HMHC Houghton Mifflin Harcourt Co - 10-K

Item 1A. Risk Factors

Risks Related to Pending Transaction with Veritas

We may not complete the pending transaction with entities owned by Veritas within the time frame we anticipate or at all, which could have an adverse effect on our business, financial results and/or operations.

On February 21, 2022, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among us, Harbor Holding Corp., a Delaware corporation (the “Parent”), and Harbor Purchaser Inc., a Delaware corporation and a wholly owned subsidiary of the Parent (the “Purchaser”). The Parent and the Purchaser are beneficially owned by The Veritas Capital Fund VII, L.P. (“Veritas”). The Merger Agreement provides for the acquisition of us by the Parent through a cash tender offer (the “Offer”) by the Purchaser for all of the Company’s outstanding shares of common stock at a price of $21.00 per share of common stock. Following the completion of the Offer, subject to the absence of injunctions or other legal restraints preventing the consummation of the Merger, the Purchaser will merge with and into the Company, with the Company surviving as a wholly owned subsidiary of the Parent (the “Merger”), pursuant to the procedure provided for under Section 251(h) of the Delaware General Corporation Law, without any additional stockholder approvals. We currently expect the Offer and the Merger to be completed in the second quarter of 2022.

If the transaction is not completed within the expected time frame or at all, we may be subject to a number of material risks. The price of our common stock may decline to the extent that current market prices of our common stock reflect a market assumption that the Merger will be completed. We could be required to pay Veritas a termination fee of $65 million if the Merger Agreement is terminated under specific circumstances described in the Merger Agreement. The failure to complete the transaction also may result in negative publicity and negatively affect our relationship with our stockholders, employees, strategic partners, customers, suppliers and other business partners. We may also be required to devote significant time and resources to litigation related to any failure to complete the Merger or related to any enforcement proceeding commenced against us to perform our obligations under the Merger Agreement.

The Company’s ability to complete the Merger is subject to certain closing conditions and the receipt of consents and approvals from government entities which may impose conditions that could adversely affect the Company or cause the Merger to be abandoned.

The Merger Agreement contains certain closing conditions, including, among others, that the number of shares of common stock validly tendered and not validly withdrawn, together with any shares of common stock beneficially owned by the Parent or any subsidiary of the Parent, equals at least a majority of all shares of common stock then outstanding, the absence of any legal impediment that has the effect of enjoining, restraining, preventing or prohibiting or prohibiting the consummation of the Offer or making the Offer or the Merger illegal, that, since the date of the Merger Agreement, there shall not have occurred any material adverse effect with respect to the Company, and other conditions as specified in the Merger Agreement. The Company cannot provide any assurance that the conditions to the consummation of the Merger will be satisfied or waived, or will not result in the abandonment or delay of the Merger.

In addition, the Merger is conditioned on the expiration or termination of any waiting period applicable to the consummation of the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. The granting of these regulatory approvals could involve the imposition of additional conditions on the closing of the Merger. The imposition of such conditions or the failure or delay to obtain regulatory approvals could have the effect of delaying completion of the Merger or of imposing additional costs or limitations on the Company or may result in the failure to close the Merger. The regulatory approvals may not be received at all, may not be received in a timely fashion, or may contain conditions on the completion of the Merger.

The pendency of the transaction with Veritas could adversely affect our business, financial results and/or operations.

Our efforts to complete the Merger could cause substantial disruptions in, and create uncertainty surrounding, our business, which may materially adversely affect our results of operation and our business. Uncertainty as to

whether the transaction will be completed may affect our ability to recruit prospective employees or to retain and motivate existing employees. Employee retention may be particularly challenging while the transaction is pending because employees may experience uncertainty about their roles following consummation of the transaction. A substantial amount of our management’s and employees’ attention is being directed toward the completion of the transaction and thus is being diverted from our day-to-day operations. Uncertainty as to our future could adversely affect our business and our relationship with strategic partners, customers, suppliers, school districts and other business partners. Changes to or termination of existing business relationships could adversely affect our results of operations and financial condition, as well as the market price of our common stock. The adverse effects of the pendency of the Merger could be exacerbated by any delays in completion of the transaction or termination of the Merger Agreement.

While the Merger Agreement is in effect, we are subject to restrictions on our business activities.

While the Merger Agreement is in effect, we are subject to restrictions on our business activities, generally requiring us and our subsidiaries (i) to conduct business and operations in the ordinary course and in accordance in all material respects with past practice, (ii) not to engage in specified types of transactions during the pendency of the Merger and (iii) not to solicit proposals or, subject to certain exceptions, engage in discussions relating to alternative acquisition proposals or change the recommendation of our Board of Directors to our stockholders regarding the Merger Agreement. These restrictions could prevent us from pursuing strategic business opportunities, taking actions with respect to our business that we may consider advantageous and responding effectively and/or timely to competitive pressures and industry developments, and may as a result materially and adversely affect our business, results of operations and financial condition.

In certain instances, the Merger Agreement requires us to pay a termination fee to Veritas, which could require us to use available cash that would have otherwise been available for general corporate purposes.

Under the terms of the Merger Agreement, we may be required to pay Veritas a termination fee of $65 million if the Merger Agreement is terminated under specific circumstances described in the Merger Agreement, including, but not limited to, our entry into an agreement with respect to a superior proposal or a change in the recommendation of our Board of Directors. If the Merger Agreement is terminated under such circumstances, the termination fee we may be required to pay under the Merger Agreement may require us to use available cash that would have otherwise been available for general corporate purposes and other uses. For these and other reasons, termination of the Merger Agreement could materially and adversely affect our business operations and financial condition, which in turn would materially and adversely affect the price of our common stock.

We have incurred, and will continue to incur, direct and indirect costs as a result of the pending transaction with Veritas.

We have incurred, and will continue to incur, significant costs and expenses, including fees for professional services and other transaction costs, in connection with the pending transaction. We must pay substantially all of these costs and expenses whether or not the transaction is completed. There are a number of factors beyond our control that could affect the total amount or the timing of these costs and expenses.

Risks Related to the COVID-19 Pandemic

The ongoing COVID-19 pandemic has had, and may continue to have, material adverse effects on our business, financial position, results of operations and cash flows.

Our business and financial results has been negatively impacted by the current COVID-19 pandemic which has had, and may continue to have, negative impacts on our business, including causing significant volatility in demand for our products, our ability to service our customers, changes in consumer behavior and preference, disruptions in our supply chain operations and warehousing operations, limitations on our employees’ ability to work and travel, adverse impacts on third parties upon which we rely, our liquidity, declines in state revenues and related impacts on educational budgets, and significant changes in the economic or political conditions in markets in which we operate, both near-term and potentially long-term. We continue to experience ongoing supply chain disruption both nationally and globally related to the continuing impact of COVID-19 on labor shortages, raw

material supply and transportation challenges, and manufacturing and warehousing capacity, particularly in markets where COVID-19 case levels are elevated. Moreover, significant uncertainties continue to exist regarding the format and other safety procedures schools may follow at various points during the school year. The decisions various schools make with regards to in-person and/or remote learning and whether to deviate from a chosen format due to outbreaks will impact demand for our products and services in ways that we cannot predict and may be challenging for us to respond to. Despite our efforts to manage these risks, their ultimate impact will depend on factors that may be beyond our knowledge or control, including the administration rates and effectiveness of vaccines, the severity and containment of certain COVID-19 variants, the continued duration and severity of the current pandemic and the effectiveness of actions taken to contain its spread and mitigate its public health effects and how quickly and to what extent normal economic and operating conditions can resume.

Risks Related to Our Industry and Operations

Our business and results of operations may be adversely affected by changes in federal, state and local education funding, and changes in legislation and public policy.

A majority of our sales are to public school districts in the United States, most of which rely primarily on a combination of local tax revenues and state legislative appropriations for general operating funds and to pay for purchases of goods and services, including instructional materials. Funding for public schools at both the state and local levels can be affected by tax collections, which are typically sensitive to general economic conditions, and by political and policy choices made by state and local governments. A reduction in funding levels, whether due to an economic downturn or legislative action, or a failure of projected funding increases to materialize, can constrain resources available to school districts for making purchases of instructional materials and adversely affect our business and results of operations. The economic slowdown resulting from the COVID-19 pandemic has had a negative impact on tax revenues and other financial resources in some states and localities, which could adversely affect public school finances and spending in those places, including for instructional materials and professional learning services.

Some states, including most adoption states, provide dedicated state funding for the purchase of instructional content and/or classroom technology, and expenditures for instructional materials in those states tend to be highly dependent on appropriation of those funds. If dedicated funding is not appropriated, or if the amount is substantially less than anticipated or legislative action is taken to lift restrictions on the use of those funds, then purchases of instructional materials may be significantly reduced and our net sales may be adversely impacted.

In addition, many school districts, including most large urban districts, receive substantial federal funding through the Elementary and Secondary Education Act (“ESEA”), the Individuals with Disabilities Act (“IDEA”), and other federal education programs. These funds supplement state and local funding and are used primarily to serve specific populations, such as low-income students and families, students with disabilities, and English language learners as well as to support programs to improve the quality of instruction, including educator professional learning. The funding of these programs is subject to Congressional appropriation. A significant reduction in appropriation levels could have an adverse effect on our sales, particularly sales of intervention, supplemental and professional learning products and services.

Federal and state legislative and policy changes can also affect our business. At the federal level, ESEA governs to a significant degree how states approach assessment and accountability, support and improvement of low performing schools, and take into account evidence of effectiveness in adopting strategies and selecting educational products and services paid for with federal funds. Changes in ESEA and/or state legislation and administrative policy decisions on matters such as assessment and accountability, curriculum and intervention could affect demand for our products.

State instructional materials adoptions, which account for a significant portion of our net sales of K-12 instructional materials, are highly cyclical and pose significant inherent risks that could materially impact our results of operations.

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 and/or larger sales opportunities than others. Since a large portion of our sales are derived from state adoptions, our overall results can be materially affected from year to year by the adoption schedule, particularly in large adoption states. Our failure to secure approval for our programs

or perform according to our expectations in larger new adoption opportunities could materially and adversely affect our net sales for the year of the adoption and in subsequent years.

In any state adoption, there is the inherent risk that one or more of our programs will not be approved by a particular state board of education or other adopting authority. While school districts in most adoption states are not precluded from purchasing materials that have not been approved by the state, in many cases, exclusion of a program on the state-adopted list can materially and adversely impact our ability to compete effectively at the school district level. Moreover, even if our program is approved by the state, we face significant competition and there is no guarantee that school districts will select our program or that we will be able to capture a meaningful share of the sales in such state.

State adoptions can be delayed, postponed or cancelled—sometimes with little or no warning and after we have made significant investments in anticipation of the adoption—due to various reasons, such as funding shortfalls, delays in development and approval of state academic standards and specifications, competing priorities or school readiness. In addition, individual school districts may decline to purchase new programs in accordance with the state’s adoption schedule. A substantial delay, postponement or cancellation of a large adoption opportunity can adversely affect the amount and timing of our net sales return on investment for the affected product, our business and our results of operations.

Further, the timing of the legislative appropriations process in most states is such that it is often impossible to know with certainty whether implementation of an adoption will be funded until after products have been submitted for review. By that time, investments have been made for product development and substantial expenses incurred for sales, marketing and other costs. If the legislature in a state that provides dedicated funding for instructional materials decides not to appropriate those funds or appropriates substantially less than anticipated, due to a revenue shortfall or other reasons, or if the legislature lifts restrictions on use of those funds, then implementation of that adoption could be substantially compromised or delayed and our net sales and return on investment could be adversely affected.

Changes in state academic standards could affect our market and require investment in development of new programs or modifications to our existing programs and any delays or controversies in the implementation of such standards could impact our results of operations.

States may adopt new academic standards or revise existing standards, which may affect our market and require investment in the development of new programs or modifications to our existing programs offered for sale in states that adopt such changes. Delays or controversies in the implementation of the adoption of new or revised academic standards may result in insufficient lead time before the deadline to submit instructional materials for an adoption. As a result, we have in the past and may again have to invest more than planned in order to complete product development or make the modifications in the compressed timeframe to bring our program into alignment with the new or revised standards, adversely affecting our return on investment. Alternatively, we may determine that completing product development or making the modifications within the available timeframe is not practicable, and elect not to participate in the adoption, forgoing what might have been a significant sales opportunity which could materially and adversely affect our net sales for the year of the adoption and subsequent years.

We operate in a highly competitive environment where the risks from competition are intensified due to rapid changes in our markets and industry; as a result, we must continue to adapt to remain competitive.

We operate in highly competitive markets. The risks of competition are intensified in the current environment where investment in new technology is ongoing and there are rapid changes in the products and services our customers are seeking and our competitors are offering, as well as new technologies, sales and distribution channels. In addition to national curriculum publishers, we compete with a variety of specialized or regional publishers that focus on select disciplines and/or geographic regions in the K-12 market. Our larger competitors include Savvas Learning Co. (formerly Pearson Education, Inc.), McGraw Hill Education, Stride Inc. (formerly K-12 Inc.), Cengage Learning, Inc., Scholastic Corporation, John Wiley & Sons, Inc., Curriculum Associates, LLC, Benchmark Education, LLC, Accelerate Learning, Inc., and Amplify Education, Inc. Some of these established competitors may have greater resources and less debt than us and, therefore, may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and

sale of their products and services than we can. Also competing in our market as a substitute are open source educational resources. In addition, the market shift toward digital education solutions has induced both established technology companies and new start-up companies to enter certain parts of our market. These new competitors have the possible advantage of not needing to transition from a print business to a digital business. In addition, many established technology companies have substantial resources that they could devote to developing or acquiring digital educational products and/or content and, distributing their own and/or aggregated educational content to the K-12 market, which could negatively affect our business, financial condition and results of operations. There is also a risk of further disintermediation, which is the occurrence of state, district and other customers contracting directly with technology companies, enabling technology companies to develop direct relationships with our customers, and accordingly, have significant influence over access to and, pricing and distribution of , digital and print education materials. We may not be able to adapt as needed to remain competitive in the market given the foregoing factors.

The availability of free and low-cost open education resources could adversely affect our net sales and exert downward pressure on prices for our education products.

In the K-12 market, we face growing competition from free, openly licensed content, often referred to as open education resources (“OER”). Free or low-cost OER content is typically delivered via the internet, and in some cases print versions and related services are available for purchase. A number of states support the use of OER by providing curated resources and others, including New York, Louisiana, Michigan, Tennessee, and Texas, are funding development of OER or have done so in the past. In addition, not-for-profit organizations such as the Gates Foundation and the Hewlett Foundation have supported the development of open source educational content that can be made available to educational institutions for free or at nominal costs. The increased availability of free and low-cost OER could negatively affect our customers’ perception of the value of our content, reduce demand for our educational products, and/or exert downward pressure on prices for our products, and adversely impact our net sales.

If we fail to maintain strong relationships with our authors, illustrators and other creative talent, as well as to develop relationships with new creative talent, our net sales and results of operations could be adversely affected.

Certain aspects of our K-12 business are highly dependent on maintaining strong relationships with the authors, illustrators and other creative talent who produce books and other products sold to our customers. We operate in a highly visible industry where there is intense competition for successful authors, illustrators and other creative talent. Any overall weakening of these relationships, or the failure to develop successful new relationships, could have an adverse effect on our net sales and results of operations.

If we are unable to attract, retain and focus a strong leadership team, a dynamic sales force, software engineers and other key personnel, it could have an adverse effect on our business and ability to remain competitive, financial condition and results from operations.

Our success depends, in part, on our ability to continue to attract, focus and retain a strong leadership team, a dynamic sales force, software engineers and other key personnel at economically reasonable compensation levels. We operate in highly competitive industry that continue to change to adapt to customer needs and technological advances and in which there is intense competition for experienced and highly effective personnel. If we are unable to timely attract and retain key personnel with relevant skills it could adversely affect our business, financial condition and results of operations and our ability to remain competitive.

In addition, our business results depend largely upon the experience and knowledge of local market dynamics and long-standing customer relationships of our sales personnel. Our inability to attract, retain and focus effective sales and other key personnel at economically reasonable compensation levels could materially and adversely affect our ability to operate profitably and grow our business.

Risks Related to Operations and Strategic Plans

We may not be able to execute on our long-term growth strategy or achieve expected benefits from actions taken in furtherance of our strategy, which could materially and adversely affect our business, financial condition and results of operations and/or our growth.

If we are not able to execute on our long-term growth strategy or achieve expected benefits from our actions in furtherance of our strategy, it could materially and adversely affect our business, financial condition and results of operations and/or our growth. In any event, actions taken in furtherance of our strategy, such as transitioning to new business models or entering into new market segments could adversely impact our cash flow and our business in unforeseen ways.

Our investments in new products, service offerings, platforms and/or technologies could impact our profitability.

We operate in highly competitive markets that continue to change to adapt to customer needs. These needs include an increasing demand for integrated learning solutions. In order to address these needs, we are investing in new products, new technology and infrastructure, and a new common platform to integrate our products, services and solutions. These investments may be less profitable than what we have experienced historically, may consume substantial financial resources and/or may divert management’s attention from existing operations, all of which could materially and adversely affect our business, results of operations and financial condition.

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

We rely on third parties for some of our software and technology development. For example, some of the technologies and software that compose our instruction and assessment technologies are developed by third parties. We rely on those third parties for the development of future components and modules. Thus, we face risks associated with technology and software product development and the ability of those third parties to meet our needs and their obligations under our contracts with them. In addition, we rely on third parties for our internet-based product hosting. The loss of one or more of these third-party partners, a material disruption in their business or their failure to otherwise perform in the expected manner could cause disruptions in our business that may materially and adversely affect our results of operations and financial condition.

Defects in our digital products and platforms could cause financial loss and reputational damage.

In the fast-changing digital marketplace, demand for innovative technology has generally resulted in short lead times for producing products that meet customer needs. Growing demand for innovation and additional functionality in digital products increases the risk that our digital products and platforms may contain flaws or corrupted data that may only become apparent after product launch, particularly for new products and platforms and new features for existing products and platforms that are developed and brought to market under tight time constraints. Problems with the performance of our digital products and platforms could result in liability, loss of revenue or harm to our reputation.

We are dependent on a small number of third parties to print and bind our products and to supply paper, a principal material for our products. If we were to lose our relationship with our key print vendor and/or paper merchant, our business and results of operations may be materially and adversely affected.

We outsource the printing and binding of our products and currently rely on a small group of vendors that handle approximately 35% of our printing requirements, and we expect a small number of print vendors will continue to account for a substantial portion of our printing requirements for the foreseeable future. The loss of, or a significant adverse change in our relationship with our key print vendor could have a material adverse effect on our business and cost of sales.

In addition, we purchase paper, a principal raw material for our print products, primarily through one paper merchant. Further, paper merchants, including our paper merchant, rely on paper mills to produce the paper that they broker. There can be no assurance that our relationships with our print vendor and/or paper merchant will continue or that their business or operations will not be affected by disruptions in the industries that they rely on, including a

disruption in the paper mill industry, labor shortages, major disasters or other external factors. The loss of our key print vendor and/or paper merchant, a material change in our relationship with them, a material disruption in their business or their failure to otherwise perform in the expected manner could cause disruptions in our business that may materially and adversely affect our results of operations and financial condition.

Prolonged inflation could result in higher costs and decreased margins and earnings.

Recent inflationary pressures have resulted in increased raw material, labor, energy, freight and logistics expenses and other costs. We may not be able to fully offset such higher costs through price increases or other cost saving actions. If our costs are subject to continuing significant inflationary pressures, our inability to offset such costs could have an adverse impact on our results of operations resulting in lower margins, earnings and cash flows.

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

Across our business, we manage complex operational and logistical arrangements including distribution centers, data centers and large office facilities. Failure to recover from a major disaster (such as fires, floods, adverse weather events (including those brought about by climate change) or other natural disasters) or other external threat (such as terrorist attacks, strikes, weather, outbreaks of pandemic or contagious diseases, or political unrest or other external factors) at a key center or facility could affect our business and employees, disrupt our daily business activities and/or restrict our ability to supply products and services to our customers.

Risks Related to Information Technology Systems and Cybersecurity

We are subject to risks based on information technology systems. A major breach in security or information technology system failure could interrupt the availability of our internet-based products and services, result in corruption and/or loss of data, cause liability or reputational damage to our brands and business and/or result in financial loss.

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

We face several technological risks associated with software and/or internet-based product and service delivery in our educational businesses, including with respect to information technology capability, reliability and security, enterprise resource planning, system implementations and upgrades. Failures of our information technology systems and products (including because of operational failure, natural disaster, computer virus or hacker attacks) could interrupt the availability of our internet-based products and services, result in corruption or loss of data or breach in security and result in liability, reputational damage to our brands and/or adversely impact our operating results.

While we have policies, processes, internal controls and cybersecurity mechanisms in place intended to maintain the stability of our information technology, provide security from unauthorized access to our systems and maintain business continuity, no mechanisms are entirely free from the risk of failure and we have no guarantee that our security mechanisms will be adequate to prevent all security threats. Our brand, reputation, especially in the K-12 market, and consequently our operating results may be adversely impacted by unanticipated system failures, corruption, loss of data and/or breaches in security.

Failure to prevent or detect a malicious cyber-attack on our information technology systems could result in liability, reputational damage, loss of revenue and/or financial loss.

Cyber-attacks and hackers are becoming more sophisticated and pervasive. Our business is dependent on information technology systems to support our complex operational and logistical arrangements across our business. We provide software and/or internet-based products and services to our customers. We also use complex information technology systems and products to support our business activities, particularly in infrastructure and as we move our products and services to an increasingly digital delivery platform. Across our business we hold large volumes of personal data, including that of employees, customers and students.

Efforts to prevent cyber-attacks and hackers from entering our systems are expensive to implement and may limit the functionality of our systems. Individuals try to gain unauthorized access to our systems and data for malicious purposes, and our security measures may fail to prevent such unauthorized access. Cyber-attacks and/or intentional hacking of our systems could adversely affect the performance or availability of our products, result in loss of customer data, adversely affect our ability to conduct business, or result in theft of our funds or proprietary information, the occurrence of which could result in liability, reputational damage, loss of revenue and/or financial loss.

Risks Related to Financial Condition, Credit Facilities and Liquidity

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

Our business is seasonal. Purchases of K-12 products are typically made in the second and third quarters of the calendar year in preparation for the beginning of the school year. 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 typically incur a net cash deficit from all of our activities into the third quarter of the year. We cannot be sure that our second and third quarter net sales will continue to be sufficient to fund our business and meet our obligations or that they will be higher than our net sales for our other quarters or in the prior-year periods. In the event that we do not derive sufficient net sales for the second and third quarter, we may have a liquidity shortfall and be unable to fund our business and/or meet our debt service requirements and other obligations.

Our net sales, operating profit or loss and net cash provided or used by operations are impacted by the inherent seasonality of the academic calendar. As purchases of K-12 products are typically made in the second and third quarters of a given calendar year, changes in our customers’ ordering patterns may impact the comparison of results between a quarter and the same quarter of the prior year, between a quarter and the prior consecutive quarter or between a fiscal year and the prior fiscal year, which can make it difficult for us to forecast the timing of customer purchases and assess our financial performance until late in the year.

Our history of operations includes periods of operating and net losses, and we may incur operating and net losses in the future. Such losses may impact our liquidity.

Although we generated operating income and net income for the year ended December 31, 2021, for the years ended December 31, 2020 and 2019, we generated operating losses of $447.9 million and $168.9 million, respectively, and net losses of $479.8 million and $213.8 million, respectively. If we revert to suffering operating and net losses, our liquidity may suffer and we may not be able to fund our business and/or meet our debt service requirements and other obligations. Furthermore, the market price of our common stock may decline significantly.

Our major operating costs and expenses include employee compensation as well as paper, printing and binding costs and expenses for product-related manufacturing, and a significant increase in such costs and expenses could have a material adverse effect on our profitability.

Our major operating costs and expenses include employee compensation as well as paper, printing and binding costs for product-related manufacturing.

We offer competitive salary and benefit packages in order to attract and retain the employees required to grow and expand our business. Compensation costs are influenced by general economic and business factors, including those affecting the cost of health insurance, payout of commissions and incentive compensation and post-retirement benefits, as well as trends specific to the employee skillsets we require.

Paper is one of our principal raw materials. Paper prices fluctuate based on the worldwide demand for and supply of paper in general and for the specific types of paper we use. The price of paper may fluctuate significantly in the future, and changes in the market supply of, or demand for paper, could affect delivery times and prices. Paper mills and other suppliers may consolidate or there may be disruptions in their industry and as a result, there may be future shortfalls in quality and quantity supplies necessary to meet the demands of the entire marketplace, including our demands. As a result, we may need to find alternative sources for paper from time to time. In addition, we have extensive printing and binding requirements. We outsource the printing and binding of our books, workbooks and other printed products to third parties, typically under multi-year contracts. Increases in any of these operating costs and expenses could materially and adversely affect our business, profitability, financial condition and results of operations. Further, higher energy costs and other factors affecting the cost of publishing, transporting and distributing our products could adversely affect our financial results.

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

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

In the ordinary course of business, we issue performance-related surety bonds and letters of credit posted as security for our operating activities, some of which obligate us to make payments if we fail to perform under certain contracts in connection with the sale of instructional materials and assessment programs. The surety bonds are partially backstopped by letters of credit. As of December 31, 2021, our contingent liability for all letters of credit was approximately $16.1 million, of which $0.5 million were issued to backstop $1.1 million of surety bonds. The letters of credit reduce the borrowing availability on our revolving credit facility, which could affect liquidity and, therefore, our ability to meet our obligations. We may increase the number and amount of contracts that require the use of letters of credit, which may further restrict liquidity and, therefore, our ability to meet our obligations in the future.

Our level of indebtedness could adversely affect our financial condition and results of operations.

As of December 31, 2021, we had approximately $325.0 million ($317.6 million, net of discount and issuance costs) of total indebtedness outstanding, comprised of $21.7 million of term loans and $303.3 million of senior secured notes. Our outstanding indebtedness could have important consequences, including the following:

our level of indebtedness could make it more difficult for us to satisfy our obligations;

our level of indebtedness could adversely impact our credit rating;

the restrictions imposed on the operation of our business under the agreements governing such indebtedness may hinder our ability to take advantage of strategic opportunities to grow our business and to make attractive investments;

our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, restructuring, acquisitions or general corporate purposes may be impaired, which could be exacerbated by volatility in the credit markets;

we must use a portion of our cash flow from operations to pay principal and interest on our indebtedness, which will reduce the funds available to us for operations, working capital, capital expenditures and other purposes;

our level of indebtedness could place us at a competitive disadvantage compared to our competitors that may have proportionately less debt;

our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate may be limited;

our failure to satisfy our obligations under the agreements governing our indebtedness could result in an event of default, which could result in all of our debt becoming immediately due and payable and could permit our secured lenders to foreclose on our assets securing such indebtedness;

our level of indebtedness makes us more vulnerable to economic downturns and adverse developments in our business and industry; and

we may be vulnerable to interest rate increases, as certain of our borrowings bear interest at variable rates. A 1% increase or decrease in the interest rate will change our interest expense by approximately $0.2 million on an annual basis for our term loan facility and $2.5 million on an annual basis for our revolving credit facility, assuming it is fully drawn.

Any of the foregoing could have a material adverse effect on our business, financial condition, results of operations, prospects and ability to satisfy our obligations. In addition, we may incur substantial additional indebtedness in the future. The terms of the agreements governing our existing indebtedness do not, and any future debt may not, fully prohibit us from doing so. If new indebtedness is added to our current indebtedness levels, the related risks that we now face could substantially intensify.

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, including our senior secured notes, 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 senior secured term loan and revolving credit facilities have certain restrictions on 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.

We may record future goodwill or additional indefinite-lived intangibles impairment charges which could have a material adverse impact on 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. In evaluating the potential for impairment of goodwill and indefinite-lived intangible assets, we make assumptions regarding estimated net sales 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 business or small changes in other key assumptions may result in future impairment charges, which could have a material adverse impact on our results of operations. We had goodwill and indefinite-lived intangible assets of approximately $438.0 million and $161.0 million as of December 31, 2021 and 2020, respectively. There was a goodwill impairment charge of $279.0 million for the year ended December 31, 2020. There were no goodwill impairment charges for the years ended December 31, 2021 and 2019. There were also no impairment charges for indefinite-lived intangible assets for the years ended December 31, 2021, 2020 and 2019.

A change from up-front payment by school districts for multi-year programs and actions taken in furtherance of our long-term growth strategy could adversely affect our cash flow.

In keeping with the past practice of payments, school districts typically pay up-front when buying multi-year programs. If school districts changed their payment practices to spread their payments to us over the term of a program, our cash flow could be adversely affected. Further, as we execute on our long-term growth strategy, actions taken in furtherance of our strategy, such as transitioning to new business models could adversely impact our cash flow and our business in unforeseen ways.

The shift to sales of greater digital content or an increase in consumable print core programs may affect the comparability of our revenue to prior periods and cause increases or decreases in our sales to be reflected in our results of operations on a delayed basis.

Our customers typically pay for purchased products up-front; however, we recognize a significant portion of our time-based digital sales over their respective terms, as required by Generally Accepted Accounting Principles in the United States. As a result, an increase in the portion of our sales coming from digital sales may impact the comparison of our revenue results for a period with the same prior-year or consecutive period. Further, sales of consumable print core programs typically result in net sales being recognized over longer periods similar to time-based digital products. As more product offerings move to a consumable print format, more revenue will be deferred and recognized over a longer period of time.

Another effect of recognizing revenue from digital and consumable print core program sales over their respective terms is that any increases or decreases in sales during a particular period may not translate into proportional increases or decreases in revenue during that period. Consequently, deteriorating sales activity may be less immediately observable in our results of operations.

Risks Related to Laws and Regulations

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 print, digital and web-based media. We rely on a combination of copyright, trademark and other intellectual property laws and rights as well as employee agreements and other contracts to establish and protect our proprietary rights in our products and technology. However, our efforts to protect our intellectual property and proprietary rights may not be sufficient and we cannot make assurances that our proprietary rights will not be challenged, invalidated or circumvented. Moreover, we conduct business in certain other countries where the extent of effective legal protection for intellectual property rights is uncertain. It is possible we could be involved in expensive and time-consuming litigation to maintain, defend or enforce our intellectual property.

Furthermore, 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, including in certain foreign countries where we conduct or seek to conduct business, 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.

Failure to comply with privacy laws or adequately protect personal data could cause financial loss and reputational damage.

Across our businesses we hold large volumes of personal data, including that of employees, customers and students. We are subject to a wide array of different privacy laws, rules, regulations and standards in the U.S. as well as in foreign jurisdictions where we conduct business, including, but not limited to (i) the Children’s Online Privacy Protection Act and state student data privacy laws in connection with personally identifiable information of students, (ii) the Payment Card Industry Data Security Standards in connection with collection of credit card information from customers, and (iii) various EU data protection and privacy laws, including a comprehensive General Data Privacy Regulation that became effective in May 2018.

There has been increased public attention regarding the use of personal information and data transfer, accompanied by legislation and regulations intended to strengthen data protection, information security and consumer and personal privacy. The law in these areas continues to develop and the changing nature of privacy laws in the U.S., the European Union and elsewhere could impact our processing of personal and sensitive information of our employees, vendors and customers.

Continued privacy concerns may result in new or amended laws and regulations. Our brands and customer relationships are important assets. Future laws and regulations with respect to the collection, compilation, use, and publication of information and data privacy could result in limitations on our operations, increased compliance or litigation expense, adverse publicity, reputational damage to our brands and customer relationships, potential cancellation of existing business and diminished ability to compete for future business. It is also possible that we could be prohibited from collecting or disseminating certain types of data, which could affect our ability to meet our customers’ needs.

Changes in U.S. federal, state and local or foreign tax law, interpretations of existing tax law, or adverse determinations by tax authorities, could increase our tax burden or otherwise adversely affect our financial condition or results of operations.

We are subject to taxation at the federal, state or provincial and local levels in the U.S. and various other countries and jurisdictions. Any new tax legislative initiatives or tax reforms may result in further changes in tax laws and related regulations, our financial results could be materially impacted. Given the unpredictability of these possible changes, it is very difficult to assess whether the overall effect of such potential tax changes would be cumulatively positive or negative for our earnings and cash flow, but such changes could adversely impact our financial results.

Other Risks Related to Our Business

We may not be able to identify and complete any future acquisitions or achieve the expected benefits from any future acquisitions, which could materially and adversely affect our business, financial condition and results of operations and/or our growth.

We have at times used acquisitions as a means of expanding our business and technologies and expect that we will continue to do so in the future as part of our capital allocation strategy. We may be unable to identify suitable acquisition opportunities and, even if we were able to do so, we may not be able to finance or complete any such future acquisition on terms satisfactory to us. Further, we may not be able to successfully integrate acquisitions into our existing business, achieve anticipated operating advantages and/or realize anticipated cost savings or other synergies. The acquisition and integration of businesses involve a number of risks, including: use of available cash, issuance of equity or debt securities, incurrence of new indebtedness or borrowings under our revolving credit facility to consummate the acquisition and/or integrate the acquired business; diversion of management’s attention from operations of our existing businesses and those of the acquired business to the integration; integration of complex systems, technologies and networks into our existing systems; difficulties in the assimilation and retention of employees; unexpected costs, delays or other risks related to transition support services provided under any transition services agreement that may be executed as part of the acquisition. These transactions may create multiple and overlapping product lines that are offered, priced and supported differently, which could cause customer confusion and delays in service. The demands on our management related to the increase in our size after an acquisition also may have potential adverse effects on our operating results.

If we are unable to finance or complete any future acquisition on terms satisfactory to us (or at all) and/or we are unable to successfully integrate any acquisitions into our existing business, achieve anticipated operating advantages and/or realize anticipated cost savings or other synergies from any such acquired business, it could materially and adversely affect our business, financial condition and results of operations.

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

In the ordinary course of business, we are involved in legal actions, claims, litigation, investigations and other matters arising from our business operations 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, particularly with respect to proprietary photographs and images, is common in the educational publishing industry. While management does not expect any of the existing legal actions and claims arising from our business operations 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 costs of pursuing or defending against any particular legal proceeding, or the resolution of any particular legal proceeding 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, our coverage for certain product lines has been exhausted and there can be no assurance that our liability insurance for other product lines will cover all events or that the limits of such coverage will be sufficient to fully cover all potential liabilities thereunder.

We face risks of doing business abroad.

We conduct business in a number of regions outside of the U.S., including emerging markets in South America, Asia, Africa and the Middle East. Accordingly, we face exposure to the risks of doing business abroad, including, but not limited to, longer customer payment terms in certain countries; increased credit risk; difficulties in protecting intellectual property, enforcing or terminating agreements and collecting receivables under certain foreign legal systems; compliance under local privacy laws, rules, regulations and standards; the need to comply with U.S. Foreign Corrupt Practices Act and local laws, rules and regulations; and in some countries, a higher risk of political instability, economic volatility, terrorism, corruption, and social and ethnic unrest.

Although we are committed to conducting business in a legal and ethical manner in compliance with local and international statutory requirements and standards applicable to our business, there is a risk that our management, employees or representatives may take actions that violate applicable laws and regulations prohibiting the making of improper payments for the purposes of obtaining or keeping business, including laws such as the U.S. Foreign Corrupt Practices Act or the U.K. Bribery Act. Responding to investigations is costly and requires a significant amount of management’s time and attention. In addition, investigations may adversely impact our reputation, or lead to litigation and financial impacts.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to facilitate an understanding of our results of operations and financial condition and should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. The following discussion and analysis of our financial condition and results of operations contains forward-looking statements about our business, operations and industry that involve risks and uncertainties, such as statements regarding our plans, objectives, expectations and intentions. Actual results and the timing of events may differ materially from those expressed or implied in such forward-looking statements due to a number of factors, including those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K. See “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Overview

We are a learning technology company committed to delivering connected solutions that engage learners, empower educators and improve student outcomes. As a leading provider of K–12 core curriculum, supplemental and intervention solutions, and professional learning services, we partner with educators and school districts to uncover solutions that unlock students’ potential and extend teachers’ capabilities. We estimate that we serve more than 50 million students and three million educators in 150 countries.

Recent Developments

Acquisition by Veritas

On February 21, 2022, we entered into a merger agreement which provides for the acquisition of our company by entities beneficially owned by The Veritas Capital Fund VII, L.P. at a price of $21.00 per share of our common stock. The transaction is expected to close in the second quarter of 2022. See Note 20 - Acquisition by Entities Beneficially Owned by Veritas for additional information related to this pending transaction.

HMH Books & Media Consumer Publishing Business and Discontinued Operations

On May 10, 2021, we completed the sale of all of the assets and liabilities used primarily in the HMH Books & Media segment, our consumer publishing business, for cash consideration of $349.0 million, subject to a customary working capital adjustment resulting in a payment to the purchaser of $8.4 million, and the purchaser’s assumption of all liabilities relating to the HMH Books & Media business subject to specified exceptions (collectively, the “Transaction”). Total net cash proceeds after the payment of transaction costs and exclusive of working capital adjustment, were approximately $337.0 million, which we used to pay down debt. The divestiture enables HMH to focus singularly on K–12 education and accelerate growth momentum in digital sales, annual recurring revenue and free cash flow while paying down a significant portion of our debt. As part of the agreement, all HMH Books & Media business employees joined the acquiring company.

Upon entering into the asset purchase agreement on March 26, 2021 and qualifying as held-for-sale, the HMH Books & Media business was classified as a discontinued operation due to its relative size and strategic rationale, and accordingly, all results of the HMH Books & Media business have been removed from continuing operations for all periods presented, including from discussions of total net sales and other results of operations. Included within the years ended December 31, 2021, 2020 and 2019 discontinued operations financial results is interest expense of $9.4 million, $28.3 million and $19.3 million, respectively, based on our required repayment of the Company’s debt with the net proceeds from the sale. On the balance sheet, all assets and liabilities that transferred to the acquirer have been classified as Assets of discontinued operations or Liabilities of discontinued operations. The results of the HMH Books & Media business were previously reported in its own reportable segment. We currently report our revenues and financial results from continuing operations under one reportable segment.

Unless otherwise indicated, all financial information refers to continuing operations.

COVID-19

Over the past two years, we implemented a number of measures intended to help protect our shareholders, employees, and customers amid the COVID-19 pandemic. We also took actions to help mitigate some of the adverse impact of COVID-19 to our profitability and cash flow including, but not limited to, furloughs, salary reductions, spending freezes, and proactive outreach to schools to support them through this period of disruption with virtual learning resources.

2020 Restructuring Plan

We revised our cost structure amid the COVID-19 pandemic to further align our cost structure to our net sales and long-term strategy. As part of this effort, o n September 4, 2020, we finalized a voluntary retirement incentive program, which was offered to   all U.S. based employees at least 55 years of age with at least five years of service. Of the eligible employees, 165 elected to participate representing approximately 5% of our workforce. The majority of the employees voluntarily retired as of September 4, 2020 with select employees leaving later in the year.  Each of the employees received separation payments in accordance with our severance policy.

On September 30, 2020, our Board of Directors committed to a restructuring program, including a reduction in force, as part of the ongoing assessment of our cost structure amid the COVID-19 pandemic. The reduction in force resulted in a 22% reduction in our workforce, including positions eliminated as part of the voluntary retirement incentive program mentioned above, and net of newly created positions to support our digital-first operations. The reduction in force resulted in the departure of approximately 525 employees and was completed in October 2020. Each of the employees received separation payments in accordance with our severance policy. The total one-time, non-recurring cost incurred in connection with the 2020 restructuring program, inclusive of the voluntary retirement incentive program (collectively the “2020 Restructuring Plan”), all of which represented cash expenditures, was approximately $30.9 million. These actions streamlined the cost structure of the Company.

Strategic Transformation Plan

On October 15, 2019, our Board of Directors approved changes connected with our ongoing strategic transformation to simplify our business model and accelerate growth. This includes new product development and go-to-market capabilities, as well as the streamlining of operations company-wide for greater efficiency. These actions, which we refer to as our 2019 Restructuring Plan, resulted in the net elimination of approximately 10% of our workforce, after taking into account new strategy-aligned positions that are expected to be added, and additional operating and capitalized cost reductions, including an approximately 20% reduction in previously planned content development expenditures over the next three years. These steps were intended to further simplify our business model while delivering increased value to customers, teachers and students. The workforce reductions were completed during the first quarter of 2020.

After considering additional headcount actions, implementation of the planned actions resulted in total charges of $15.8 million which was recorded in the fourth quarter of 2019. With respect to each major type of cost associated with such activities, substantially all costs were severance and other termination benefit costs and resulted in cash expenditures.

Further, as part of the strategic transformation plan, we recorded an incremental $9.8 million inventory obsolescence charge in the fourth quarter of 2019 which was recorded in cost of sales in the statement of operations.

Key Aspects and Trends of Our Operations

Net Sales

We derive revenue primarily from the sale of print and digital content and instructional materials, multimedia instructional programs, software and services, consulting and training. We primarily sell to customers in the United States. Our net sales are driven primarily as a function of volume and, to a certain extent, changes in price. Our net sales consist of our invoices for products and services, less revenue that will be deferred until future recognition

along with the transaction price allocation adjusted to reflect the estimated returns for the arrangement. Deferred revenues primarily derive from online interactive digital content, digital and online learning components along with undelivered work-texts, workbooks and services. The work-texts, workbooks and services are deferred until control is transferred to the customer, which often extends over the life of the contract, and our hosted online and digital content is typically recognized ratably over the life of the contract. The digitalization of education content and delivery is driving a shift in the education market. As the K-12 educational market transitions to purchasing more digital, personalized education solutions, we believe our ability now or in the future to offer embedded assessments, adaptive learning, real-time interaction and student specific personalization of educational content in a platform- and device-agnostic manner will provide new opportunities for growth. An increasing number of schools are utilizing digital content in their classrooms and implementing online or blended learning environments, which is altering the historical mix of print and digital educational materials in the classroom. As a result, our business model includes integrated solutions comprised of both print and digital offerings/products to address the needs of the education marketplace. The level of revenues being deferred can fluctuate depending upon the mix of product offering between digital and non-digital products, the length of programs and the mix of product delivered immediately or over time.

Core curriculum programs, which historically represent the most significant portion of our net sales, cover curriculum standards in a particular K-12 academic subject and include a comprehensive offering of teacher and student materials required to conduct the class throughout the school year. Products and services in these programs include print and digital offerings for students and a variety of supporting materials such as teacher’s editions, formative assessments, supplemental materials, whole group instruction materials, practice aids, educational games and professional services. The process through which materials and curricula are selected and procured for classroom use varies throughout the United States. Currently, 19 states, known as adoption states, review and approve new programs usually every six to eight years on a state-wide basis. School districts in those states typically select and purchase materials from the state-approved list. The remaining states are known as open states or open territory states. In those states, materials are not reviewed at the state level, and each individual school or school district is free to procure materials at any time, although most follow a five-to-ten year replacement cycle. The student population in adoption states represents approximately 50% of the U.S. elementary and secondary school-age population. Some adoption states provide “categorical funding” for instructional materials, which means that those state funds cannot be used for any other purpose. Our core curriculum programs typically have higher deferred sales than other parts of the business. The higher deferred sales are primarily due to the length of time that our programs are being delivered, along with greater component and digital product offerings. A significant portion of our net sales is dependent upon our ability to maintain residual sales, which are subsequent sales after the year of the original adoption, and our ability to continue to generate new business by developing new programs that meet our customers’ evolving needs. In addition, our market is affected by changes in state curriculum standards, which drive instruction, assessment and accountability in each state. Changes in state curriculum standards require that instructional materials be revised or replaced to align to the new standards, which historically has driven demand for core curriculum programs.

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

Further, we also derive net sales from the delivery of services to K-12 educators and administrators to build instructional excellence, cultivate leadership and provide school districts with the comprehensive support they need to raise student achievement. These offerings include ongoing curriculum support and expertise in professional development, coaching, and strategic consulting.

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

Factors affecting our net sales include:

general economic conditions at the federal and state level;

state and school district per student funding levels;

federal funding levels;

the cyclicality of the purchasing schedule for adoption states;

student enrollments;

adoption of new academic standards;

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

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

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

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

We monitor the purchasing cycles for specific disciplines in the adoption states in order to manage our product development and to plan sales campaigns. Our sales may be materially impacted during the years that major adoption states, such as Florida, California and Texas, are or are not scheduled to make significant purchases. For example, Texas adopted Reading/English Language Arts materials in 2018 for purchase in 2019 and 2020 and will call in 2022 for K-12 Science materials for purchase in 2024. California adopted history and social science materials in 2017 for purchase in 2018 through 2020 and adopted Science materials in 2018 for purchase in 2019 and continuing through 2021. Florida called for K-12 English Language Arts materials in 2020 for purchase beginning in 2021 and called for K-12 Mathematics for review in 2021 and purchase beginning in 2022. Both Florida and Texas, along with several other adoption states, provide dedicated state funding for instructional materials and classroom technology, with funding typically appropriated by the legislature in the first half of the year in which materials are to be purchased. Texas has a two-year budget cycle, and in the 2021 legislative session appropriated funds for purchases in 2021 and 2022. California funds instructional materials in part with a dedicated portion of state lottery proceeds and in part out of general formula funds, with the minimum overall level of school funding determined according to the Proposition 98 funding guarantee. There is no guarantee that our programs will be approved for purchase in future instructional materials adoptions in these states.

Long-term growth in the U.S. K-12 market is positively correlated with student enrollments, which is a driver of growth in the educational publishing industry. Although economic cycles may affect short-term buying patterns, school enrollments are highly predictable and are expected to trend upward over the longer term. From 2018 to 2029, total public school enrollment, a major long-term driver of growth in the K-12 Education market, is projected to increase by 0.8% to 51.1 million students, according to the National Center for Education Statistics.

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

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

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

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

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

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

Publishing rights and Pre-publication amortization

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

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

Selling and administrative expenses

Our selling and administrative expenses include the salaries, benefits and related costs of employees engaged in sales and marketing, fulfillment and administrative functions. Also included within selling and administrative expenses are variable costs such as commission expense, outbound transportation costs (approximately $27.9 million for the year ended December 31, 2021) and depository fees, which are fees paid to state-mandated depositories that fulfill centralized ordering and warehousing functions for specific states. Additionally, significant fixed and discretionary costs include facilities, telecommunications, professional fees, promotions, sampling and advertising along with depreciation.

Other intangible assets amortization

Our other intangible assets amortization expense primarily includes the amortization of acquired intangible assets consisting of tradenames, customer relationships, content rights and licenses. The tradenames, customer relationships, content rights and licenses are amortized over varying periods of 5 to 25 years. The expense for the year ended December 31, 2021 was $30.3 million.

Interest expense

Our interest expense includes interest accrued on the outstanding balances of our $306.0 million in aggregate principal amount of 9.0% Senior Secured Notes due 2025 (“notes”), our $380.0 million term loan credit facility (“term loan facility”), most of which was repaid with proceeds from the Transaction, and, to a lesser extent, our revolving credit facility, the amortization of any deferred financing fees and loan discounts, and payments in connection with interest rate hedging agreements. Our interest expense for the year ended December 31, 2021 was $35.0 million.

Results of Operations

Consolidated Operating Results for the Years Ended December 31, 2021 and 2020

Year Ended

Year Ended

December 31,

December 31,

Dollar

Percent

(dollars in thousands)

change

Change

Net sales

Costs and expenses:

Cost of sales, excluding publishing rights and

pre-publication amortization

Publishing rights amortization

Pre-publication amortization

Cost of sales

Selling and administrative

Other intangible asset amortization

Impairment charge for goodwill

Restructuring/severance and other charges

Gain on sale of assets

Operating income (loss)

Other income (expense):

Retirement benefits non-service income (expense)

Interest expense

Interest income

Change in fair value of derivative instruments

Gain on investments

Income from transition services agreement

Loss on extinguishment of debt

Income (loss) from continuing operations before taxes

Income tax expense (benefit) for continuing operations

Income (loss) from continuing operations, net of tax

Loss from discontinued operations, net of tax

Gain on sale of discontinued operations, net of tax

Income (loss) from discontinued operations, net of tax

Net income (loss)

NM = not meaningful

Net sales for the year ended December 31, 2021 increased $210.3 million, or 25.0%, from $840.5 million in 2020 to $1,050.8 million. Core Solutions increased by $91.0 million from $459.0 million in 2020 to $550.0 million, driven by strong open territory demand resulting from the strength of our connected solutions and the continued market recovery, as well as the success of our digital first, connected strategy. Further, net sales in Extensions, consisting of our Heinemann brand, intervention and supplemental products as well as professional services, increased by $120.0 million from $381.0 million in 2020 to $501.0 million. Within Extensions, net sales of our Heinemann products increased due to strong demand across most product portfolios.

Operating income (loss) for the year ended December 31, 2021 favorably changed from a loss of $ 447.9  million in 2020 to income of $ 48.2  million, due primarily to the following:

An impairment charge for goodwill in 2020 of $279.0 million that did not reoccur in 2021. This non-cash impairment was a direct result of the adverse impact that the COVID-19 pandemic had on the Company and its stock price in 2020;

A $210.3 million increase in net sales;

A $19.5 million decrease in restructuring/severance and other charges. In 2021, there were $12.3 million of non-cash restructuring/severance and other charges primarily related to vacated office space formerly utilized by employees of the HMH Books & Media business, of which $11.7 million is reflected as a reduction in operating lease assets and $1.6 million as a reduction in property, plant, and equipment. In 2020, there were $31.9 million of severance costs associated with the 2020 Restructuring Plan;

A $15.0 million decrease in net amortization expense related to publishing rights, pre-publication and other intangible assets, primarily due to a decrease in pre-publication amortization attributed to a streamlining of capital spend and, to a lesser extent, our use of accelerated amortization methods for publishing rights amortization, partially offset by the amortization of certain other intangible assets due to product life cycle reductions; and

A $3.7 million gain on sale of assets in 2021 from the sale of intellectual property, including the copyrights and trademarks, of certain product titles.

Partially offset by:

A $28.1 million increase in our cost of sales, excluding publishing rights and pre-publication amortization, from $370.6 million in 2020 to $398.7 million, primarily due to an increase in sales volume, partially offset by lower print costs, product mix, increased virtual delivery of products and services along with favorable inventory obsolescence due to strong net sales. Our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of sales, decreased to 38.0% from 44.1%; and

A slight increase in selling and administrative expenses, primarily due to an increase in variable expenses such as sales commissions and transportation due to higher billings along with an increase in incentive compensation. Partially offsetting the aforementioned was reduced labor, professional fees and travel and marketing costs.

Retirement benefits non-service (expense) income for the year ended December 31, 2021 changed favorably by $1.0 million due to lower interest cost related to the pension plan during 2021.

Interest expense for the year ended December 31, 2021 decreased $2.9 million from $37.9 million in 2020 to $35.0 million, primarily due to net settlement payments on our interest rate derivative instruments during 2020, which did not repeat in 2021, and to a lesser extent lower term loan facility interest expense driven by lower LIBOR rates.

Interest income for the year ended December 31, 2021 decreased $0.8 million due to lower interest rates on our money market funds in 2021.

Change in fair value of derivative instruments for the year ended December 31, 2021 unfavorably changed by $1.9 million due to foreign exchange forward contracts executed on the Euro that were unfavorably impacted by the strengthening of the U.S. dollar against the Euro.

Gain on investments for the year ended December 31, 2021 decreased $0.6 million from $2.1 million in 2020 to $1.4 million and was related to the fair value change in our equity interests in educational technology private companies .

Income from transition services agreement for the year ended December 31, 2021 was $ 3.7 million and was related to transition service fees under the transition services agreement with the purchaser of our HMH Books & Media business. We had no transition services agreement during 2020.

Loss on extinguishment of debt for the year ended December 31, 2021 consisted of a $10.0 million write-off of the remaining balance of the debt discount associated with the term loan facility and a $2.5 million write-off related to unamortized deferred financing fees associated with the term loan facility. The total write-off of $12.5 million was proportional to the pay down in term loan debt in connection with the Transaction.

Income tax benefit for continuing operations for the year ended December 31, 2021 decreased $15.0 million, from a benefit of $12.4 million in 2020 to an expense of $2.7 million in 2021. For both periods income tax expense (benefit) was primarily attributed to movement in the deferred tax liability associated with tax amortization on indefinite-lived intangibles, state and foreign taxes, as well as the impact of certain discrete tax items including the accrual of potential interest and penalties on uncertain tax positions. The effective tax rate was 56.6% and 2.6% for the years ended December 31, 2021 and 2020, respectively.

Income (loss) from discontinued operations, net of tax for the year ended December 31, 2021 favorably changed by $220.7 million from a loss of $9.1 million in 2020, to income of $211.5 million primarily due to the gain on sale of our HMH Books & Media business, which has been accounted for as a discontinued operation whereby the direct results of its operations were removed from the results from continuing operations for the periods presented. Included within the income (loss) is interest expense of $9.4 million and $28.3 million, for 2021 and 2020, respectively, based on the repayment of debt with the net proceeds from the sale, which was required by our debt facilities, as we did not reinvest such amounts in the business.

Consolidated Operating Results for the Years Ended December 31, 2020 and 2019

Year Ended

Year Ended

December 31,

December 31,

Dollar

Percent

(dollars in thousands)

change

Change

Net sales

Costs and expenses:

Cost of sales, excluding publishing rights and

pre-publication amortization

Publishing rights amortization

Pre-publication amortization

Cost of sales

Selling and administrative

Other intangible asset amortization

Impairment charge for goodwill

Restructuring/severance and other charges

Operating loss

Other income (expense):

Retirement benefits non-service (expense) income

Interest expense

Interest income

Change in fair value of derivative instruments

Gain on investments

Income from transition services agreement

Loss on extinguishment of debt

Loss from continuing operations before taxes

Income tax (benefit) expense for continuing operations

Loss from continuing operations, net of tax

Loss from discontinued operations, net of tax

Net loss

Net sales for the year ended December 31, 2020 decreased $371.3 million, or 30.6%, from $1,211.8 million in 2019 to $840.5 million. The decrease was primarily due to lower net sales in Extensions, which primarily consist of our Heinemann brand, intervention and supplemental products as well as professional services, which decreased by $253.0 million from $634.0 million in 2019 to $381.0 million. Within Extensions, net sales decreased due to lower sales of the Heinemann’s Fountas & Pinnell Classroom, Calkins and LLI Leveled Literacy products due to a difficult comparison to prior year Texas K-6 sales coupled with the impact of the COVID-19 pandemic in 2020. Also, contributing to the decrease was lower professional services with the decline of the in-person learning environment as a result of the COVID-19 pandemic. Further, there were lower net sales from Core Solutions which decreased by $119.0 million from $578.0 million in 2019 to $459.0 million, primarily due to the smaller new adoption market opportunity in Texas ELA, along with impacts of the COVID-19 pandemic.

Operating loss for the year ended December 31, 2020 unfavorably changed from a loss of $168.9 million in 2019 to a loss of $447.9 million, due primarily to the following:

A $371.3 million decrease in net sales;

An impairment charge for goodwill in 2020 of $279.0 million. This non-cash impairment is a direct result of the adverse impact that the COVID-19 pandemic has had on the Company and its stock price; and

A $11.2 million increase in costs associated with our restructuring/severance and other charges due to $31.9 million of severance costs associated with the 2020 Restructuring Plan,

Partially offset by:

A $177.5 million decrease in selling and administrative expenses, primarily due to lower labor costs, resulting from cost savings associated with our employee furlough initiative, which began in April and ceased at the end of July, in response to COVID-19, our 2020 Restructuring Plan and a freeze on hiring. Also, there was a decrease of variable expenses such as commissions and transportation due to lower billings. Further, there were lower discretionary costs primarily related to travel and expense reduction measures and marketing along with lower depreciation expense;

A $179.3 million decrease in our cost of sales, excluding publishing rights and pre-publication amortization, from $549.9 million in 2019 to $370.6 million, primarily due to lower billings. Our cost of sales, excluding publishing rights and pre-publication amortization, as a percentage of sales, decreased to 44.1% from 45.4%; and

A $25.7 million decrease in net amortization expense related to publishing rights, pre-publication and other intangible assets, primarily due to a decrease in pre-publication amortization attributed to the timing and large amount of 2019 major product releases coupled with our streamlining of capital spend.

Retirement benefits non-service (expense) income for the year ended December 31, 2020 changed unfavorably by $1.0 million due to the recognition of a $1.1 million settlement charge related to the pension plan during 2020.

Interest expense for the year ended December 31, 2020 increased $8.2 million from $29.8 million in 2019 to $37.9 million, primarily due to our 2019 debt refinancing during the fourth quarter of 2019. Further, there was an increase of $2.4 million of net settlement payments on our interest rate derivative instruments during 2020.

Interest income for the year ended December 31, 2020 decreased $2.3 million from $3.2 million in 2019 to $0.9 million, primarily due to lower interest rates on our money market funds in 2020.

Change in fair value of derivative instruments for the year ended December 31, 2020 favorably changed by $1.6 million due to foreign exchange forward contracts executed on the Euro that were favorably impacted by the weakening of the U.S. dollar against the Euro.

Gain on investments for the year ended December 31, 2020 was $2.1 million and was related to the fair value change in our equity interests in educational technology private companies .

Income from transition services agreement for the year ended December 31, 2019 was $4.2 million and was related to transition service fees under the transition services agreement with the purchaser of o ur Riverside Business pursuant to which we performed certain support functions through September 30, 2019. We had no income from transition services agreement for the year ended December 31, 2020.

Loss on extinguishment of debt for the year ended December 31, 2019 consisted of a $3.4 million write-off related to unamortized deferred financing fees associated with the portion of our previous term loan facility that was accounted for as an extinguishment. Further, there was a $1.0 million write off of the remaining balance of the debt discount associated with the previous term loan facility. We had no loss on extinguishment of debt for the year ended December 31, 2020.

Income tax (benefit) expense for continuing operations for the year ended December 31, 2020 decreased $16.2 million, from an expense of $3.9 million in 2019, to a benefit of $12.4 million. The change was due to an income tax benefit primarily due to the impairment charge on goodwill, which reduced related deferred tax liabilities. The effective tax rate was 2.6% and (2.0%) for the years ended December 31, 2020 and 2019, respectively.

Loss from discontinued operations, net of tax for the year ended December 31, 2020 favorably changed by $4.5 million from a loss of $13.7 million in 2019, to a loss of $9.1 million primarily due to higher net sales. The HMH Books & Media business has been accounted for as a discontinued operation whereby the direct results of its

operations were removed from the results from continuing operations for the periods presented due to the sale in 2021. Included within the loss is interest expense of $ 28.3 million and $ 19.3 million for 2020 and 2019, respectively, based on the repayment of debt with the net proceeds from the sale, which was required by our debt facilities, as we did not reinvest such amounts in the business.

Adjusted EBITDA from Continuing Operations

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

Below is a reconciliation of our net loss to Adjusted EBITDA from continuing operations for the years ended December 31, 2021, 2020 and 2019:

Years Ended December 31,

Net income (loss) from continuing operations

Interest expense

Interest income

Provision (benefit) for income taxes

Depreciation expense

Amortization expense

Non-cash charges—goodwill impairment

Non-cash charges—stock-compensation

Non-cash charges— (gain) loss on derivative instruments

Inventory obsolescence related to strategic transformation plan

Fees, expenses or charges for equity offerings,

debt or acquisitions/dispositions

Gain on investments

Gain on sale of assets

Loss on extinguishment of debt

Legal settlement

Restructuring/severance and other charges

Adjusted EBITDA from continuing operations

Seasonality and Comparability

Our net sales, operating profit or loss and net cash provided by or used in operations are impacted by the inherent seasonality of the academic calendar, which typically results in a cash flow usage in the first half of the year and a cash flow generation in the second half of the year. Consequently, the performance of our business 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 typically conduct the majority of their purchases in the second and third quarters of the calendar year in preparation for the beginning of the school year. Thus, over the past three completed fiscal years, approximately 69% of our consolidated net sales were realized in the second and third quarters. Sales of K-12 instructional materials are also cyclical, with some years offering more sales opportunities than others based on the state adoption calendar. The amount of funding available at the state level for educational materials also has a significant effect on year-to-year net sales. Although the loss of a single customer would not have a material adverse effect on our business, schedules of school adoptions and market acceptance of our products can materially affect year-to-year net sales performance.

The following table is indicative of the seasonality of our business and the related results:

Quarterly Results of Continuing Operations

First

Second

Third

Fourth

First

Second

Third

Fourth

Quarter

Quarter

Quarter

Quarter

Quarter

Quarter

Quarter

Quarter

(in thousands)

Net sales

Costs and expenses:

Cost of sales, excluding publishing rights and

pre-publication amortization

Publishing rights amortization

Pre-publication amortization

Cost of sales

Selling and administrative

Other intangible assets amortization

Impairment charge for goodwill

Restructuring/severance and other charges

Gain on sale of assets

Operating (loss) income

Other income (expense):

Retirement benefits non-service (expense) income

Interest expense

Interest income

Change in fair value of derivative instruments

Gain on investments

Income from transition services agreement

Loss on extinguishment of debt

(Loss) income from continuing operations before taxes

Income tax (benefit) expense for continuing operations

(Loss) income from continuing operations

(Loss) income from discontinued operations, net of tax

Gain (loss) on sale of discontinued operations, net of tax

(Loss) income from discontinued operations, net of tax

Net (loss) income

During the fourth quarter of 2020, we recorded an adjustment of $17.0 million and $1.0 million to increase both the goodwill impairment charge and income tax benefit recorded, respectively, to correct an error of the previously recorded goodwill impairment of $262.0 million and related income tax benefit in the first quarter of 2020. Management believes these adjustments are not material to the prior period financial statements.

Liquidity and Capital Resources

December 31,

(in thousands)

Cash and cash equivalents

Current portion of long-term debt

Long-term debt, net of discount and issuance costs

Revolving credit facility

Borrowing availability under revolving credit facility

Years ended December 31,

Net cash provided by operating activities - continuing operations

Net cash provided by (used in) investing activities - continuing operations

Net cash used in financing activities - continuing operations

Operating activities

Net cash provided by operating activities from continuing operations was $263.8 million for the year ended December 31, 2021, a $157.3 million favorable change from the $106.5 million of net cash provided by operating activities from continuing operations for the year ended December 31, 2020. The $157.3 million improvement in cash provided by operating activities from continuing operations was primarily due to an increase in operating profit, net of non-cash items, of $215.0 million. The improvement was partially offset by unfavorable cash flow changes in net operating assets and liabilities of $57.7 million primarily due to unfavorable changes in accounts receivable of $61.3 million related to higher billings and the timing of collections, changes in severance and other charges of $26.4 million mainly attributable to the 2020 Restructuring Plan, changes in other operating assets and liabilities of $26.0 million, period over period inventory changes of $14.9 million and changes in interest payable of $7.0 million due to the timing of payments and changes in pension and postretirement benefits of $6.4 million, offset by favorable cash flow changes in accounts payable of $52.8 million due to timing of disbursements and favorable changes in royalties and author advances of $31.3 million.

Net cash provided by operating activities from continuing operations was $106.5 million for the year ended December 31, 2020, a $142.1 million decrease from the $248.5 million of net cash provided by operating activities from continuing operations for the year ended December 31, 2020. The decrease in cash provided by operating activities was primarily driven by unfavorable changes in net operating assets and liabilities of $74.3 million primarily due to changes in deferred revenue of $143.3 million and $25.0 million of royalties related to greater billings in 2019, accounts payable of $18.7 million related to timing of disbursements and severance and other charges of $3.4 million due to the 2020 Restructuring Plan, offset by period over period inventory changes of $72.4 million, changes in accounts receivable of $10.5 million, an increase in operating lease liabilities of $15.3 million, pension and postretirement benefits of $8.2 million, interest payable of $3.5 million due to the timing of our 2019 Refinancing and other assets and liabilities of $6.2 million. Additionally, operating profit, net of non-cash items, decreased by $67.7 million.

Investing activities

Net cash provided by investing activities from continuing operations was $250.3 million for the year ended December 31, 2021, an increase of $362.1 million from the $(111.8) million of net cash used in investing activities from continuing operations for the year ended December 31, 2020. The increase in cash provided by investing activities was primarily due to proceeds from the sale of our HMH Books & Media business of $340.6 million and from the sale of assets of $5.0 million during 2021 and to a lesser extent, lower capital investing expenditures related to pre-publication costs and property, plant, and equipment of $16.5 million in connection with planned reductions in content development.

Net cash used in investing activities from continuing operations was $(111.8) million for the year ended December 31, 2020, an increase of $16.3 million from the year ended December 31, 2019.  The increase in cash used in investing activities was primarily due to lower net proceeds from sales and maturities of short-term

investments of $50.0 million compared to 2019, offset by lower capital investing expenditures related to pre-publication costs and property, plant, and equipment of $27. 5  million in connection with previously planned reductions in content development, and by the acquisition of a business for $5.4 million along with an investment in preferred stock of $0.8 million in 2019.

Financing activities

Net cash used in financing activities, which is all continuing operations, was $335.4 million for the year ended December 31, 2021, an increase of $317.3 million from the $18.1 million used in financing activities for the year ended December 31, 2020. The increase in cash used in financing activities was primarily due to a net increase in our debt repayments of $323.0 million primarily from the proceeds of the sale of our HMH Books & Media business. Partially offsetting the increase was net collections under the transition services agreement of $6.2 million in 2021.

Net cash used in financing activities, which is all continuing operations, was $18.1 million for the year ended December 31, 2020, a decrease of $97.5 million from the year ended December 31, 2019. The decrease in cash used in financing activities was primarily due to a reduction in net debt principal repayments of $88.3 million in connection with the 2019 Refinancing along with payments of financing fees of $8.5 million related to our notes offering, term loan facility and revolving credit facility amendments in 2019. Additionally, there was a decrease in tax withholding payments related to net share settlements of restricted stock units of $2.0 million partially offset by lower net collections under the transition services agreement of $1.1 million.

Debt

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

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

Senior Secured Notes

On November 22, 2019, we completed the sale of $306.0 million in aggregate principal amount of 9.0% Senior Secured Notes due 2025 (the “notes”) in a private placement to qualified institutional buyers under Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and to persons outside the United States pursuant to Regulation S under the Securities Act. The notes mature on February 15, 2025 and bear interest at a rate of 9.0% per annum. Interest is payable semi-annually in arrears on February 15 and August 15 of each year, beginning on February 15, 2020.  As of December 31, 2021, we had $303.3 million ($296.6 million, net of discount and issuance costs) outstanding under the notes.

We may redeem all or a portion of the notes at redemption prices as described in the notes. We redeemed $2.7 million of the notes during the second quarter of 2021 utilizing proceeds from the sale of the HMH Books & Media business.

The notes do not require us to comply with financial maintenance covenants. We are currently required to meet certain incurrence based financial covenants as defined under the notes.

The notes are subject to customary events of default. If an event of default occurs and is continuing, the administrative agent may, or at the request of certain required lenders shall, accelerate the obligations outstanding under the notes.

Term Loan Facility

On November 22, 2019, we entered into a second amended and restated term loan credit agreement for an aggregate principal amount of $380.0 million (the “term loan facility”). As of December 31, 2021, we had $21.7 million ($21.0 million, net of discount and issuance costs) outstanding under the term loan facility.

The term loan facility matures on November 22, 2024 and the interest rate per annum is equal to, at the option of the Company, either (a) LIBOR plus a margin of 6.25% or (b) an alternate base rate plus a margin of 5.25%. As of December 31, 2021, the interest rate on the term loan facility was 7.25%.

The term loan facility was required to be repaid in quarterly installments of approximately $4.8 million with the balance being payable on the maturity date. We repaid $334.6 million of the term loan facility during the second quarter of 2021 utilizing proceeds from the sale of the HMH Books & Media business. There are no future quarterly repayment installments required and the balance is payable on the maturity date; however, we are not prohibited from continuing to make debt payments and may elect to do so.

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

The term loan facility contains customary mandatory prepayment requirements, including with respect to excess cash flow, proceeds from certain asset sales or dispositions of property, and proceeds from certain incurrences of indebtedness. The term loan facility permits the Company to voluntarily prepay outstanding amounts at any time without premium or penalty, other than customary breakage costs with respect to LIBOR loans.

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

We are subject to an excess cash flow provision under our term loan facility which is predicated upon our leverage ratio and cash flow.

Revolving Credit Facility

On November 22, 2019, we entered into a second amended and restated revolving credit agreement that provides borrowing availability in an amount equal to the lesser of either $250.0 million or a borrowing base that is computed monthly or weekly and comprised of the Borrowers’ and the Guarantors’ eligible inventory and receivables (the “revolving credit facility”).

The revolving credit facility includes a letter of credit subfacility of $50.0 million, a swingline subfacility of $20.0 million and the option to expand the facility by up to $100.0 million in the aggregate under certain specified conditions. The amount of any outstanding letters of credit reduces borrowing availability under the revolving credit facility on a dollar-for-dollar basis. As of December 31, 2021, there were no amounts outstanding on the revolving credit facility. As of December 31, 2021, we had approximately $16.1 million of outstanding letters of credit and approximately $64.9 million of borrowing availability under the revolving credit facility. As of February 24, 2022, there were no amounts outstanding under the revolving credit facility.

The revolving credit facility has a five - year term and matures on November 22, 2024. The interest rate applicable to borrowings under the facility is based, at our election, on LIBOR plus a margin between 1.50% and 2.00% or an alternative base rate plus a margin between 0.50% and 1.00%, which margins are based on average daily availability. The revolving credit facility may be prepaid, in whole or in part, at any time, without premium.

The revolving credit facility requires us to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 on a trailing four-quarter basis for periods in which excess availability under the revolving credit facility is less than the greater of $25.0 million and 12.5% of the lesser of the total commitment and the borrowing base then in effect, or less than $20.0 million if certain conditions are met. The minimum fixed charge coverage ratio was not applicable under the facility as of December 31, 2021, due to our level of borrowing availability.

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

General

We had $463.1 million of cash and cash equivalents and no short-term investments at December 31, 2021. We had $281.2 million of cash and cash equivalents and no short-term investments at December 31, 2020.

Our business is impacted by the inherent seasonality of the academic calendar, which typically results in a cash flow usage in the first half of the year and a cash flow generation in the second half of the year. We expect our net cash provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund our current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months. Our primary credit facilities do not require us to comply with financial maintenance covenants.

Critical Accounting Policies and Estimates

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 and variable consideration, deferred revenue and related standalone selling price estimates, allowance for bad debts, recoverability of advances to authors, valuation of inventory, financial instruments valuation, income taxes, pensions and other postretirement benefits obligations, contingencies, litigation, depreciation and amortization periods, and the recoverability of long-term assets such as property, plant and equipment, capitalized pre-publication costs, other identified intangibles, and goodwill. 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 a complete description of our significant accounting policies, see Note 3 to the consolidated financial statements. The following policies and account descriptions include those identified as critical to our business operations and the understanding of our results of operations.

The critical accounting estimates used in the preparation of the Company’s consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes.  Actual results may differ from these estimates due to the uncertainty around the magnitude and duration of the COVID-19 pandemic, as well as other factors.

The following are the critical accounting policies and estimates:

Revenue Recognition

Revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. To determine revenue recognition for arrangements that we determine are within the scope of the new revenue recognition accounting standard, we perform the following five steps: (i) identify the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy a performance obligation. We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer. At contract inception, we assess the goods or services promised within each contract and determine those that are performance obligations and assess whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or services to a customer. To the extent the transaction price includes variable consideration, which generally reflects estimated future product returns, we estimate the amount of variable consideration that should be included in the transaction price utilizing the expected value method to which we expect to be entitled. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and the determination of whether to include estimated amounts in the transaction price are based largely on all information (historical, current and forecasted) that is reasonably available. Sales, value add, and other taxes collected on behalf of third parties are excluded from revenue.

We estimate the collectability of contracts upon execution. For contracts with rights of return, the transaction price is adjusted to reflect the estimated returns for the arrangement on these sales and is made at the time of sale based on historical experience by product line or customer. The transaction prices allocated are adjusted to reflect expected returns and are based on historical return rates and sales patterns. Shipping and handling fees charged to customers are included in net sales.

When determining the transaction price of a contract, an adjustment is made if payment from a customer occurs either significantly before or significantly after performance, resulting in a significant financing component. We do not assess whether a significant financing component exists if the period between when we perform our obligations under the contract and when the customer pays is one year or less. Significant financing components’ income is included in interest income.

Contracts are sometimes modified to account for changes in contract specifications and requirements. Contract modifications exist when the modification either creates new, or changes the existing, enforceable rights and obligations. Generally, contract modifications are for products or services that are not distinct from the existing contract due to the inability to use, consume or sell the products or services on their own to generate economic benefits and are accounted for as if they were part of that existing contract. The effect of such a contract modification on the transaction price and measure of progress for the performance obligation to which it relates is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

Physical product revenue is recognized when the customer obtains control of our product, which occurs at a point in time, and may be upon shipment or upon delivery based on the contractual shipping terms of a contract. Revenues from static digital content commence upon delivery to the customer of the digital entitlement that is required to access and download the content and is typically recognized at a point in time. Revenues from subscription software licenses, related hosting services and product support are recognized evenly over the license term as we believe this best represents the pattern of transfer to the customer. The perpetual software licenses provide the customer with a functional license to our products and their related revenues are recognized when the customer receives entitlement to the software. Revenue associated with the digital content hosting services related to perpetual licenses is recognized evenly over the contract term. The delivery/start date is the date access to the hosted content is granted. For the technical services provided to customers in connection with the software license, we

recognize revenue upon delivery of the services. As the invoices are based on each day of service, this is directly linked to the transfer of benefit to the customer.

If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. We enter into certain contracts that have multiple performance obligations, one or more of which may be delivered subsequent to the delivery of other performance obligations. These performance obligations may include print and digital media, professional development services, training, software licenses, access to hosted content, and various services related to the software including but not limited to hosting, maintenance and support, and implementation. We allocate the transaction price based on the estimated relative standalone selling prices of the promised products or services underlying each performance obligation. We determine standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price taking into account available information such as market conditions and internally approved standard pricing discounts related to the performance obligations. Generally, our performance obligations include print and digital textbooks and instructional materials, formative assessment materials and multimedia instructional programs; access to hosted content; and services including professional development, consulting and training. Our contracts may also contain software performance obligations including perpetual and subscription-based licenses and software maintenance and support services.

Deferred Revenue

Our contract liabilities consist of advance payments and billings in excess of revenue recognized and are classified as deferred revenue on our consolidated balance sheets. Our contract assets and liabilities are accounted for and presented on a net basis as either a contract asset or contract liability at the end of each reporting period. We classify deferred revenue as current or noncurrent based on the timing of when we expect to recognize revenue. In order to determine revenue recognized in the period from contract liabilities, we first allocate revenue to the individual contract liability balance outstanding at the beginning of the period until the revenue exceeds that balance. If additional advances are received on those contracts in subsequent periods, we assume all revenue recognized in the reporting period first applies to the beginning contract liability as opposed to a portion applying to the new advances for the period.

Allowance for Doubtful Accounts and Reserves for Book Returns

Accounts receivable include amounts billed and currently due from customers and 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 and develop those estimates to reflect the risk of credit loss. Allowances for doubtful accounts are established through the evaluation of accounts receivable aging, prior collection experience, current conditions and reasonable and supportable forecasts of the economic conditions that will exist through the contractual life of the financial asset. We monitor our ongoing credit exposure through an active review of collection trends and specific facts and circumstances. Our activities include monitoring the timeliness of payment collection and performing timely account reconciliations. At the time we determine that a receivable balance, or any portion thereof, is deemed to be permanently uncollectible, the balance is written off. Reserves for book returns are based on historical return rates and sales patterns. We determine the required reserves by segregating our returns into the applicable product or sales channel pools. Returns in the K-12 market have been historically low. We have experienced higher returns with respect to sales to resellers and international sales, which all result in a greater degree of risk and subjectivity when establishing the appropriate level of reserves for this customer base. We estimate the amount of returns using the expected value method to reduce transaction price at the time of the sale. The allowance for doubtful accounts and reserve for returns are reported as reductions of the accounts receivable balance and amounted to $3.5 million and $4.1 million, and $3.8 million and $4.6 million as of December 31, 2021 and 2020, respectively.

Inventories

Inventories are substantially 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, recent sales history, the future sales forecast, known forward-looking trends including our development cycle to replace the title or program and competing titles or programs. A change in sales trends, or

strategic direction of our product development , could affect the estimated reserve. The reserve for excess or obsole te inventory is reported as a reduction of the inventories balance and amounted to $ 58 . 6  million and $ 61.2  million as of December 31, 2021 and 2020 , respectively.

Pre-publication Costs

Pre-publication costs are capitalized and are primarily amortized from the year of sale over five years using the sum-of-the-years-digits method, which is an accelerated method for calculating an asset’s amortization. Under this method, the amortization expense recorded for a pre-publication cost asset is approximately 33% (year 1), 27% (year 2), 20% (year 3), 13% (year 4) and 7% (year 5). We utilize this policy for all pre-publication costs, except the content of certain intervention products acquired in 2015, which we amortize over 7 years using an accelerated amortization method. The amortization methods and periods chosen best reflects 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, 2021, 2020 and 2019 were $108.6 million, $125.8 million and $149.3 million, respectively.

For the years ended December 31, 2021, 2020 and 2019, no pre-publication costs were deemed to be impaired.

Goodwill and Indefinite-Lived Intangible Assets

Goodwill and indefinite-lived intangible assets (certain tradenames) are not amortized, but are reviewed at least annually for impairment or earlier, if an indication of impairment exists. 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 various valuation techniques including an evaluation of our market capitalization and peer company multiples depending on the best approximation of fair value in the current social and economic environment, net sales growth rates and operating margins, risk-adjusted discount rates, future economic and market conditions, the determination of appropriate market comparables as well as the fair value of certain individual assets and liabilities.

We have the option of first assessing qualitative factors to determine whether it is necessary to perform a quantitative impairment test for goodwill or we can perform the quantitative impairment test without performing the qualitative assessment. In performing the qualitative assessment, we consider certain events and circumstances specific to the reporting unit and to the entity as a whole, such as macroeconomic conditions, industry and market considerations, overall financial performance and cost factors when evaluating whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount.

If the results of the quantitative test indicate 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, goodwill is deemed impaired and is written down to the extent of the difference between the fair value of the reporting unit and the carrying value .

We estimate the total fair value of the reporting unit by using one or more various valuation techniques including an evaluation of our market capitalization and peer company multiples depending on the best approximation of fair value of the reporting unit in the current social and economic environment. With regard to indefinite-lived intangible assets, which includes only the Houghton Mifflin Harcourt tradename, the recoverability is evaluated using a one-step process whereby we determine the fair value by asset and then compare it to its carrying value to determine if the asset is impaired. We estimate the fair value by preparing a relief-from-royalty discounted cash flow analysis using forward looking revenue projections. The significant assumptions used in discounted cash flow analysis include: future net sales, a long-term growth rate, a royalty rate and a discount rate used to present value future cash flows. The discount rate is based on the weighted-average cost of capital method at the date of the evaluation. Adverse changes in our market capitalization could give rise to an impairment.

We completed our annual goodwill impairment tests as of October 1, 2021 and 2020. For October 1, 2021, we assessed qualitative factors and determined it was not necessary to perform a quantitative impairment test for goodwill. The fair value of the reporting unit was in excess of its carrying value by approximately 18% as of October 1, 2020. There was no goodwill impairment for the years ended December 31, 2021 and 2019.  We will continue to monitor and evaluate the carrying value of goodwill. If market and economic conditions or business performance deteriorate, this could increase the likelihood of us recording an impairment charge.

We recorded a goodwill impairment charge of $279.0 million for the year ended December 31, 2020. Refer to Note 2 of the consolidated financial statements for a discussion of the factors and circumstances leading to the goodwill impairment.

We completed our annual indefinite-lived asset impairment tests as of October 1, 2021 and 2020. No indefinite-lived intangible assets were deemed to be impaired for the years ended December 31, 2021, 2020 and 2019. The fair value significantly exceeded its carrying value as of October 1, 2021 and was in excess of its carrying value by approximately 18% as of October 1, 2020.

Impact of Inflation and Changing Prices

We believe that inflation has not had a material impact on our results of operations during the years ended December 31, 2021, 2020 and 2019. We cannot be sure that future inflation will not have an adverse impact on our operating results and financial condition in future periods. Our ability to adjust selling prices has always been limited by competitive factors and long-term contractual arrangements which either prohibit price increases or limit the amount by which prices may be increased. Further, a weak domestic economy at a time of low inflation could cause lower tax receipts at the state and local level, and the funding and buying patterns for textbooks and other educational materials could be adversely affected.

Covenant Compliance

As of December 31, 2021, we were in compliance with all of our debt covenants and we expect to be in compliance over the next twelve months.

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