6.20.2012
Second Amendment to DIP/Exit Revolving Loan Credit Agreement 6.20.2012
Revolving Facility Guarantee and Collateral Agreement 5.22.2012
Term Loan/Revolving Facility Lien Subordination and Intercreditor Agreement 5.22.2012
Investor Rights Agreement 6.22.2012
Director Nomination Agreement 6.22.2012
2012 Management Incentive Plan
2012 Management Incentive Plan Form of Award Notice
2012 Change in Control Severance Plan
2012 Management Incentive Plan Restricted Stock Unit Award Notice
Code of Conduct
List of Subsidiaries
131
Schedule II
Valuation and Qualifying Accounts
Balance at Beginning
of Year
$
$
2012
Allowance for doubtful accounts
Reserve for returns
Reserve for royalty advances
Deferred tax valuation allowance
2011
Allowance for doubtful accounts
Reserve for returns
Reserve for royalty advances
Deferred tax valuation allowance
For the period March 10, 2010 to December 31, 2010
Allowance for doubtful accounts
Reserve for returns
Reserve for royalty advances
Deferred tax valuation allowance
For the period January 1, 2010 to March 9, 2010
Allowance for doubtful accounts
Reserve for returns
Reserve for royalty advances
Deferred tax valuation allowance
18,229
25,614
12,262
822,485
10,249
20,130
3,700
434,471
5,527
21,395
-
246,134
7,834
27,856
109,541
910,096
$
$
Net Charges
to Expenses
2,113
$
44,213
8,770
-
Utilization of
Allowances
Balance at End
of Year
$
(9,799)
(44,043)
(594)
(310,251)
$
10,543
25,784
20,438
512,234
$
8,910
49,388
8,802
388,014
$
(930)
(43,904)
(240)
-
$
18,229
25,614
12,262
822,485
$
5,238
38,751
6,240
188,337
$
437
1,954
740
129,687
$
(516)
(40,016)
(2,540)
-
$
10,249
20,130
3,700
434,471
$
(2,744)
(8,415)
(37)
-
$
5,527
21,395
110,244
1,039,783
132
2 0 1 2
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