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Houghton Mifflin Harcourt Publishers Inc. -- Moody's upgrades Houghton Mifflin's CFR to B3; outlook stable

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Rating Action: Moody's upgrades Houghton Mifflin's CFR to B3; outlook stableGlobal Credit Research - 05 Apr 2021Approximately US$690 million in rated securities affectedNew York, April 05, 2021 -- Moody's Investors Service ("Moody's") upgraded Houghton Mifflin Harcourt Publishers Inc.'s ("HMH") ratings, including its corporate family rating (CFR) to B3 from Caa1 and its speculative grade liquidity rating to SGL-2 from SGL-3. The rating outlook remains stable.The upgrades reflect Moody's expectation for a substantial reduction in HMH's financial leverage following an expected $337 million debt paydown after the close of its planned divestiture of HMH Book & Media business, coupled with the expectation of a faster than previously anticipated earnings recovery in 2021. The debt reduction will provide HMH with additional financial flexibility to execute its planned investment strategy and manage its exposure to the competitive and cyclical K-12 education market.Moody's anticipates debt to EBITDA to decline to around 3.5x by the end of 2021 from 6.2x at year end 2020, with the help of divestiture proceeds and earnings recovery following the pandemic. Both metrics incorporate Moody's standard adjustments and expense cash prepublication costs. Today's rating actions also take into account an expectation for EBITDA margin improvements stemming from the restructuring actions that the company initiated in Q4 2020. HMH eliminated 22% of its workforce and took other cost reduction measures which on a run rate basis, would result in $95M-$100M in annual savings.The divestiture, which is expected to close in Q2 2021, will result in substantial deleveraging that more than offsets the credit effects of reduced scale and business diversification. Moody's expects 2021-2022 to be challenging for HMH due to potential educational funding pressures at state and local levels, but we expect the company to operate with good liquidity, generate positive free cash flow and maintain credit metrics supportive of its B3 rating.Upgrades:..Issuer: Houghton Mifflin Harcourt Publishers Inc..... Corporate Family Rating, Upgraded to B3 from Caa1.... Probability of Default Rating, Upgraded to B3-PD from Caa1-PD.... Speculative Grade Liquidity Rating, Upgraded to SGL-2 from SGL-3....Senior Secured Bank Credit Facility, Upgraded to B3 (LGD4) from Caa1 (LGD4)....Senior Secured Regular Bond/Debenture, Upgraded to B3 (LGD4) from Caa1 (LGD4)Outlook Actions:..Issuer: Houghton Mifflin Harcourt Publishers Inc.....Outlook, Remains StableRATINGS RATIONALEHMH's B3 CFR reflects the company's exposure to a highly cyclical K-12 core educational market, which leads to volatility in year-over-year operating performance, cash flow, and leverage. HMH has a good market position within K-12 educational publishing, but is dependent for a majority of its revenue on state and local budget appropriations at a time when tax revenues are pressured by the fallout from the pandemic. It is also exposed to highly seasonal school spending, yearly fluctuations in state adoptions and intense competition from the on-going shift to utilize technology to cost-effectively improve student learning outcomes.Lower leverage proforma for the divestiture, good liquidity with $281 million cash on the balance sheet at December 31, 2020 and lack of near-term debt maturities provide HMH sufficient financial flexibility as operating performance recovers from COVID-related revenue declines and the company executes its growth initiatives.HMH's rating continues to garner support from its good market position within K-12 educational publishing, a broad portfolio of educational publishing products, a customer footprint that extends to 90% of schools in the US, established relationships with customers, large sales force, education industry entry barriers and a well-known brand. In addition, the company's learning Intervention products have performed well, and HMH intends to expand and grow its presence in the Extensions products over the next several years. HMH is also looking to transform its business towards a service-like offering, adopting a more incremental approach toward product development.The strategic shift towards greater focus on Extensions and continuous incremental product investment will likely provide for reduced cash flow volatility over the long term and reduce reliance on highly cyclical core educational materials adoptions, but there are some operational and investment risks associated with this move as well. Moody's anticipates that competition will remain strong, particularly in the more discretionary Extensions market. Moody's also expects digital adoption of courseware in the K-12 market to accelerate due to on-line and hybrid learning formats that many schools have adopted across the country, presenting a growth opportunity to HMH.The stable rating outlook reflects the company's good liquidity and moderate leverage position that should support additional organic and acquisition investment flexibility over the next 12-18 months.ESG CONSIDERATIONSAn on-going digitalization of education content and delivery is driving a shift in the education market. Moody's views the growing acceptance of educational solutions in digital formats as an important social trend that has been reshaping and will continue to transform the way HMH and its peers go to market. HMH has responded to these social trends by investing in adaptive learning, real-time interaction and personalized educational content in a platform- and device-agnostic manner. Further accelerated by the coronavirus pandemic, schools are using more digital content in their classrooms and implementing online or blended learning tools, which is shifting the historical mix of print and digital educational materials, continuing to transform the company's growth strategy.The coronavirus outbreak has placed an increased level of uncertainty regarding school districts' ability and willingness to make purchasing decisions during and immediately following the pandemic, when school districts may face funding constraints as states consider passing revenue declines downstream to balance their budgets.The current management team has noted their priority of debt repayment and has successfully managed a challenging liquidity position during the pandemic in 2020 and a trough period in 2017-2018. HMH plans to use net proceeds from the Book & Media business sale to pay down debt, which supports today's ratings upgrade.LIQUIDITY AND STRUCTURAL CONSIDERATIONSThe company's SGL-2 speculative-grade liquidity rating reflects good liquidity. It reflects Moody's expectation that HMH's existing cash ($281 million as of December 31, 2020), an undrawn $250 million ABL revolver (with seasonally low borrowing base of $105 million expected as of 12/31/21) and FY2021 free cash flow of around $30 million will be sufficient to fund seasonal working capital needs, capital investments and other basic cash needs. The ABL revolver (unrated) matures in November 2024. It is subject to a springing minimum 1.0x fixed charge coverage ratio (FCCR) that Moody's does not expect to be tested over the next 12-18 months. Also supporting the company's liquidity are an extended debt maturity profile with no debt maturities until November 2024 and lack of term loan financial maintenance covenants.HMH's $306 million senior secured note due February 2025 and the $380 million first lien term loan due November 2024 are each rated B3, reflecting the company's B3-PD Probability of Default Rating and an average expected family recovery rate of 50% at default as these obligations account for the vast majority of the capital structure. The first-lien debt is effectively subordinated to the $250 million ABL revolver with respect to the securitized assets.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSRatings could be upgraded if the company demonstrates its ability to profitably grow revenue and significantly increases the proportion of recurring billings while remaining moderately levered. Sustained positive free cash flow and good liquidity would also be needed for an upgrade.The ratings could be downgraded if HMH is unable to grow revenue, if investment spending or operating weakness leads to deterioration in liquidity or sustained negative free cash flow, or the company increases leverage through acquisitions or distributions to shareholders. Market share erosion and delays in local or state spending on education materials could also result in a downgrade.The principal methodology used in these ratings was Media Industry published in June 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1077538. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.Headquartered in Boston, MA, Houghton Mifflin Harcourt Company is one of the three largest US education publishers focusing on the K-12 market. The company expects to generate annualized billing in the $905-$955 million range in 2021, proforma for the HMH Book & Media divestiture. The company is publicly traded with Wellington Management Company and Burgundy Asset Management Ltd as the largest shareholders with an approximate 13% and 8% ownership of the company, respectively, as of 12/31/2020.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.At least one ESG consideration was material to the credit rating action(s) announced and described above.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Dilara Sukhov, CFA Asst Vice President - Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. 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