Back to GetFilings.com
1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 1-5406
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
------------------------
HOUGHTON MIFFLIN COMPANY
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-1456030
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
222 BERKELEY ST., BOSTON 02116-3764
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (617) 351-5000
------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
Common Stock, $1 par value New York Stock Exchange
Preferred Stock Purchase Rights
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting stock of the registrant held by
nonaffiliates of the registrant was approximately $1,209,625,000 as of February
29, 2000.
The registrant had outstanding 30,383,039 shares of common stock (exclusive
of Treasury shares) and 30,383,039 Preferred Stock Purchase Rights as of
February 29, 2000.
------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement (the "Definitive Proxy
Statement") to be filed with the Securities and Exchange Commission relative to
the Company's 2000 Annual Meeting of Stockholders are incorporated into Part
III.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2
HOUGHTON MIFFLIN COMPANY
TABLE OF CONTENTS
FORM 10-K
PAGE
----
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 6
Item 3. Legal Proceedings........................................... 6
Item 4. Submission of Matters to a Vote of Securities Holders....... 6
PART II
Item 5. Market for Houghton Mifflin's Common Stock and Related
Stockholder Matters......................................... 9
Item 6. Selected Financial Data..................................... 9
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 12
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 23
Item 8. Consolidated Financial Statements and Supplementary Data.... 25
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 58
PART III
Item 10. Directors and Executive Officers of Houghton Mifflin........ 58
Item 11. Executive Compensation...................................... 58
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 58
Item 13. Certain Relationships and Related Transactions.............. 58
PART IV
Item 14. Exhibits, Financial Statements and Schedule, and Reports on
Form 8-K.................................................... 58
Index to Consolidated Financial Statements and Financial
Schedules................................................... 58
Financial Statement Schedule................................ 58
Signatures.................................................. 60
Index to Exhibits........................................... 61
This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Houghton Mifflin's actual results could differ materially
from the expectations described in the forward-looking statements. Some of the
factors that might cause such a difference are discussed in the section entitled
" 'Safe Harbor' Statement under Private Securities Litigation Reform Act of
1995" on page 12 of this Form 10-K.
3
PART I
ITEM 1. BUSINESS
(a) DESCRIPTION OF BUSINESS
Houghton Mifflin Company was incorporated in 1908 in Massachusetts as the
successor to a partnership formed in 1880. Antecedents of the partnership date
back to 1832. Houghton Mifflin has five operating subsidiaries: McDougal Littell
Inc., Evanston, Illinois, publishes educational materials for the secondary
school market; The Riverside Publishing Company, Itasca, Illinois, publishes
assessment materials for the educational and clinical testing markets; Great
Source Education Group, Inc., Wilmington, Massachusetts, publishes supplementary
instructional materials for the elementary and secondary school markets;
Sunburst Technology Corporation (formerly Houghton Mifflin Interactive
Corporation), Somerville, Massachusetts, develops and sells multimedia
instructional products for the elementary and secondary school markets; and
Computer Adaptive Technologies, Inc., Evanston, Illinois, specializes in the
development and delivery of computer-based testing solutions to corporations and
associations worldwide.
Houghton Mifflin's principal business is publishing, and our operations are
classified into three operating segments:
- K-12 Publishing, which includes textbooks and other educational materials
and services for the kindergarten through grade twelve, or K-12, school
markets;
- College Publishing, which includes textbooks and other educational
materials and services for the post-secondary higher education market;
and
- Other, which includes fiction, nonfiction, children's books, dictionary
and reference materials in a variety of formats and media and
computer-based testing solutions.
In this description of our business, all subsidiaries are treated as part
of Houghton Mifflin.
In May 1999, we acquired all of the outstanding stock of Sunburst
Communications, Inc., a leading developer of software and video instructional
materials for the elementary and secondary school markets, for approximately
$34.1 million in cash. The financial statements include Sunburst's operating
results from the date of acquisition in the K-12 Publishing segment.
In January 1999, we acquired the assets of Little Planet Literacy Series, a
leading technology-based pre-kindergarten to grade three literacy program, from
Applied Learning Technologies, Inc. for approximately $4.4 million in cash. The
financial statements reflect the impact of Little Planet Literacy on our
operating results from the date of acquisition in the K-12 Publishing segment.
In March 1994, Houghton Mifflin's former Software Division successfully
completed an initial public offering. We retained an equity interest in the
successor company, INSO Corporation, of approximately 40%. On August 2, 1999, we
elected to deliver approximately 1.9 million shares of INSO common stock to
repay the remaining 6% Exchangeable Notes due 1999 -- Stock Appreciation Income
Linked Securities, or SAILS. In December 1999, we sold our remaining shares of
INSO common stock.
(b) FINANCIAL INFORMATION ABOUT THE OPERATING SEGMENTS
Financial information about Houghton Mifflin's operating segments is in
Part II, Item 8, the Notes to Consolidated Financial Statements, in Note 12
under the heading "Segment and Related Information" on page 52 and the schedule
titled "Five-Year Financial Summary" on page 10.
1
4
(c) NARRATIVE DESCRIPTION OF BUSINESS
As a publisher, Houghton Mifflin shapes ideas, information, and
instructional methods into various media that satisfy the lifelong need of
people to learn, gain proficiency, and be entertained. We seek out, select, and
generate worthwhile concepts and then enhance their value and accessibility
through creative development, design, production (performed by outside
suppliers), marketing, sales, and distribution. While Houghton Mifflin's works
have been published principally in printed form, we publish many programs or
works in other formats including computer software, laser discs, CD-ROM, and
other electronic media.
K-12 PUBLISHING
This operating segment includes textbooks and instructional materials,
tests for measuring achievement and aptitude, clinical/special needs testing
products, multimedia instructional programs for the K-12 market, and a
computer-based career and college guidance information system in versions for
both junior and senior high school students. The principal markets for these
products are elementary and secondary schools. Beginning in 1999, we focused
Sunburst Technology's (formerly Houghton Mifflin Interactive Corporation)
business on the growing educational technology marketplace rather than on the
retail market. Therefore, the 1999 information relating to Sunburst Technology
is included in the K-12 Publishing segment.
K-12 Publishing consists of five Houghton Mifflin divisions:
- The School Division, which publishes for the elementary school market;
- McDougal Littell Inc., which publishes for the secondary school market;
- Great Source Education Group, Inc., which publishes supplementary
materials for both the elementary and secondary school markets;
- Sunburst Technology Corporation, which develops and sells multimedia
instructional products for both the elementary and secondary school
markets; and
- The Riverside Publishing Company, which publishes tests for educational
and psychological assessment and provides career guidance products and
services.
Houghton Mifflin's major regional sales offices for this segment are in
California, Georgia, Illinois, Massachusetts, New Jersey, New York, and Texas.
Each of these divisions has its own dedicated sales force. We distribute
products of the School Division, McDougal, and Great Source from two facilities
located in Indianapolis, Indiana and Geneva, Illinois. In addition, some states
require us to use in-state textbook depositories for educational materials sold
in that state. Sunburst's products are shipped from its facility located in
Pleasantville, New York, and Riverside's products are shipped directly from
vendor site locations.
In the school market, which consists of kindergarten through grade twelve,
the process by which elementary and secondary schools select and purchase new
instructional materials is referred to as the "adoption" process. Twenty-one
states, representing approximately one-half of the United States elementary and
secondary school-age population, select new instructional materials on a
statewide basis for a particular subject approximately every five to eight
years. These twenty-one states are referred to as "adoption states." Generally,
a school or school district within an adoption state may use state monies to
purchase instructional materials only from the list of publishers' programs that
have been approved, or "adopted," by the particular state's governing body. In
the other states, referred to as "open territories," individual schools or
school districts make the purchasing decisions from the unrestricted offerings
of all publishers. The industry terms "adopted" or "adoption" may be used both
to describe a state governing body's approval process, or to describe a school
or school
2
5
district's selection and purchase of instructional materials. After adopting, or
selecting, instructional materials, schools later decide the quantity and timing
of their purchases.
In general, Houghton Mifflin presents products to schools and teachers by
sending samples to teachers in a school market which is considering a purchase.
Sending sample copies is an essential part of marketing instructional materials.
Since any educational program may have many individual components, and samples
are widely distributed, the cost of sampling a new program can be substantial.
In addition, once a program is purchased, we provide a variety of ancillary
materials (such as teachers' editions, charts, classroom displays, classroom
handouts, and tests) to purchasers at no cost. We also conduct training sessions
within a school district that has purchased our materials to help teachers learn
to use our products effectively. These free materials, usually called
"implementation" and "in-service" training, are a cost of doing business.
The elementary school market, which consists of kindergarten through grade
eight, has four major disciplines:
- reading and language arts (which includes handwriting and spelling),
- mathematics,
- science and health, and
- social studies.
The School Division develops and markets its products for all four of these
disciplines.
The secondary school market, which consists of sixth grade through twelfth
grade, has six major disciplines:
- literature and language arts,
- mathematics,
- social studies,
- world languages,
- science and health, and
- vocational studies.
McDougal develops and markets its products for four of these disciplines:
literature and language arts, social studies, mathematics, and world languages.
Great Source develops and distributes supplemental materials for the
kindergarten through twelfth grade market principally in the following
disciplines: reading and language arts, mathematics, and social studies.
Sunburst develops and distributes educational software and video
instructional materials for the kindergarten through twelfth grade market.
Sunburst develops computer-based programs in areas such as problem solving,
early learning tools, language arts, and mathematics and video instructional
programs on subjects such as conflict resolution, self esteem, drug education,
and success skills.
Riverside publishes tests for educational and psychological assessment and
provides career guidance products and service. Educational tests include
norm-referenced tests that compare students to national performance levels.
Riverside also contracts with states to custom develop criterion-referenced,
standards-based educational assessments. Psychological tests are administered to
one person at a time by a trained clinician or specialist.
3
6
COLLEGE PUBLISHING
This operating segment, which consists of the College Division, includes
textbooks, ancillary products such as workbooks and study guides,
technology-based instructional materials, and other services for introductory
and upper level courses in the post-secondary higher education market. Products
may be in print or electronic form. The principal markets for these products are
two- and four-year colleges and universities, served by the national sales
office in Boston, Massachusetts, or by the regional sales office in St. Charles,
Illinois. Houghton Mifflin also sells these products for high school advanced
placement courses (through the McDougal sales force) and to for-profit,
certificate-granting institutions, or private career schools, which offer
skill-based training and job placement. Products for this segment are
distributed from the Indianapolis, Indiana facility.
In the college and private career school markets, the faculty generally
selects the texts and other materials to be used in class, acting either as a
committee or individually. The College Division sales force promotes product to
faculty through a combination of on-campus visits, shipment of sample copies of
products to instructors, and e-mail correspondence. In addition, targeted
marketing and advertising to faculty, in both print and electronic form, are an
important part of the selling process. For high school advanced placement
courses, the selection of college product is made through the adoption process.
For the college market, once the faculty selects the educational content
for a course, students have the option of purchasing product from several
different sources:
- bookstores;
- through an Internet bookstore site; or
- direct from the publisher.
A bookstore or Internet site may purchase product for a course "new" from
the publisher or, in the case of product with a copyright older than one year,
"used" from other students. Approximately 30% of all student purchases in the
college market are used product. In the private career school market, the
institution generally purchases product directly from the publisher and requires
students to purchase the product from the institution as part of the tuition.
The College Division publishes in approximately eighteen disciplines,
including mathematics, chemistry, business, history, English, and modern
languages. Most textbooks are on a three- or four-year revision cycle. Textbooks
with a current-year copyright date are referred to in the industry as
"frontlist," and textbooks with an older copyright date are referred to as
"backlist." The success of each year's frontlist titles significantly influences
sales of backlist titles in subsequent years. Consequently, most of the selling
and marketing activities of college publishers focus on promoting frontlist
titles.
OTHER
In 1999, Houghton Mifflin's Other operating segment consists of unallocated
corporate-related items and two divisions:
- The Trade & Reference, or Trade, Division; and
- Computer Adaptive Technologies, Inc., or CAT.
The Trade Division publishes fiction and nonfiction for adults and
children, dictionaries, and other reference works. Its principal markets are
retail stores, including Internet bookstore sites, and wholesalers. The division
also sells reference materials to schools, colleges, office supply distributors,
and businesses. The sales volume for trade books and reference works may vary
significantly from year to year based on the success of one or more titles. The
division also licenses book rights and content to paperback publishers, book
clubs, Web sites, and other publishers and electronic businesses in the United
States and abroad. The Trade Division's publications are sold by its own sales
force, as well as some of Houghton Mifflin's other divisional sales forces and
commission agents. The division's
4
7
major corporate sales and support offices are in Massachusetts and New York.
Products for the Trade Division are distributed from our leased facility in
Indianapolis, Indiana.
CAT specializes in developing and delivering computer-based testing
solutions. Its principal markets are corporations and associations worldwide.
CAT's products are sold by its own sales force, and its major corporate sales
and support offices are in Illinois.
COMPANY BUSINESS AS A WHOLE
Book printing and binding capacity and the availability of raw materials
remained at satisfactory levels throughout the year. Houghton Mifflin is not
dependent on any one supplier. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" on page 12.
We derive approximately 90% of our revenues from educational publishing in
the K-12 and College Publishing segments, which are markedly seasonal
businesses. Schools and colleges make most of their purchases in the second and
third quarters of the calendar year, in preparation for the beginning of the
school year in September. Thus, we realize approximately 50% of net sales and a
substantial portion of annual net income during the third quarter, making
third-quarter results material to full-year performance. We also
characteristically post a net loss in the first and fourth quarters of the year,
when fewer educational institutions are making purchases.
Sales of K-12 instructional materials are also cyclical, with some years
offering more sales opportunities than others. The amount of funding available
at the state level for educational materials also has a significant impact on
Houghton Mifflin's year-to-year revenues. Although the loss of a single customer
or a few customers would not have a materially adverse effect on our business,
schedules of school adoptions and market acceptance of its products can affect
year-to-year revenue performance. In 1999, the increase in statewide adoption
opportunities and funding in the social studies and science disciplines for the
elementary school market and in the mathematics and social studies disciplines
in the secondary school market, more than offset fewer open territory and
adoption opportunities in the reading and language arts disciplines, as compared
to 1998. See "Summary of Quarterly Results of Operations (unaudited)" for the
two-year period ended December 31, 1999 on page 56.
Houghton Mifflin expects that in 2000 there will be an increase in
statewide adoption opportunities, as well as additional funding opportunities,
for instructional and assessment materials and services in both adoption and
open territory states. The adoption opportunities will be primarily in the
science and reading and language arts disciplines for the elementary school
market and in the literature and language arts and world language disciplines
for the secondary school market. Houghton Mifflin also expects growth
opportunities in the other divisions to contribute to higher revenues in 2000
compared to 1999. During 2000, we will continue to invest in new products and
services to take advantage of opportunities in all publishing segments. Houghton
Mifflin will also continue to invest in and improve operating and support
systems. These investments will help us maintain a market-leading educational
product line, as well as improve our efficiency, profitability, and service to
customers.
We sell our products in highly competitive markets and believe the major
competitive factors are quality of product and customer service. There are four
significant publishers serving the elementary and secondary school markets, and
seven significant publishers serving the college market.
At December 31, 1999, Houghton Mifflin employed approximately 3,300 people.
We anticipate no substantial expenditures for compliance with environmental
laws or regulations.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND EXPORT SALES
Export sales are not significant to Houghton Mifflin's three business
segments.
5
8
ITEM 2. PROPERTIES
Houghton Mifflin's principal executive office is located at 222 Berkeley
Street, Boston, Massachusetts.
The following table describes the approximate building areas, principal
uses, and the years of expiration on leased premises of Houghton Mifflin's
significant operating properties at December 31, 1999. We believe that these
properties are suitable and adequate for our present and anticipated business
needs, satisfactory for the uses to which each is put, and, in general, fully
utilized.
EXPIRATION APPROXIMATE PRINCIPAL
YEAR: LEASED AREA USE
LOCATION PREMISES IN SQUARE FEET OF SPACE SEGMENT USED BY
- ---------------------------------- ------------ -------------- ---------------- ------------------------------
OWNED PREMISES
Indianapolis, Indiana............. 503,000 Offices & K-12 Publishing and College
Warehouse Publishing
Geneva, Illinois.................. 486,000 Offices & K-12 Publishing; sales office
Warehouse
Pleasantville, New York........... 50,000 Offices & K-12 Publishing
Warehouse
LEASED PREMISES
Indianapolis, Indiana............. 2007 310,000 Warehouse Other
Boston, Massachusetts............. 2007 301,000 Executive & All segments and
222 Berkeley Street/ Business offices Corporate headquarters
500 Boylston Street
West Chicago, Illinois............ 2001 129,000 Warehouse K-12 Publishing
Itasca, Illinois.................. 2006 75,000 Offices K-12 Publishing; sales office
Evanston, Illinois................ 2004 70,000 Offices K-12 Publishing; sales office
Dallas, Texas..................... 2005 70,000 Offices & K-12 Publishing; sales office
Warehouse
Wilmington, Massachusetts......... 2005 50,000 Offices K-12 Publishing; corporate
support; sales office
Morris Plains, New Jersey......... 2006 40,000 Office K-12 Publishing; sales office
Kennesaw, Georgia................. 2004 39,000 Warehouse K-12 Publishing
New York, New York................ 2004 30,000 Offices College Publishing and Other
Evanston, Illinois................ 2004 20,000 Offices K-12 Publishing
Evanston, Illinois................ 2004 19,000 Offices Other
St. Charles, Illinois............. 2006 17,000 Offices College Publishing; sales
office
Somerville, Massachusetts......... 2001 12,000 Offices K-12 Publishing
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Houghton Mifflin did not submit any matters to a stockholder vote during
the last quarter of the fiscal year ended December 31, 1999.
6
9
EXECUTIVE OFFICERS OF HOUGHTON MIFFLIN
OTHER
OFFICE POSITIONS
AGE AT HELD WITH THE
NAME 2/29/00 OFFICE SINCE COMPANY
- ---- ------- ------------------------------------------- ------ ---------
Nader F. Darehshori..... 63 Chairman, President, and Chief Executive 1991 Director
Officer
Arthur S. Battle, 49 Vice President, Human Resources 1998 --
Jr. ..................
Albert Bursma, Jr. ..... 62 Executive Vice President; President, Great 1995 --
Source Education Group, Inc.
David R. Caron.......... 39 Vice President, Controller 1997 --
Gail Deegan............. 53 Executive Vice President and Chief 1996 --
Financial Officer
Richard C. Gershon...... 40 Senior Vice President, Strategic Technology 1999 --
Integration
Elizabeth L. Hacking.... 58 Senior Vice President, Strategic 1993 --
Development
John E. Laramy.......... 55 Senior Vice President; President, The 1999 --
Riverside Publishing Company
George A. Logue......... 49 Executive Vice President, School Division 1997 --
Julie A. McGee.......... 57 Executive Vice President; President, 1995 --
McDougal Littell Inc.
Mark E. Mooney.......... 47 Senior Vice President, Chief Technology 1997 --
Officer
John H. Oswald.......... 50 Executive Vice President; President, 1999 --
Computer Adaptive Technologies, Inc.
Conall E. Ryan.......... 42 Senior Vice President; President, Sunburst 1997 --
Technology Corporation
Gary L. Smith........... 55 Senior Vice President, Administration 1991 --
June Smith.............. 56 Executive Vice President, College Division 1994 --
Wendy J. Strothman...... 49 Executive Vice President, Trade & Reference 1996 --
Division
Paul D. Weaver.......... 57 Senior Vice President, Clerk, Secretary, 1989 --
and General Counsel
The following information provides a brief description of the business
experience of each executive officer during the past five years. Each executive
officer, other than Mr. Battle, Mr. Bursma, Mr. Caron, Ms. Deegan, Mr. Gershon,
Mr. Mooney, Mr. Ryan, and Ms. Strothman, has been employed by Houghton Mifflin
for more than five years.
Nader F. Darehshori
1991 -- Chairman, President, and Chief Executive Officer
Arthur S. Battle, Jr.
1998 -- Vice President, Human Resources
1995 -- Divisional Vice President, Human Resources, Corning, Inc.
Albert Bursma, Jr.
1995 -- Executive Vice President; President, Great Source Education Group, Inc.*
David R. Caron
1997 -- Vice President, Controller
1996 -- Assistant Controller
1995 -- Director -- Corporate Accounting, NYNEX
Gail Deegan
1998 -- Executive Vice President and Chief Financial Officer
1996 -- Executive Vice President, Chief Financial Officer, and Treasurer
1995 -- Senior Vice President, Regulatory and Government Affairs, NYNEX
7
10
Richard C. Gershon
1999 -- Senior Vice President, Strategic Technology Integration
1998 -- Senior Vice President; President, Computer Adaptive Technologies, Inc.*
1984 -- President and Chief Executive Officer, Computer Adaptive Technologies,
Inc. (Computer Adaptive Technologies, Inc. was not affiliated with
Houghton Mifflin prior to its acquisition on July 21, 1998.)
Elizabeth L. Hacking
1993 -- Senior Vice President, Strategic Development
John E. Laramy
1999 -- Senior Vice President; President, The Riverside Publishing Company*
1994 -- Vice President, Director of Sales, The Riverside Publishing Company*
George A. Logue
1998 -- Executive Vice President, School Division
1997 -- Senior Vice President, School Division
1994 -- Vice President, Sales and Marketing, School Division
Julie A. McGee
1995 -- Executive Vice President; President, McDougal Littell Inc.*
Mark E. Mooney
1997 -- Senior Vice President, Chief Technology Officer
1996 -- Vice President, Director of Information Technology, The Bureau of
National Affairs
1991 -- Director of Information Services, The Bureau of National Affairs
John H. Oswald
1999 -- Executive Vice President; President, Computer Adaptive Technologies,
Inc.*
1993 -- Executive Vice President; President, The Riverside Publishing Company*
Conall E. Ryan
1999 -- Senior Vice President; President, Sunburst Technology Corporation*
1997 -- Senior Vice President; President, Houghton Mifflin Interactive
Corporation*
1996 -- President, Houghton Mifflin Interactive Corporation*
1995 -- Corporate Vice President, Houghton Mifflin Interactive
Gary L. Smith
1991 -- Senior Vice President, Administration
June Smith
1994 -- Executive Vice President, College Division
Wendy J. Strothman
1996 -- Executive Vice President, Trade & Reference Division
1995 -- Vice President, Publisher, Adult Trade and Reference
Paul D. Weaver
1989 -- Senior Vice President, Clerk, Secretary, and General Counsel
* A subsidiary of Houghton Mifflin
8
11
PART II
ITEM 5. MARKET FOR HOUGHTON MIFFLIN'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Houghton Mifflin's common stock trades on the New York Stock Exchange. As
of February 29, 2000, Houghton Mifflin had approximately 5,940 stockholders of
record.
The following table shows information about stock prices and dividends paid
per share.
HOUGHTON MIFFLIN COMPANY
STOCK PRICES AND DIVIDENDS PAID PER SHARE (UNAUDITED)
1999 1998
---------------------------- ----------------------------
DIVIDEND DIVIDEND
HIGH LOW PAID HIGH LOW PAID
------ ------ -------- ------ ------ --------
First Quarter....................... $47.63 $40.00 $0.125 $39.00 $26.94 $0.125
Second Quarter...................... 50.31 42.63 0.125 35.31 31.06 0.125
Third Quarter....................... 52.50 40.50 0.130 33.56 30.19 0.125
Fourth Quarter...................... 43.25 34.88 0.130 47.25 30.44 0.125
------ ------
Year................................ $0.510 $0.500
====== ======
ITEM 6. SELECTED FINANCIAL DATA
The per-share amounts presented in the Five-Year Financial Summary on the
next page and in Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, are calculated using the diluted weighted
average shares outstanding, unless the per-share amounts are specifically
identified as basic. For further discussion of earnings per share, see Note 13
in the Notes to the Consolidated Financial Statements on page 55.
9
12
HOUGHTON MIFFLIN COMPANY
FIVE-YEAR FINANCIAL SUMMARY
(UNAUDITED, IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
1999 1998 1997 1996 1995
---------- -------- ---------- ---------- ----------
OPERATING RESULTS
Net sales....................................... $ 920,118 $861,657 $ 797,320 $ 717,863 $ 529,022
Operating income (loss)......................... 111,960 102,020 106,558 87,382 (13,095)
Net interest expense............................ 29,770 33,981 38,926 40,875 13,008
Gains (losses) on INSO Corporation common stock
and equity in earnings (losses) of INSO
Corporation................................... (5,100) 18,797 15,901 27,446 14,659
Loss on sale of long-term investment............ -- (3,017) -- -- --
Acquired in-process research and development.... -- (3,500) -- -- --
Income (loss) before taxes and extraordinary
item.......................................... 77,090 79,269 83,533 73,953 (11,444)
Extraordinary gain on extinguishment of debt,
net of tax.................................... 30,320 18,010 -- -- --
Net income (loss)............................... 76,304 63,649 49,822 43,622 (7,243)
---------- -------- ---------- ---------- ----------
PER COMMON SHARE
Basic:
Income (loss) before extraordinary item....... $1.60 $1.59 $1.76 $1.57 $(0.26)
Extraordinary gain on extinguishment of
debt........................................ 1.05 0.63 -- -- --
----- ----- ----- ------ -----
Basic net income (loss) per share............. $2.65 $2.22 $1.76 $1.57 $(0.26)
===== ===== ===== ====== ======
Diluted:
Income (loss) before extraordinary item....... $1.57 $1.57 $1.73 $1.56 $(0.26)
Extraordinary gain on extinguishment of
debt........................................ 1.03 0.62 -- -- --
----- ----- ----- ------ ------
Basic net income (loss) per share............. $2.60 $2.19 $1.73 $1.56 $(0.26)
===== ===== ===== ====== ======
Dividends declared per share.................... $0.51 $0.50 $0.49 $0.48 $0.465
Book value...................................... 14.41 13.20 10.61 9.22 8.05
Stock price -- High............................. 52.50 47.25 40.25 28.32 27.38
Low............................... 34.88 26.94 26.31 20.25 19.82
Close............................. 42.19 47.25 38.38 28.32 21.50
FINANCIAL DATA
Total assets.................................... $1,038,743 $983,668 $1,000,648 $1,017,283 $1,054,116
Long-term debt less current portion............. 254,638 274,521 371,081 500,999 426,148
Additions to book plates and property, plant,
and equipment................................. 98,314 73,984 67,903 74,943 54,278
Dividends paid.................................. 14,748 14,388 13,959 13,371 12,845
Weighted average shares outstanding:
Basic......................................... 28,823 28,689 28,237 27,801 27,609
Diluted....................................... 29,308 29,111 28,826 27,919 27,609
NET SALES -- CLASSES OF SIMILAR PRODUCTS
K-12 Publishing................................. $ 657,289 $611,770 $ 560,259 $ 497,709 $ 359,523
College Publishing.............................. 172,240 160,677 148,969 138,346 82,277
Other........................................... 90,589 89,210 88,092 81,808 87,222
---------- -------- ---------- ---------- ----------
$ 920,118 $861,657 $ 797,320 $ 717,863 $ 529,022
========== ======== ========== ========== ==========
On August 2, 1999, the remaining 50%, or $65.3 million in aggregate
principal, of the outstanding 6% Exchangeable Notes, or SAILS, matured. Houghton
Mifflin elected to deliver approximately 1.9 million shares of INSO common stock
to repay the remaining SAILS. The transaction represented a surrender of the
shares and generated a non-cash loss of $5.6 million ($3.2 million after tax),
or $0.11 per share. In addition, we also recognized a $52.3 million
extraordinary gain ($30.3 million after tax), or $1.03 per share, as a result of
the extinguishment of the SAILS indebtedness. In 1999, we recorded a gain of
$0.5 million ($0.3 million after tax), or $0.01 per share, on the sale of our
remaining shares of INSO common stock.
10
13
Beginning in 1999, Houghton Mifflin implemented a change in the method of
accounting for the amortization of book plate assets. The change is from a class
of assets method previously used to a specific identification method by which
amortization commences in the year of publication. This change was made
prospectively for book plate additions beginning in 1999. This change resulted
in a decrease in amortization expense of approximately $5.1 million ($3.1
million after tax), or $0.10 per share, for the twelve months ended December 31,
1999.
On August 1, 1998, Houghton Mifflin redeemed 50%, or $65.3 million in
aggregate principal amount, of the outstanding 6% Exchangeable Notes, or SAILS,
with approximately 1.9 million shares of INSO common stock. The redemption
represented a surrender of the shares and generated a non-cash gain on the INSO
shares of $15.4 million ($8.9 million after tax), or $0.31 per share. In
addition, we recorded a $31.1 million extraordinary gain ($18.0 million after
tax), or $0.62 per share, as a result of the extinguishment of the SAILS
indebtedness. In 1998, Houghton Mifflin recorded items related to INSO resulting
from INSO's special charge of $2.8 million in connection with its acquisitions
of Henderson Software, Inc. and ViewPort Development AB. Our portion of these
charges amounted to approximately $0.8 million ($0.5 million after tax), or
$0.01 per share. We also recorded a gain of $3.2 million ($1.9 million after
tax), or $0.06 per share, resulting from INSO's sale of its linguistic software
net assets.
Houghton Mifflin recognized a loss of $3.0 million ($2.0 million after
tax), or $0.07 per share, on the sale of our investment in Cassell Plc in 1998.
Houghton Mifflin's acquisition of CAT in July 1998 included the purchase of
certain technology under research and development, which resulted in a charge of
$3.5 million, or $0.12 per share.
In 1997, Houghton Mifflin recognized a gain of $14.9 million ($8.6 million
after tax), or $0.30 per share, representing our portion of the increase in
INSO's net equity as a result of INSO's completion of a public offering of 1.2
million shares of common stock at a net offering price of approximately $47 per
share in the fourth quarter of 1996 (see Note 1 and Note 9 in the Notes to the
Consolidated Financial Statements for a summary of Houghton Mifflin's
recognition policy). The 1997 results include special charges of $2.5 million
($1.5 million after tax), or $0.05 per share, related to INSO's acquisition of
the Mastersoft line of products from Adobe Systems Incorporated, the acquisition
of Level Five Research, Inc., and a restructuring charge affecting INSO's
Information Products and certain of its Information Management Tools products.
In 1996, Houghton Mifflin recorded a gain of $34.3 million ($19.9 million
after tax), or $0.71 per share, on the sale of 770,000 shares of INSO common
stock. We also recorded special charges in 1996 of $11.7 million ($7.1 million
after tax), or $0.25 per share, relating to our investment in INSO, resulting
from INSO's acquisitions of ImageMark Software Labs, Inc. and Electronic Book
Technologies, Inc.
In October 1995, Houghton Mifflin completed the acquisition of D.C. Heath
and Company from Raytheon Company in a purchase transaction. As a result, we
recorded in 1995 charges totaling $49.3 million ($30.0 million after tax), or
$1.09 per share, associated with the integration of the Heath business. In 1995,
there was a $2.2 million charge, or $0.08 per share, relating to our investment
in INSO resulting from INSO's acquisition of Systems Compatibility Corporation.
We also recorded a gain in 1995 of $13.1 million ($7.8 million after tax), or
$0.28 per share, in connection with an additional public offering of 1.2 million
shares made by INSO.
11
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1999
"SAFE HARBOR" STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: This report includes forward-looking statements which reflect Houghton
Mifflin's current views about future events and financial performance. Words
such as "believe," "expect," "anticipate," and similar expressions identify
forward-looking statements. Investors should not rely on forward-looking
statements because they are subject to a variety of risks, uncertainties, and
other factors that could cause actual results to differ materially from our
expectations, and we expressly do not undertake any duty to update
forward-looking statements. These factors include, but are not limited to: (i)
cost of development and market acceptance of our educational and testing
products and services; (ii) the seasonal and cyclical nature of our educational
sales; (iii) possible changes in funding in school systems throughout the
nation, which may result in both cancellation of planned purchases of
educational and testing products and services and shifts in timing of purchases;
(iv) changes in purchasing patterns in elementary and secondary school and
college markets; (v) changes in the competitive environment, including those
which could adversely affect selling expenses; (vi) regulatory changes which
could affect the purchase of educational and testing products and services;
(vii) strength of the retail market for general-interest publications and market
acceptance of newly published titles and new electronic products; (viii) delays
or unanticipated expenses in connection with development of new CAT products or
establishment of CAT testing facilities; and (ix) other factors detailed from
time to time in Houghton Mifflin's filings with the Securities and Exchange
Commission.
RESULTS OF OPERATIONS
Net income:
TWELVE MONTHS ENDED DECEMBER 31,
---------------------------------------------------
DILUTED EARNINGS
(LOSS) PER SHARE
---------------------
1999 1998 1997 1999 1998 1997
------- ------- ------- ----- ----- -----
(IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)
Income after tax, but excluding extraordinary
and infrequent items:........................ $48,943 $40,750 $42,650 $1.67 $1.40 $1.48
Extraordinary and infrequent items, net of
taxes, where applicable:
Extraordinary gain on extinguishment of
debt...................................... 30,320 18,010 -- 1.03 0.62 --
Gain (loss) on surrender of INSO
Corporation common stock to satisfy
indebtedness.............................. (3,241) 8,913 -- (0.11) 0.31 --
Gain on sale of INSO Corporation common
stock..................................... 282 24 -- 0.01 -- --
Loss on sale of long-term investment......... -- (1,961) -- -- (0.07) --
Acquired in-process research and
development............................... -- (3,500) -- -- (0.12) --
Gain on equity transaction of INSO
Corporation............................... -- -- 8,645 -- -- 0.30
Other gains (losses)......................... -- 1,413 (1,473) -- 0.05 (0.05)
------- ------- ------- ----- ----- -----
Net income..................................... $76,304 $63,649 $49,822 $2.60 $2.19 $1.73
======= ======= ======= ===== ===== =====
Consolidated net income in 1999 was $76.3 million, or $2.60 per share,
compared to net income of $63.6 million, or $2.19 per share, in 1998 and net
income of $49.8 million, or $1.73 per share, in 1997.
Income after tax, but excluding extraordinary and infrequent items, for
1999 was $48.9 million, or $1.67 per share, compared to income after tax, but
excluding extraordinary and infrequent items, of $40.8 million, or $1.40 per
share, in 1998. The primary reasons for the increase were higher net sales,
operating efficiencies, product mix, and lower interest expense, partially
offset by higher
12
15
development costs, increased selling expenses related to sales opportunities in
2000 and beyond, and additional goodwill amortization resulting from the
acquisitions of CAT, DiscoveryWorks, and Sunburst Communications.
Income after tax, but excluding infrequent items, was $40.8 million, or
$1.40 per share, in 1998, compared to $42.7 million, or $1.48 per share, in
1997. The primary reasons for the decrease were the dilution arising from the
operating expenses and goodwill amortization of CAT (acquired in July 1998) and
costs related to Houghton Mifflin's unsuccessful bid for a portion of Simon &
Schuster's publishing assets. Increases in product development spending, higher
selling expenses, and additional costs related to information systems
initiatives and the Year 2000 computer issue were offset by higher sales.
During 1999, Houghton Mifflin recorded a non-cash loss of $5.6 million
($3.2 million after tax), or $0.11 per share, resulting from the surrender of
INSO common stock upon maturity of the remaining outstanding SAILS. We also
recognized an extraordinary gain of $52.3 million ($30.3 million after tax), or
$1.03 per share, on the extinguishment of the SAILS indebtedness. In addition,
we sold our remaining shares of INSO and recognized a gain of $0.5 million ($0.3
million after tax), or $0.01 per share.
During 1998, Houghton Mifflin recognized a non-cash gain of $15.4 million
($8.9 million after tax), or $0.31 per share, resulting from the surrender of
INSO common stock used to redeem one-half of the outstanding SAILS. We also
recognized an extraordinary gain of $31.1 million ($18.0 million after tax), or
$0.62 per share, on the extinguishment of the SAILS indebtedness. In 1998,
Houghton Mifflin recognized a loss of $3.0 million ($2.0 million after tax), or
$0.07 per share, on the sale of our investment in Cassell Plc. The acquisition
of CAT included the purchase of certain technology under research and
development which resulted in a charge of $3.5 million, or $0.12 per share.
During 1998, Houghton Mifflin also recorded a one-time gain (net of charges) of
$2.4 million ($1.4 million after tax), or $0.05 per share, related to the equity
investment in INSO.
In 1997, Houghton Mifflin recognized a gain of $14.9 million ($8.6 million
after tax), or $0.30 per share, representing its portion of the increase in
INSO's net equity as a result of INSO's completion of a public offering in 1996,
and a special charge of $2.5 million ($1.5 million after tax), or $0.05 per
share, related to the equity investment in INSO.
Net sales:
INCREASE (DECREASE)
------------------------------
TWELVE MONTHS ENDED DECEMBER 31, 1999 VS. 1998 1998 VS. 1997
--------------------------------- ------------- --------------
1999 1998 1997 $ % $ %
--------- --------- --------- ------- --- ------- ----
(IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS)
K-12 Publishing............... $657,289 $611,770 $560,259 $45,519 7.4% $51,511 9.2%
College Publishing............ 172,240 160,677 148,969 11,563 7.2 11,708 7.9
Other......................... 90,589 89,210 88,092 1,379 1.5 1,118 1.3
-------- -------- -------- ------- -------
Total net sales..... $920,118 $861,657 $797,320 $58,461 6.8% $64,337 8.1%
======== ======== ======== ======= =======
Houghton Mifflin's net sales in 1999 increased $58.5 million, or 6.8%, to
$920.1 million from $861.7 million in 1998. The K-12 Publishing segment's net
sales of $657.3 million in 1999 were $45.5 million, or 7.4%, above 1998 net
sales of $611.8 million. All divisions in the K-12 Publishing segment reported
increased revenues in 1999 even though the sales opportunities were limited in
elementary and secondary school reading and language arts. New product lines
such as reading intervention and Math Steps contributed to the net sales gain,
as did the inclusion of sales of DiscoveryWorks, the elementary school science
program we acquired in December 1998, and multimedia instructional materials we
acquired with Sunburst in May 1999. The College Publishing segment's net sales
of $172.2 million in 1999 increased $11.6 million, or 7.2%, from $160.7 million
in 1998. The increase was primarily due to higher sales of new frontlist titles
and additional sales to the high school
13
16
advanced placement market. The Other segment's net sales in 1999 increased by
$1.4 million, or 1.5%, to $90.6 million from $89.2 million in 1998. This was
primarily due to the Trade Division's increased sales from its adult trade list,
partially offset by the shift of Sunburst Technology, formerly Houghton Mifflin
Interactive, to the K-12 Publishing segment in 1999.
Houghton Mifflin's net sales in 1998 increased $64.3 million, or 8.1%, to
$861.7 million from $797.3 million in 1997. The K-12 Publishing segment's net
sales of $611.8 million in 1998 were $51.5 million, or 9.2%, above 1997 net
sales of $560.3 million. All divisions in the K-12 Publishing segment reported
increased revenues in 1998 due to strong sales performance in statewide adoption
and open territory opportunities, as well as increased funding for instructional
and assessment materials. The College Publishing segment's net sales of $160.7
million in 1998 increased $11.7 million, or 7.9%, from $149.0 million in 1997.
Sales of both new editions and backlist titles in the college market rose, and
sales to the high school advanced placement market increased significantly. The
Other segment's net sales in 1998 increased by $1.1 million, or 1.3%, to $89.2
million from $88.1 million in 1997. The Trade Division's net sales were higher
in 1998 compared to 1997 due to increased sales of adult, children's, and
reference products, partially offset by lower guidebook sales, reflecting the
expiration of the Insight Travel Guide distribution arrangement on December 31,
1997. The Other net sales increase also reflected the inclusion of sales from
CAT, acquired in 1998. Lower net sales at Sunburst Technology partially offset
these net sales increases. Sunburst Technology's sales declined year over year
due to increased competition in the retail market.
Costs and expenses:
INCREASE (DECREASE)
-------------------------------
TWELVE MONTHS ENDED DECEMBER 31, 1999 VS. 1998 1998 VS. 1997
--------------------------------- -------------- --------------
1999 1998 1997 $ % $ %
--------- --------- --------- ------- ---- ------- ----
(IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS)
Cost of sales.................. $411,114 $390,922 $362,501 $20,192 5.2% $28,421 7.8%
Selling and administrative,
excluding intangible asset
amortization................. 365,176 340,207 300,347 24,969 7.3 39,860 13.3
Intangible asset
amortization................. 31,868 28,508 27,914 3,360 11.8 594 2.1
-------- -------- -------- ------- -------
Total costs and
expenses........... $808,158 $759,637 $690,762 $48,521 6.4% $68,875 10.0%
======== ======== ======== ======= =======
Cost of sales:
In 1999, cost of sales increased $20.2 million, or 5.2%, to $411.1 million
from $390.9 million during 1998. The increased cost of sales was primarily due
to higher net sales and increased editorial expense related to new program
development and product revisions in preparation for the sales opportunities in
the year 2000 and beyond, partially offset by lower plate amortization primarily
due to the accounting change regarding book plate amortization. Beginning in
1999, Houghton Mifflin implemented a change in the method of accounting for the
amortization of book plate assets. The change is from a class of assets method
previously used to a specific identification method by which amortization
commences in the year of publication. This change was made prospectively for
book plate additions beginning in 1999. This change resulted in a decrease in
amortization expense of approximately $5.1 million for the twelve months ended
December 31, 1999. As a percent of sales, cost of sales decreased to 44.7% in
1999 from 45.4% in 1998. The lower percentage was primarily due to higher net
sales, lower plate amortization expense and lower manufacturing and royalty
costs.
In 1998, cost of sales increased $28.4 million, or 7.8%, to $390.9 million
from $362.5 million during 1997. The increased cost of sales was due to higher
net sales and increased editorial expense and plate amortization. As a percent
of sales, cost of sales decreased slightly to 45.4% in 1998 from 45.5% in 1997.
Although editorial expenses and plate amortization were considerably higher in
absolute dollars, the net sales gains offset the percentage increase in these
items.
14
17
Selling and administrative:
Selling and administrative expenses, excluding intangible asset
amortization, were $365.2 million in 1999, an increase of $25.0 million, or
7.3%, over the $340.2 million recorded in 1998. As a percent of sales, selling
and administrative expense increased slightly to 39.7% in 1999 from 39.5% in
1998. The primary reasons for this increase were higher selling costs related to
sales opportunities in 2000 and beyond, the additional selling and
administrative costs for the operations of CAT and Sunburst, and increased
spending on efforts to improve customer support systems and to address the Year
2000 computer issue. The increases were partially offset by lower distribution
costs. Implementation of a new warehouse automation system and in-sourcing of
the Trade Division's distribution function contributed to the lower distribution
costs.
In 1998, selling and administrative expenses, excluding intangible asset
amortization, were $340.2 million, an increase of $39.9 million, or 13.3%, from
$300.3 million in 1997. As a percent of sales, selling and administrative
expense increased to 39.5% in 1998 from 37.7% in 1997. The primary reasons for
this increase were higher costs related to information systems initiatives and
the Year 2000 computer issue, the additional selling and administrative costs
for the operations of CAT, and increased selling expenses related to sales
opportunities in 1999.
Intangible asset amortization:
Due to the 1998 acquisitions of CAT and DiscoveryWorks, the January 1999
acquisition of Little Planet, and the May 1999 acquisition of Sunburst
Communications, intangible asset amortization increased to $31.9 million in 1999
from $28.5 million in 1998.
Intangible asset amortization increased to $28.5 million in 1998 from $27.9
million in 1997 due to the 1998 acquisitions of CAT and DiscoveryWorks and the
1997 acquisitions of Wintergreen/ Orchard House and Chapters Publishing.
Net interest expense:
Net interest expense of $29.8 million in 1999 decreased $4.2 million from
$34.0 million in 1998. The reduction was primarily due to the maturity on August
2, 1999 of $65.3 million of SAILS, the redemption of $65.3 million of SAILS on
August 1, 1998, and the repayment of $39.5 million of debt at the end of 1998.
Net interest expense of $34.0 million in 1998 decreased $4.9 million from
$38.9 million in 1997. The reduction was primarily due to repayment of $68.7
million of debt in the fourth quarter of 1997 and the redemption of $65.3
million of SAILS debt in August 1998.
Equity in earnings (losses) of INSO Corporation:
During 1998, Houghton Mifflin recognized $3.4 million in equity earnings of
INSO, representing a one-time gain of $3.2 million and $1.0 million of INSO's
earnings, partially offset by $0.8 million of one-time charges recognized by
INSO. During 1997, we recognized $1.0 million in equity earnings of INSO, of
which $3.5 million related to INSO's earnings, offset by $2.5 million related to
one-time charges recognized by INSO.
Other expense:
In 1998, Houghton Mifflin recognized a $1.1 million pre-tax charge related
to our unsuccessful bid for a portion of Simon & Schuster's publishing assets.
Income taxes:
The provision for taxes in 1999 decreased $2.5 million, or 7.5%, from 1998.
This decrease was primarily due to lower income and a decrease in the effective
tax rate to 40.4% in 1999 from 42.4%
15
18
in 1998. The decrease in the effective tax rate reflects the non-deductible
charge for acquired in-process research and development from CAT in 1998.
The provision for taxes in 1998 decreased $0.1 million from 1997. This
decrease was primarily due to the decrease in operating income in 1998 compared
to 1997, offset by an increase in the effective tax rate to 42.4% in 1998 from
40.4% in 1997. The increase in the effective tax rate was primarily due to the
acquired in-process research and development charge from CAT.
Houghton Mifflin recognized net deferred tax assets aggregating $7.6
million at December 31, 1999 and $0.4 million at December 31, 1998. The assets
related principally to pension and post-retirement benefits, inventory, and tax
liabilities related principally to differences in the depreciation of fixed
assets and amortization of book plates. In view of the consistent profitability
of our past operations, we believe that these assets will be substantially
recovered and that no significant additional valuation allowances are necessary.
K-12 PUBLISHING
The K-12 Publishing segment's net sales of $657.3 million in 1999
represented a $45.5 million, or 7.4%, increase over 1998 net sales of $611.8
million. All divisions in this segment reported higher net sales in 1999 as
compared to 1998. Although sales opportunities were limited in elementary school
reading and language arts, the School Division's strongest markets and the
markets to which its customers direct the most funding, the School Division's
net sales increased year over year. This increase was due to the acquisition of
DiscoveryWorks and new product lines such as reading intervention and Math
Steps. Great Source reported increased net sales primarily due to higher sales
of the Write Source product line and new products in mathematics and social
studies. Riverside's slightly higher sales were primarily due to the increased
sales in clinical and custom products, mostly offset by lower state contract
sales. McDougal's net sales increased only slightly over 1998 and were lower
than expected. Increases in social studies revenues were offset by
lower-than-expected funding in both adoption and open territory states and lower
math sales. Sunburst Technology's net sales rose sharply, reflecting the May
acquisition of Sunburst Communications.
Operating income for the K-12 Publishing segment decreased $0.8 million, or
0.8%, to $97.1 million in 1999 from $97.9 million in 1998. The resulting
operating margin for 1999 was 14.8% compared to 16.0% in 1998. This decrease in
operating margin was primarily due to an increase in cost of sales, selling and
administrative expenses, and intangible asset amortization. Cost of sales
increased due to higher editorial expenses incurred for new program development
and product revisions in preparation for sales opportunities in the year 2000
and beyond, partially offset by lower plate amortization. Selling expenses
increased due to expansion of the sales staff and higher sampling and
promotional expenses in anticipation of the increased sales opportunities in the
year 2000 and beyond. Administrative expenses rose due to efforts to improve
customer support systems and to address the Year 2000 computer issue. The shift
of Sunburst Technology to the K-12 Publishing segment also accounted for some of
the increase in selling and administrative costs. The increase in intangible
asset amortization was due to the 1998 acquisition of DiscoveryWorks and the
1999 acquisitions of Little Planet and Sunburst Communications.
The K-12 Publishing segment's net sales of $611.8 million in 1998 were
$51.5 million, or 9.2%, above 1997 net sales of $560.3 million. This increase
was due to strong sales performance in statewide adoption and open territory
opportunities, as well as increased funding for instructional and assessment
materials. McDougal's sales increased due to its strong performance in
mathematics and social studies adoptions. Riverside reported an increase in
sales due to higher sales of group assessment and clinical tests. Riverside
benefited both from increased funding for assessment programs and from its
strategy to invest in the development of criterion-referenced tests. Great
Source had a significant sales increase, principally in its Write Source and
mathematics product lines. The School Division's English, spelling, and new
reading intervention programs performed extremely
16
19
well in both adoption states and open territories. The School Division's reading
program did not generate increased sales year over year, but sales from this
product line were higher than originally expected. The School Division's math
program had higher sales year over year, but less than originally expected.
Overall, the School Division had a year-over-year net sales gain, rather than
the decline initially expected.
Operating income for the K-12 Publishing segment increased $1.1 million, or
1.2%, to $97.9 million in 1998 from $96.8 million in 1997. The resulting
operating margin for 1998 was 16.0% compared to 17.3% in 1997. The decrease in
operating margin was primarily due to the increase in editorial costs incurred
for product revisions and new product development and a change in the mix of
products sold, which included a higher percent of revenues from products with
lower margins. Increased selling expense also contributed to this decrease.
Higher selling expense was related to the cost of preparing for anticipated
sales opportunities in 1999. The year-over-year increase in administrative
expense as a percent of sales was primarily due to additional costs related to
information systems initiatives and the Year 2000 computer issue and the
inclusion of gains recorded on the sales of property in 1997, which, in turn,
lowered administrative expense in 1997.
COLLEGE PUBLISHING
The College Publishing segment reported 1999 net sales of $172.2 million, a
7.2% increase over 1998 net sales of $160.7 million. This increase was primarily
due to strong sales of new products and higher sales to the high school advanced
placement market.
In 1999, operating income for the College Publishing segment increased $4.0
million, or 20.3%, to $23.7 million from $19.7 million in 1998. The resulting
operating margin for 1999 was 13.8% compared to 12.3% in 1998. The operating
margin improvement was primarily due to the increase in net sales and lower
manufacturing, editorial, and distribution expenses as a percent of sales in
1999 compared to 1998. These decreases were partially offset by higher
administrative expenses.
The College Publishing segment reported net sales of $160.7 million in
1998, a 7.9% increase over 1997 net sales of $149.0 million. Sales of both
frontlist and backlist titles as well as sales to the high school advanced
placement market increased significantly.
Operating income for the College Publishing segment increased $3.9 million,
or 24.5%, to $19.7 million in 1998 from $15.9 million in 1997. The resulting
operating margin for 1998 was 12.3% compared to 10.6% in 1997. The operating
margin improvement was primarily due to the increase in net sales and lower
manufacturing and editorial expense as a percent of sales. These decreases were
partially offset by higher administrative expense. The higher administrative
expense was due to additional costs related to information system initiatives
and the Year 2000 computer issue.
OTHER
In 1999, the Other segment's net sales increased by $1.4 million, or 1.5%,
to $90.6 million from $89.2 million in 1998. The Trade Division was the major
contributor to this gain with a sales increase due to higher sales of adult
trade titles. The sales increase for the segment was also due to the inclusion
of CAT, which was acquired in July 1998. Lower revenues due to the shift of
Sunburst Technology to the K-12 Publishing segment beginning in 1999 partially
offset these increases.
The Other segment's operating loss was $8.9 million in 1999 compared to
$15.7 million in 1998. The lower operating loss was primarily due to the shift
of Sunburst Technology to the K-12 publishing segment, higher net sales, and
lower manufacturing and distribution costs for the Trade Division, partially
offset by the operating expenses and intangible asset amortization of CAT.
The Other segment's net sales in 1998 increased by $1.1 million to $89.2
million from $88.1 million in 1997. This increase was primarily attributable to
the Trade Division, due to higher sales of adult, children's, and reference
titles. Excluding the 1997 revenues from Insight Travel Guides, which
17
20
were no longer being distributed by this division after December 1997, sales
would have increased by more than 10%. The sales increase in this segment was
also due to the inclusion of sales from CAT, a new division acquired in 1998.
Lower net sales from Sunburst Technology partially offset these increases.
The Other segment's operating loss was $15.7 million in 1998 compared to
$6.1 million in 1997. The increased operating loss was primarily due to the
operating loss attributable to Houghton Mifflin's acquisition of CAT, the higher
loss at Sunburst Technology due to lower sales, and costs incurred in moving the
Trade Division's distribution facility in 1998.
LIQUIDITY AND CAPITAL RESOURCES
Houghton Mifflin's principal businesses are seasonal, with almost 90% of
revenues derived from educational publishing in the K-12 and College Publishing
segments, markedly seasonal businesses. We realize approximately 50% of net
sales and a substantial portion of net income during the third quarter and
characteristically posts a net loss in the first and fourth quarters of the
year.
This sales seasonality affects our operating cash flow. Houghton Mifflin
normally incurs a net cash deficit from all of our activities through the middle
of the third quarter of the year. We fund the deficit through the draw-down of
cash and marketable securities, supplemented by short-term borrowings,
principally commercial paper.
Net cash provided by operating activities was $143.8 million in 1999, a
decrease of $3.0 million from $146.8 million in 1998. Net income excluding
non-cash items increased $12.2 million in 1999 from 1998. Changes in operating
assets and liabilities used $15.2 million more cash in 1999 than 1998 due to an
increase in tax payments and higher accounts receivable and inventories,
partially offset by higher accounts payable. Higher accounts receivable were
primarily due to the timing of sales, as fourth-quarter sales in 1999 increased
significantly over the fourth quarter of 1998. Inventory levels increased in
anticipation of greater sales opportunities in 2000.
In 1998, net cash provided by operating activities was $146.8 million, an
increase of $5.0 million from $141.8 million in 1997. Net income excluding
non-cash items increased by $11.5 million in 1998 from 1997. Changes in
operating assets and liabilities used $6.5 million more cash during 1998 than in
1997. This increase was primarily due to the increase in income tax payments
relating to the surrender of INSO common stock and the redemption of the SAILS,
offset by lower working capital requirements.
Houghton Mifflin anticipates that cash provided by operating activities in
2000 will be higher than in 1999 due to higher earnings.
Houghton Mifflin used $144.0 million in cash for investing activities in
1999, an increase of $46.2 million over the $97.8 million used during 1998. The
increase reflects a $20.4 million increase for acquisitions of publishing and
technology assets, a $13.7 million increase for book plate expenditures, and a
$10.6 million increase in property, plant, and equipment expenditures. The
increases were principally due to the following: the acquisitions of Sunburst
Communications and the Little Planet Literacy Series and a contingent
consideration payment related to the 1998 acquisition of CAT; higher investments
in new products; increased spending on information systems initiatives; and the
build out of Trade Division's distribution facility.
Houghton Mifflin used $97.8 million in cash for investing activities in
1998, an increase of $26.0 million over the $71.8 million used during 1997. The
increase reflected a $15.8 million increase for acquisitions of publishing and
technology assets, an increase in property, plant, and equipment expenditures of
$7.0 million incurred primarily for information systems initiatives in 1998, and
the $5.2 million in proceeds from the sales of property and plant in 1997. We
received $0.8 million in proceeds from the sale of 400,000 ordinary shares of
Cassell Plc in 1998.
18
21
Net proceeds from financing activities were $8.3 million in 1999, primarily
due to the net issuance of $39.3 million of debt partially offset by common
stock repurchases of $17.9 million and common stock dividend payments of $14.7
million. Total debt decreased to $346.0 million as of December 31, 1999 from
$369.7 million at the end of 1998. Houghton Mifflin's percentage of debt
(commercial paper borrowings, current portion of long-term debt, and long-term
debt) to total capitalization (debt plus stockholders' equity) decreased to
44.4% at the end of 1999 from 48.1% at the end of 1998. The decrease in debt was
due to the following factors: non-cash redemption of the remaining $63.3 million
in principal amount of outstanding SAILS using INSO common stock, repayment of
$20.0 million of medium-term notes, and repayment of $30.0 million outstanding
under our five-year revolving credit facility, offset by the issuance of $80.0
million of medium-term notes and commercial paper borrowings of $9.5 million.
Houghton Mifflin used $50.7 million for financing activities in 1998,
primarily to make net repayments of $39.5 million of debt in the fourth quarter
of 1998 and pay dividends. Total borrowing decreased $102.7 million to $369.7
million as of December 31, 1998 from $472.4 million at the end of 1997. Our
percentage of debt (commercial paper borrowings, current portion of long-term
debt, and long-term debt) to total capitalization (debt plus stockholders'
equity) decreased to 48.1% at the end of 1998 from the 59.8% at the end of 1997.
The decrease in debt was due to the non-cash redemption of 50%, or $63.3 million
in principal amount, of outstanding SAILS using INSO common stock, repayment of
$40 million of medium-term notes, and repayment of $49.5 million of commercial
paper borrowings, offset by $50 million of borrowings under our five-year
revolving credit facility.
In 1999, Houghton Mifflin's average short-term borrowing was $113.6
million, an increase of $41.3 million from 1998. Seasonal borrowing needs
increased as a result of higher operating expenditures, increased working
capital requirements, and the acquisition of Sunburst Communications, Inc.
In 1998, Houghton Mifflin's average short-term borrowing was $72.3 million,
an increase of $5.4 million from 1997. Seasonal borrowing needs increased as a
result of higher operating expenditures and increased working capital
requirements.
In August 1995, Houghton Mifflin completed a $126.6 million public offering
of 6% Exchangeable Notes due in 1999 at a public offering price of $34 per
SAILS. In August 1998, we redeemed 50%, or $65.3 million in aggregate principal
amount, of the outstanding SAILS. The SAILS were redeemed at an exchange rate
equal to two shares of the common stock of INSO, par value $0.01 per share, for
each SAILS, or approximately 1.9 million shares, and cash of $2.0 million for
the payment of accrued and unpaid interest at the date of the redemption. On
August 2, 1999, the remaining 50%, or $65.3 million in aggregate principal, of
the outstanding SAILS matured. In accordance with the terms of the SAILS, we
elected to deliver two shares of the common stock of INSO for each SAILS, or
approximately 1.9 million shares, and cash of $2.0 million for the payment of
all accrued and unpaid interest on the outstanding SAILS.
In May 1999, Houghton Mifflin filed a registration statement on Form S-3
with the Securities and Exchange Commission covering up to $200 million of debt
securities and common stock, which may be issued in one or more offerings from
time to time. At December 31, 1999, we had not issued any debt securities or
common stock covered by this registration statement.
At December 31, 1999, Houghton Mifflin had a $300 million unsecured
revolving credit facility for which we pay annual commitment fees. Borrowings
under the revolving credit facility are outstanding under a five-year commitment
revolving credit facility which expires on October 31, 2000. The revolving
credit facility requires us to comply with certain covenants, the most
restrictive of which include maintenance of a specific level of net worth,
fixed-charge coverage ratio, and debt-to-equity ratio. At December 31, 1999, the
outstanding balance on the revolving credit facility was
19
22
$20 million, at a weighted average interest rate of 6.75%. At December 31, 1998,
the outstanding balance on the revolving credit facility was $50 million, at a
weighted average interest rate of 5.5875%. Management routinely evaluates
interest rates available to Houghton Mifflin under the revolving credit facility
as compared to those available through the issuance of commercial paper.
Houghton Mifflin currently expects that cash flow from operations for the
full year 2000 will be sufficient to cover investment activities and dividend
payments as well as to repay by year-end a portion of the debt outstanding at
the beginning of 2000. We intend to continue using the short-term debt market,
primarily commercial paper, for seasonal liquidity needs.
PENDING ACCOUNTING PRONOUNCEMENTS
In 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Investments and Hedging Activities," which was
amended by Financial Accounting Standards Board Statement No. 137, which
deferred the adoption of FAS 133 until fiscal years beginning after June 15,
2000. Houghton Mifflin is currently evaluating the effects of implementing this
statement.
IMPACT OF INFLATION AND CHANGING PRICES
Although inflation is currently well below levels in prior years and has,
therefore, benefited recent Houghton Mifflin results, particularly in the area
of manufacturing costs, there are offsetting costs. Our ability to adjust
selling prices has always been limited by competitive factors and long-term
contractual arrangements which either prohibit price increases or limit the
amount by which prices may be increased. Further, a weak domestic economy at a
time of low inflation could cause lower tax receipts at the state and local
level, and the funding and buying patterns for textbooks and other educational
materials could be adversely affected.
Prices for paper moderated in 1998 and 1999. We expect a modest increase in
paper prices in 2000.
The most significant investments affected by inflation include book plates;
other property, plant, and equipment; and inventories. Houghton Mifflin uses the
last-in, first-out (LIFO) method to value substantially all inventory, and
therefore, the cost of inventory charged against income approximates replacement
value. The incremental replacement cost expense amounted to $20.0 million in
1999 compared with $15.8 million in 1998.
Houghton Mifflin's publishing business requires a high level of investment
in book plates for our educational and reference works, which represented
approximately 9.5% of total assets at December 31, 1999, and, increasingly, in
other property, plant, and equipment, which represented 7.1% of consolidated
assets at December 31, 1999. We expect to continue to commit funds to the
publishing areas through both internal growth and acquisitions.
Houghton Mifflin believes that by valuing our inventory using the LIFO
method, continuing to emphasize technological improvements, and quality control,
we can continue to moderate the impact of inflation on our operating results and
financial position.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisition of CAT in July 1998, Houghton Mifflin
wrote off in-process research and development totaling $3.5 million in the third
quarter of 1998. The charge was necessary because the acquired technology had
not yet reached technological feasibility and had no future alternative use.
This amount represents an allocation of the purchase price related to an
application module called CAT Software System Version 7. This project
represented an integrated application suite of products whose functionality
included test development, automated assembly and test production, test
administration, scoring, automated test reporting, and test security.
20
23
The nature of the efforts required to develop the acquired in-process
research and development into a commercially viable product principally relate
to the completion of all planning, designing, prototyping, verification, and
testing activities that are necessary to establish that the product can be
produced to meet its design specifications, including functions, features and
technical performance requirements.
We determined the value of the acquired in-process research and development
by estimating the projected net cash flows related to the product and the stage
of completion of the product and discounting these cash flows to the net present
value. The resulting projected net cash flows from the project were based on
management's estimates of revenues and operating profits related to the product.
The revenue estimates we used to value the in-process research and development
were based on estimates of relevant market sizes and growth factors, expected
trends in the related technology, and the nature and expected timing of new
product introductions by Houghton Mifflin and our competitors. The rates
utilized to discount the net cash flows to the net present value were based on a
discount rate of 30%. This discount rate took into account the time value of
money and investment risk factors described above.
The estimates used in valuing the in-process research and development were
based upon assumptions we believe to be reasonable but which are inherently
uncertain and unpredictable. Our assumptions may be incomplete or inaccurate,
and unanticipated events and circumstances may occur. Accordingly, actual
results may vary from the projected results. Any such variances may adversely
affect the sales and profitability of future periods. Additionally, the value of
other intangible assets may become impaired.
The original estimate was to complete the development of CAT Software
System Version 7 in 1998 at a cost of an additional $0.1 million. Initial market
availability of the product was expected by 1999. Due to technology issues, the
CAT Software System Version 7 release was cancelled. Instead, Houghton Mifflin
decided to improve the product with a new release CAT System Software Version 8.
Although Version 8 will use some of the features created with Version 7, the
expected completion date is now early 2000 at an additional cost of
approximately $1.4 million.
OUTLOOK
We expect that revenue opportunities in the K-12 market in 2000 will be
greater than in 1999 due to an increase in statewide adoption opportunities, as
well as additional funding available at the state level for educational and
assessment materials. The sales growth will include the effect of having
Sunburst Communications, Inc. for a full year. We expect all other divisions
will also have growth opportunities, and that sales will increase in 2000 by
approximately 15-17%.
Houghton Mifflin anticipates that the sales growth will generate increased
gross margin due to a more favorable product mix, the completion of a major
product development cycle, and the benefits from investments made in systems and
business processes. In the past two years, product development costs have
increased in order to develop new programs for sale in major adoption
opportunities in 2000-2002. In 2000, editorial expenses and plate amortization
are expected to remain in the same absolute dollar range as in 1999. Due to the
higher sales expected in 2000, editorial and plate amortization are expected to
decrease as a percentage of sales, declining approximately two percentage points
as compared to 1999. We expect selling and administrative expenses, which
include selling, distribution, administrative costs, and intangible asset
amortization to decrease as a percentage of sales, declining two to three
percentage points in 2000 compared to 1999. Each of the components is projected
to decline as a percent of sales. We expect selling expenses to increase due to
increased sales and marketing efforts and product sampling associated with the
adoption cycle for 2000 and 2001, but as a percent of sales, to decline.
Houghton Mifflin expects distribution expenses will continue to decrease as a
percent of sales, reflecting more efficient warehouse operations. We believe
administrative costs will benefit from process improvements as well as the
resolution of the Year 2000 computer issue, and due to higher sales, intangible
asset amortization will decline as a percent of sales.
21
24
EFFECT OF THE YEAR 2000 COMPUTER ISSUE
Houghton Mifflin used both internal and external resources to reprogram or
replace and test software for Year 2000 modifications. As of December 31, 1999,
Houghton Mifflin had spent approximately $30 million ($16 million expensed and
$14 million capitalized for new systems) on its Year 2000 computer project and
the development of new systems and systems modifications. To date, we have not
experienced any material problems related to Year 2000 issues.
22
25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Houghton Mifflin's exposure to market risk for changes in interest rates
relates primarily to borrowings under our commercial paper program and our
unsecured credit facility. Houghton Mifflin does not enter into speculative or
leveraged derivative transactions.
Houghton Mifflin from time to time enters into transactions involving
financial instruments for purposes of managing our exposure to interest rate
risks and funding costs. Through the use of interest rate products such as
interest rate swap agreements and interest rate locks, Houghton Mifflin attempts
to achieve a predetermined mix of fixed- and floating-rate debt. At December 31,
1999, Houghton Mifflin had two interest-rate swaps in place, each with a
notional amount of $25 million and terminating on December 1, 2000. We pay the
fixed rate on both swaps (5.90% and 5.95%) and receive a variable rate based
upon a commercial paper index.
Each interest rate swap agreement is designated with all or a portion of
the principal balance and term of a specific debt obligation. These agreements
involve the exchange of amounts based on a variable interest rate for amounts
based on a fixed interest rate over the life of the agreement without an
exchange of the notional amount upon which the payments are based. The
differential to be paid or received as interest rates change is recognized as an
adjustment to interest expense in the current period. The fair market value of
the swap agreements and changes in the fair market value as a result of changes
in market interest rates are not recognized in the financial statements.
Gains and losses on terminations of interest rate swap agreements are
deferred as an adjustment to the carrying amount of the outstanding designated
debt and amortized as an adjustment to interest expense related to the debt over
the remaining term of the original contract life of the terminated swap
agreement. In the event of the early extinguishment of a designated debt
obligation, any realized or unrealized gain or loss from the swap would be
recognized in income coincident with the extinguishment gain or loss.
Any swap agreements that are not designated with outstanding debt, or
notional amounts (or durations) of interest rate swap agreements in excess of
the principal amounts (or maturities) of the underlying debt obligations, are
recorded as an asset or liability at fair market value, with changes in fair
market value recorded in "Other income or expense" (the fair market value
method). There were no such agreements at December 31, 1999.
23
26
The following table provides information about Houghton Mifflin's financial
instruments that are sensitive to changes in interest rates. For investment
securities and debt obligations, the table presents principal cash flows and
related weighted-average interest rates by expected maturity dates.
Weighted-average variable rates are based on implied forward rates as derived
from appropriate annual spot rate observation as of the reporting date. For
interest rate swaps, the table presents notional amounts and weighted-average
interest rates by contractual maturity dates. Notional amounts are used to
calculate the contractual cash flows to be exchanged under the contract.
INTEREST RATE SENSITIVITY
PRINCIPAL (NOTIONAL) AMOUNTS AND
AVERAGE INTEREST RATES
FAIR MARKET
VALUE
2000 2001 2002 2003 2004 THEREAFTER TOTAL 12/31/99
------- ------- ------- ------- ------- ---------- -------- -----------
(IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS)
LIABILITIES
Commercial paper............. $21,358 -- -- -- -- -- $ 21,358 $ 21,358
Average interest rate........ 6.42% -- -- -- -- --
Long-term debt, including
current portion
Fixed rate................. $50,037 $30,034 -- -- $99,745 $124,859 $304,675 $297,229
Average interest rate...... 5.93% 5.99% -- -- 7.13% 7.00%
Variable rate.............. $20,000 -- -- -- -- -- $ 20,000 $ 20,000
Average interest rate...... 6.75% -- -- -- -- --
INTEREST RATE DERIVATIVE FINANCIAL INSTRUMENTS RELATED TO DEBT
Interest rate swaps
Notional amount of swap
(Pay fixed/receive
variable)................ $50,000 -- -- -- -- --
Average pay rate........... 5.93% -- -- -- -- --
Average receivable rate.... 6.14% -- -- -- -- --
24
27
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Management's Responsibility for Financial Statements........ 26
Report of Independent Auditors.............................. 27
Consolidated Balance Sheets at December 31, 1999 and 1998... 28
Consolidated Statements of Income for the years ended
December 31, 1999, 1998 and 1997.......................... 30
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.......................... 31
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1999, 1998 and 1997.............. 32
Notes to Consolidated Financial Statements.................. 34
SUPPLEMENTARY DATA
Summary of Quarterly Results of Operations (unaudited) is presented on page 56.
25
28
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of Houghton Mifflin Company is responsible for all
information and representations contained in the financial statements and other
sections of this annual report. Management is also responsible for the internal
consistency of such information and representations. In preparing the financial
statements it is necessary for management to make informed judgments and
estimates and to select accounting principles which it believes are in
accordance with generally accepted accounting principles appropriate in the
circumstances.
In meeting its responsibility for the reliability of the financial
statements, management relies on Houghton Mifflin's internal control systems and
procedures. In designing such control procedures, management recognizes that
errors or irregularities may nevertheless occur and that estimates and judgments
are needed to assess and balance the relative costs and expected benefits of
controls. However, management believes that Houghton Mifflin's accounting
controls do provide reasonable assurance that assets are safeguarded and that
transactions are properly recorded and executed in accordance with corporate
policy and management's authorization. As a further safeguard, Houghton Mifflin
has a program of internal audits and appropriate follow-up by management.
The financial statements have been audited by Houghton Mifflin's
independent auditors, Ernst & Young LLP, in accordance with generally accepted
auditing standards. In connection with its audit, Ernst & Young LLP develops and
maintains an understanding of Houghton Mifflin's accounting and financial
controls, and conducts such tests and related procedures as it deems necessary
to render its opinion on the financial statements. The adequacy of Houghton
Mifflin's internal financial controls and the accounting principles employed in
financial reporting are under the general surveillance of the Audit Committee of
the Board of Directors, consisting of five independent directors. The
independent auditors and internal auditors have free and direct access to the
Audit Committee and meet with the committee periodically to discuss accounting,
auditing, and financial reporting matters.
Houghton Mifflin has distributed to its employees a statement regarding,
among other things, potentially conflicting outside business interests of
employees, and proper conduct of domestic and international business activities.
It has developed and instituted additional internal controls and audit
procedures designed to prevent or detect violations of these policies.
Management believes this provides reasonable assurance that its operations meet
a high standard of business conduct.
Nader F. Darehshori Gail Deegan
Chairman, President, Executive Vice President and
and Chief Executive Officer Chief Financial Officer
26
29
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Houghton Mifflin Company
We have audited the accompanying consolidated balance sheets of Houghton
Mifflin Company as of December 31, 1999 and 1998, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1999. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of Houghton Mifflin's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Houghton Mifflin Company at December 31, 1999 and 1998, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
As discussed in Note 1 to the financial statements, in 1999 Houghton
Mifflin Company changed its method of accounting for the amortization of book
plate assets.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
January 25, 2000, except for the second
paragraph of Note 14, as to
which the date is February 29, 2000.
27
30
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------
1999 1998
---------- --------
(IN THOUSANDS OF
DOLLARS, EXCEPT SHARE
AND PER-SHARE AMOUNTS)
ASSETS
CURRENT ASSETS
Cash and cash equivalents.............................. $ 12,041 $ 3,953
Marketable securities and time deposits available for
sale, at fair value................................... 638 49,203
Accounts receivable.................................... 178,887 170,706
Less: allowance for bad debts and book returns.... 31,207 27,969
---------- --------
147,680 142,737
Notes receivable....................................... 1,633 --
Inventories............................................ 164,228 151,669
Deferred income taxes.................................. 35,889 15,986
Prepaid expenses....................................... 3,000 2,279
---------- --------
Total current assets.............................. 365,109 365,827
Property, plant, and equipment, net......................... 73,342 49,412
Book plates, less accumulated amortization of $115,222 in
1999 and $127,156
in 1998................................................... 98,894 80,853
OTHER ASSETS
Royalty advances to authors, less allowance of $29,631
in 1999 and $23,589 in 1998........................... 26,711 24,482
Goodwill and other intangible assets, net.............. 452,338 445,223
Other investments and long-term receivables............ 22,349 17,871
---------- --------
Total other assets................................ 501,398 487,576
---------- --------
$1,038,743 $983,668
========== ========
See accompanying Notes to Consolidated Financial Statements.
28
31
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------
1999 1998
---------- --------
(IN THOUSANDS OF
DOLLARS, EXCEPT SHARE
AND PER-SHARE AMOUNTS)
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable....................................... $ 55,601 $ 39,029
Commercial paper....................................... 21,358 11,894
Royalties.............................................. 51,141 48,371
Salaries, wages, and commissions....................... 29,814 27,177
Other accrued expenses................................. 31,246 27,019
Current portion of long-term debt...................... 70,037 83,322
---------- --------
TOTAL CURRENT LIABILITIES......................... 259,197 236,812
Long-term debt.............................................. 254,638 274,521
Accrued royalties payable................................... 967 1,148
Other liabilities........................................... 33,406 28,459
Accrued postretirement benefits............................. 29,213 28,839
Deferred income taxes....................................... 28,301 15,601
Commitments and contingencies (Notes 4 and 8)
STOCKHOLDERS' EQUITY
Preferred stock, $1 par value; 500,000 shares
authorized, none issued............................... -- --
Common stock, $1 par value; 70,000,000 shares
authorized; 31,098,023 shares issued in 1999 and
30,549,706 shares issued in 1998...................... 31,098 30,550
Capital in excess of par value......................... 108,627 95,740
Retained earnings...................................... 392,225 330,672
---------- --------
531,950 456,962
Notes receivable from stock purchase agreements........ (4,645) (4,621)
Unearned compensation related to restricted stock...... (3,029) (2,318)
Common shares held in treasury, at cost, 1,045,493
shares in 1999 and 374,052 shares in 1998............. (36,411) (8,681)
Benefits Trust assets, at market....................... (54,844) (61,432)
Accumulated other comprehensive income................. -- 18,378
---------- --------
TOTAL STOCKHOLDERS' EQUITY........................ 433,021 398,288
---------- --------
$1,038,743 $983,668
========== ========
See accompanying Notes to Consolidated Financial Statements.
29
32
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- -------- --------
(IN THOUSANDS OF DOLLARS, EXCEPT
PER-SHARE AMOUNTS)
NET SALES.................................................. $920,118 $861,657 $797,320
COSTS AND EXPENSES
Cost of sales......................................... 411,114 390,922 362,501
Selling and administrative............................ 397,044 368,715 328,261
-------- -------- --------
808,158 759,637 690,762
-------- -------- --------
OPERATING INCOME........................................... 111,960 102,020 106,558
OTHER INCOME (EXPENSE)
Net interest expense.................................. (29,770) (33,981) (38,926)
Gains (losses) on INSO Corporation common stock and
equity in earnings (losses) of INSO Corporation..... (5,100) 18,797 15,901
Loss on sale of investment............................ -- (3,017) --
Acquired in-process research and development.......... -- (3,500) --
Other expense......................................... -- (1,050) --
-------- -------- --------
(34,870) (22,751) (23,025)
-------- -------- --------
Income before taxes and extraordinary item................. 77,090 79,269 83,533
Income tax provision....................................... 31,106 33,630 33,711
-------- -------- --------
Income before extraordinary item........................... 45,984 45,639 49,822
Extraordinary gain on extinguishment of debt, net of tax of
$21,956 in 1999 and $13,042 in 1998...................... 30,320 18,010 --
-------- -------- --------
Net income................................................. $ 76,304 $ 63,649 $ 49,822
======== ======== ========
EARNINGS PER SHARE:
Basic
Income before extraordinary item...................... $ 1.60 $ 1.59 $ 1.76
Extraordinary gain on extinguishment of debt.......... 1.05 0.63 --
-------- -------- --------
Net income............................................ $ 2.65 $ 2.22 $ 1.76
======== ======== ========
Diluted
Income before extraordinary item...................... $ 1.57 $ 1.57 $ 1.73
Extraordinary gain on extinguishment of debt.......... 1.03 0.62 --
-------- -------- --------
Net income............................................ $ 2.60 $ 2.19 $ 1.73
======== ======== ========
See accompanying Notes to Consolidated Financial Statements.
30
33
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
--------- -------- ---------
(IN THOUSANDS OF DOLLARS)
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income.......................................... $ 76,304 $ 63,649 $ 49,822
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary gain on extinguishment of debt,
net of tax................................... (30,320) (18,010) --
Depreciation and amortization expense.......... 94,115 95,681 89,739
Amortization of unearned compensation on
restricted stock............................. 1,200 5,177 2,095
Losses (gains) on INSO Corporation common stock
and equity in earnings of INSO Corporation... 5,100 (18,797) (15,901)
Loss on sale of long-term investment........... -- 3,017 --
Acquired in-process research and development... -- 3,500 --
Gain on sale of property....................... -- -- (3,011)
Changes in operating assets and liabilities:
Accounts receivable............................ (1,534) 16,805 6,267
Inventories.................................... (11,266) (1,626) (5,079)
Accounts payable............................... 15,640 (9,006) (10,262)
Royalties, net................................. (1,619) 6,356 4,072
Deferred and income taxes payable.............. (12,283) (10,877) 17,209
Other, net..................................... 8,449 10,928 6,898
--------- -------- ---------
NET CASH PROVIDED BY OPERATING
ACTIVITIES.............................. 143,786 146,797 141,849
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Book plate expenditures............................. (66,979) (53,255) (54,163)
Acquisition of publishing and technology assets, net
of cash acquired.................................. (45,266) (24,845) (9,049)
Property, plant, and equipment expenditures......... (31,335) (20,729) (13,740)
Issuance of notes receivable........................ (1,133) -- --
Proceeds from sale of property...................... -- -- 5,204
Proceeds from the sale of INSO Corporation stock.... 682 210 --
Proceeds from the sale of long-term investment...... -- 835 --
Purchase of marketable securities................... -- (24) (2)
--------- -------- ---------
NET CASH USED IN INVESTING ACTIVITIES..... (144,031) (97,808) (71,750)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Dividends paid on common stock...................... (14,748) (14,388) (13,959)
Issuance (repayment) of commercial paper............ 9,464 (49,452) 61,346
Proceeds from the issuance of long-term financing... 80,000 50,000 --
Payment of long-term financing...................... (50,181) (40,000) (130,000)
Exercise of stock options........................... 1,583 2,875 4,782
Purchase of common stock............................ (17,873) -- --
Other............................................... 88 308 1,819
--------- -------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES.............................. 8,333 (50,657) (76,012)
Increase (decrease) in cash and cash equivalents......... 8,088 (1,668) (5,913)
Cash and cash equivalents at beginning of year........... 3,953 5,621 11,534
--------- -------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR................. $ 12,041 $ 3,953 $ 5,621
========= ======== =========
SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid................................... $ 43,416 $ 40,693 $ 12,890
Interest paid....................................... $ 29,242 $ 33,875 $ 39,366
See accompanying Notes to Consolidated Financial Statements.
31
34
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON CAPITAL
STOCK IN EXCESS RETAINED
$1 PAR VALUE OF PAR VALUE EARNINGS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 ------------ ------------ --------
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
BALANCE AT JANUARY 1, 1997 $29,562 $ 43,476 $245,769
Comprehensive income:
Net income................................................ -- -- 49,822
Other comprehensive income, net of tax:
Unrealized loss on available for sale securities..... -- -- --
Total comprehensive income........................... -- -- --
Common stock dividends, $0.49 per share................... -- -- (13,959)
Stock options exercised................................... 332 7,136 (66)
Issuance of restricted stock.............................. 298 8,201 (142)
Restricted stock forfeited................................ -- 228 --
Executive stock repurchases............................... -- -- --
Other equity transactions, net............................ 27 968 (13)
Issuance of stock for contribution to the retirement
savings plan............................................ -- 731 --
Benefits Trust asset remeasurement........................ -- 13,081 --
Amortization of unearned compensation on restricted
stock................................................... -- -- --
Tax benefit related to stock plan activities.............. -- 1,486 --
------- -------- --------
BALANCE AT DECEMBER 31, 1997.............................. 30,219 75,307 281,411
======= ======== ========
Comprehensive income:
Net income................................................ -- -- 63,649
Other comprehensive income, net of tax:
Unrealized gain on available for sale securities..... -- -- --
Reclassification adjustment on realized loss on sale
of security........................................ -- -- --
Total comprehensive income........................... -- -- --
Common stock dividends, $0.50 per share................... -- -- (14,388)
Stock options exercised................................... 259 5,642 --
Issuance of executive performance shares.................. 31 852 --
Issuance of restricted stock.............................. 11 306 --
Executive stock repurchases............................... -- -- --
Other equity transactions, net............................ 30 838 --
Benefits Trust asset remeasurement........................ -- 11,538 --
Amortization of unearned compensation on restricted
stock................................................... -- -- --
Tax benefit related to stock plan activities.............. -- 1,257 --
------- -------- --------
BALANCE AT DECEMBER 31, 1998.............................. 30,550 95,740 330,672
======= ======== ========
Comprehensive income:
Net income................................................ -- -- 76,304
Other comprehensive income, net of tax:
Reclassification adjustment on realized loss on sale
of security........................................ -- -- --
Total comprehensive income........................... -- -- --
Common stock dividends, $0.51 per share................... -- -- (14,748)
Stock options exercised................................... 463 10,318 --
Issuance of restricted stock.............................. 48 2,231 --
Restricted stock forfeited................................ -- -- --
Executive stock repurchases............................... -- -- --
Purchases of treasury stock............................... -- -- --
Other equity transactions, net............................ 37 1,601 (3)
Benefits Trust asset remeasurement........................ -- (6,581) --
Amortization of unearned compensation on restricted
stock................................................... -- -- --
Tax benefit related to stock plan activities.............. -- 5,318 --
------- -------- --------
BALANCE AT DECEMBER 31, 1999.............................. $31,098 $108,627 $392,225
======= ======== ========
See accompanying Notes to Consolidated Financial Statements.
32
35
UNEARNED ACCUMULATED
NOTES RECEIVABLE COMPENSATION TREASURY STOCK OTHER
FROM STOCK RELATED TO ----------------------- BENEFITS COMPREHENSIVE
PURCHASE AGREEMENTS RESTRICTED STOCK SHARES AMOUNT TRUST INCOME (LOSS) TOTAL
------------------- ---------------- ----------- -------- -------- ------------- --------
$(5,916) $(1,563) (230,780) $ (2,448) $(36,816) $(1,771) $270,293
-- -- -- -- -- --
-- -- -- -- -- (127)
-- -- -- -- -- -- 49,695
-- -- -- -- -- -- (13,959)
-- -- (74,604) (2,620) -- -- 4,782
-- (8,357) -- -- -- -- --
-- 647 (24,000) (875) -- -- --
1,547 -- (8,446) (282) -- -- 1,265
(259) -- -- -- (26) -- 697
-- -- 55,501 672 -- -- 1,403
-- -- -- -- (13,081) -- --
-- 2,095 -- -- -- -- 2,095
-- -- -- -- -- -- 1,486
------- ------- ----------- -------- -------- ------- --------
(4,628) (7,178) (282,329) (5,553) (49,923) (1,898) 317,757
======= ======= =========== ======== ======== ======= ========
-- -- -- -- -- --
-- -- -- -- -- 18,560
-- -- -- -- -- 1,716
-- -- -- -- -- 83,925
-- -- -- -- -- -- (14,388)
-- -- (88,182) (3,026) -- -- 2,875
-- -- -- -- -- -- 883
-- (317) -- -- -- -- --
220 -- -- -- -- -- 220
(213) -- (3,541) (102) 29 -- 582
-- -- -- -- (11,538) -- --
-- 5,177 -- -- -- -- 5,177
-- -- -- -- -- -- 1,257
------- ------- ----------- -------- -------- ------- --------
(4,621) (2,318) (374,052) (8,681) (61,432) 18,378 398,288
======= ======= =========== ======== ======== ======= ========
-- -- -- -- -- --
-- -- -- -- -- (18,378)
-- -- -- -- -- -- 57,926
-- -- -- -- -- -- (14,748)
-- -- (201,500) (9,198) -- -- 1,583
-- (2,279) -- -- -- -- --
-- 368 (11,069) (368) -- -- --
148 -- -- -- -- -- 148
-- -- (452,281) (17,873) -- -- (17,873)
(172) -- (6,591) (291) 7 -- 1,179
-- -- -- -- 6,581 -- --
-- 1,200 -- -- -- -- 1,200
-- -- -- -- -- -- 5,318
------- ------- ----------- -------- -------- ------- --------
$(4,645) $(3,029) (1,045,493) $(36,411) $(54,844) $ 0 $433,021
======= ======= =========== ======== ======== ======= ========
See accompanying Notes to Consolidated Financial Statements.
33
36
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of Houghton
Mifflin Company and its wholly-owned subsidiaries. All material intercompany
accounts and transactions are eliminated in consolidation.
Investments in 20% to 50% owned entities are accounted for on the equity
method, while investments in entities less than 20% owned and for which Houghton
Mifflin does not have control are accounted for under the cost method. Houghton
Mifflin uses the income statement method to account for the issuance of common
stock by a subsidiary or equity investee. Under this method gains and losses on
issuance of stock by a subsidiary or equity investee are recognized in the
income statement.
Certain amounts in the prior years' financial statements have been
reclassified to conform to the current-year presentation.
CASH AND CASH EQUIVALENTS:
Cash and cash equivalents consist primarily of cash in banks and highly
liquid investment securities that have maturities of three months or less when
purchased. The carrying amount approximates fair market value due to the
short-term maturity of these instruments.
MARKETABLE SECURITIES AND TIME DEPOSITS AVAILABLE FOR SALE:
Houghton Mifflin accounts for its investment in equity securities in
accordance with Statement of Financial Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," or SFAS 115.
Marketable securities included in current assets consist of instruments
with original maturities of three months or greater. At December 31, 1999, the
securities consisted of time deposits and are stated at fair value, which
approximates cost due to the short maturity of the instruments. The fair values
are estimated based on quoted market prices.
The December 31, 1998 balance consisted primarily of equity securities.
These securities were classified as current assets due to Houghton Mifflin's
option and expectation to use them to redeem the remaining SAILS, due on August
1, 1999 (see Note 4). These securities were classified as available for sale and
carried at fair market value based on the quoted market price. The fair market
value of these securities, $48.6 million, was included as a component of
marketable securities as of December 31, 1998.
BOOK RETURNS:
A provision for estimated future book returns is made at time of sale, and
consists of the sales value less related inventory value and royalty costs.
34
37
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INVENTORIES:
Inventory balances at December 31, 1999 and 1998 were as follows:
1999 1998
-------- --------
(IN THOUSANDS)
Finished goods......................................... $152,818 $141,457
Work in process........................................ 5,584 4,294
Raw materials.......................................... 5,826 5,918
-------- --------
$164,228 $151,669
======== ========
Inventories are stated at the lower of cost or market (replacement cost for
raw materials and net realizable value for other inventories). The last-in,
first-out (LIFO) method is used to determine the cost of inventory. If the cost
of all inventories had been determined by the first-in, first-out method (FIFO),
which approximates replacement cost, net of any reserves needed on a FIFO basis,
inventory values would have been higher by $19.8 million at both December 31,
1999 and December 31, 1998.
PROPERTY, PLANT, AND EQUIPMENT:
Property, plant, and equipment are carried on the basis of cost.
Depreciation is provided on a straight-line basis over the estimated useful
lives as follows:
ESTIMATED USEFUL LIFE
-----------------------------------
Building and building equipment............... 10 to 35 years
Machinery, equipment and capitalized
software.................................... 3 to 15 years
Leasehold improvements........................ Lesser of useful life or lease term
Balances of major classes of assets and allowances for depreciation and
amortization at December 31, 1999 and 1998, were as follows:
1999 1998
-------- --------
(IN THOUSANDS)
Land and land improvements............................. $ 2,164 $ 1,179
Building and building equipment........................ 20,822 17,410
Machinery, equipment and capitalized software.......... 113,626 85,226
Leasehold improvements................................. 13,517 11,718
-------- --------
Total........................................ 150,129 115,533
Less: allowances for depreciation and amortization..... (76,787) (66,121)
-------- --------
Property, plant, and equipment, net.................... $ 73,342 $ 49,412
======== ========
Maintenance and repair costs are charged to expense as incurred, and
renewals and improvements that extend the useful life of the assets are
capitalized. Depreciation expense was approximately $12.5 million in 1999; $10.4
million in 1998; and $8.2 million in 1997.
BOOK PLATES:
Beginning in 1999, Houghton Mifflin implemented a change in the method of
accounting for the amortization of book plate assets. The change is from a class
of assets method previously used to a specific identification method by which
amortization commences in the year of publication. This
35
38
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
change was made prospectively for book plate additions beginning in 1999. We
believe the change reflects a better matching of amortization expense with the
related revenue and is consistent with the method used by other major
publishers. This change resulted in a decrease in amortization expense of
approximately $5.1 million ($3.1 million after tax), or $0.10 per diluted share,
for the twelve months ended December 31, 1999.
Houghton Mifflin's investment in book plates is capitalized and amortized
over three to five years using the sum-of-the-years digits method. This policy
is used by all divisions, except for Riverside, which uses the straight-line
method, and the Trade Division, which expenses its book plates for all products
except reference and dictionary materials. Amortization expense was
approximately $49.8 million in 1999; $56.8 million in 1998; and $53.6 million in
1997.
INCOME TAXES:
Income taxes are provided based on the liability method of accounting
pursuant to Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes." Deferred income taxes are recorded to reflect the tax benefit and
consequences of future years differences between the tax bases of assets and
liabilities and their financial reporting amounts.
GOODWILL AND OTHER INTANGIBLE ASSETS:
Goodwill and other intangible assets at December 31, 1999 and 1998,
consisted of the following:
1999 1998
-------- --------
(IN THOUSANDS)
Goodwill............................................... $545,251 $523,219
Publishing rights and titles........................... 24,874 17,724
Other.................................................. 15,860 6,060
-------- --------
Total........................................... 585,985 547,003
Less: accumulated amortization......................... (133,647) (101,780)
-------- --------
Goodwill and other intangibles, net.................... $452,338 $445,223
======== ========
Intangible assets are amortized using the straight-line method over the
estimated useful lives as follows: Goodwill (8-20 years); Publishing rights and
titles (5-15 years); Other intangibles (various). Amortization expense on
intangible assets, principally goodwill, was approximately $31.9 million in
1999; $28.5 million in 1998; and $27.9 million in 1997.
IMPAIRMENT EVALUATION:
Houghton Mifflin examines the carrying value of its long-lived assets,
certain identifiable intangibles, and goodwill to determine whether there are
any impairment losses. An impairment assessment is performed if certain
indicators are present, such as a significant decrease in demand for a product
related to an asset, a history of operating cash flow losses, or a projection or
forecast that demonstrates continuing losses associated with a revenue producing
asset. The undiscounted cash flow method is used to determine if impairment has
occurred. If indicators of impairment are present, and the estimated
undiscounted cash flows to be derived from the related assets are not expected
to be sufficient to recover the asset's carrying amount, an impairment loss is
charged to expense in the period identified based upon the difference between
the carrying amount and the discounted cash flows. The rates that would be
utilized to discount the net cash flows to net present value would take
36
39
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
into account the time value of money and investment risk factors. As of December
31, 1999, no event had been identified that would indicate an impairment of the
value of long-lived assets, identifiable intangibles, and goodwill recorded in
the accompanying consolidated financial statements.
BENEFITS TRUST:
The Trust assets consist primarily of 1.3 million shares of Houghton
Mifflin's common stock purchased from Houghton Mifflin's treasury shares at
quoted market prices in 1992. The Trust is available to fund certain
compensation and benefit plan obligations. The common stock is carried at market
value with changes in share price from prior reporting periods reflected as an
adjustment to capital in excess of par value.
STOCK-BASED COMPENSATION:
Houghton Mifflin grants stock options for a fixed number of shares to
employees and directors with an exercise price equal to the fair market value of
the shares at the date of grant. Houghton Mifflin accounts for stock option
grants in accordance with Accounting Principle Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and, accordingly, recognizes no compensation
expense for the stock option grants. Houghton Mifflin also grants restricted
stock and performance restricted stock awards to key employees, including
officers. For such restricted stock awards, Houghton Mifflin measures
compensation equal to the fair market value of the shares at the date of grant.
Compensation expense for these awards is then recognized ratably over the period
during which the restriction lapses. For performance restricted stock awards,
adjustments are also made to recognize expense based upon achievement of the
applicable financial goals.
Houghton Mifflin has adopted the disclosure-only provision of Statement of
Financial Accounting Standards No. 123, or SFAS 123, "Accounting for Stock-Based
Compensation" (see Note 6).
COMPREHENSIVE INCOME:
Houghton Mifflin reports comprehensive income as required by Financial
Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income,"
or SFAS 130. SFAS 130 requires that unrealized gains or losses on Houghton
Mifflin's marketable equity securities be included in other comprehensive
income, as well as certain other components of stockholders' equity.
Total comprehensive income amounted to $57.9 million for the twelve months
ended December 31, 1999, $83.9 million for the twelve months ended 1998, and
$49.7 million for the twelve months ended 1997.
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION:
Houghton Mifflin reports segment information in accordance with Financial
Accounting Standards Board Statement No. 131, "Disclosures About Segments of an
Enterprise and Related Information," or SFAS 131. SFAS 131 requires public
companies to report financial and descriptive information about their operating
segments in interim financial reports to shareholders as well. See Note 12 for
the detailed presentation of business segments report.
37
40
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RISKS AND UNCERTAINTIES:
Organization:
Houghton Mifflin's business is publishing, primarily operating in three
segments in the domestic market. Based on sales, Houghton Mifflin's largest
segment is K-12 Publishing, which provides textbooks and other educational and
testing products and services for the elementary and secondary school markets.
College Publishing provides textbooks and other educational products and
services to the two-year and four-year college markets and advanced placement
programs in the secondary school market. The Other segment provides products in
a wide variety of topics, formats, and media to the general public.
Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. The
significant estimates that affect the financial statements include, but are not
limited to, book returns, recoverability of advances to authors, inventory
valuation, amortization periods, and recoverability of long-term assets such as
book plates, intangibles, and goodwill.
REVENUE RECOGNITION:
Houghton Mifflin recognizes revenues upon shipment of products, net of a
provision for estimated returns based on sales.
PENDING ACCOUNTING PRONOUNCEMENTS:
In 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Investments and Hedging Activities," which was
amended by Financial Accounting Standards Board Statement No. 137, which
deferred the adoption of FAS 133 until fiscal years beginning after June 15,
2000. Houghton Mifflin is currently evaluating the effects of implementing this
statement.
NOTE 2. ACQUISITIONS
On May 5, 1999, Houghton Mifflin acquired all of the outstanding stock of
Sunburst Communications, Inc., or Sunburst, a leading developer of software and
video instructional materials. This acquisition was accounted for as a purchase,
and the net assets acquired, liabilities assumed, and results of operations are
included in Houghton Mifflin's consolidated financial statements from the date
of the acquisition. Net cash consideration for the acquisition amounted to
approximately $34.1 million, of which $32.0 million was paid to the former
shareholders of Sunburst and $2.1 million was expended to repay debt and pay
other acquisition-related fees. The cost of the acquisition was allocated on the
basis of the estimated fair market value of the assets acquired and liabilities
assumed. Goodwill and other intangible assets of $30.3 million were recorded as
part of the acquisition and will be amortized on a straight-line basis over
periods ranging from approximately 7 to 20 years.
On January 8, 1999, Houghton Mifflin acquired the assets of the Little
Planet Literacy Series, a leading technology-based pre-kindergarten to grade
three literacy program, from Applied Learning Technologies, Inc. The acquisition
was accounted for as a purchase, and the net assets and results of
38
41
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
operations are included in Houghton Mifflin's consolidated financial statements
from the date of the acquisition. Net cash consideration for the acquisition
amounted to approximately $4.4 million. The cost of the acquisition was
allocated on the basis of the estimated fair market value of the assets acquired
and the liabilities assumed. The excess of the purchase price over the net
assets acquired, or goodwill, will be amortized on a straight-line basis over a
period of approximately 8 years.
On December 23, 1998, Houghton Mifflin acquired the assets of
DiscoveryWorks, a science program for the elementary school market from Silver
Burdett Ginn Inc., a subsidiary of Pearson Plc. The acquisition was accounted
for as a purchase, and the net assets and results of operations are included in
Houghton Mifflin's consolidated financial statements from the date of the
acquisition. Net cash consideration for the acquisition amounted to
approximately $11.1 million. The cost of the acquisition was allocated on the
basis of the estimated fair market value of the assets acquired. The excess of
the net assets acquired, or goodwill, is being amortized on a straight-line
basis over a period of 12 years.
On July 21, 1998, Houghton Mifflin acquired all of the outstanding stock of
Computer Adaptive Technologies, Inc., or CAT, which specializes in developing
and delivering computer-based testing solutions to organizations worldwide. The
acquisition was accounted for as a purchase, and the assets acquired,
liabilities assumed, and results of operations are included in Houghton
Mifflin's consolidated financial statements from the date of the acquisition.
Net cash consideration paid in 1998 for the acquisition amounted to
approximately $10.7 million, of which $8.0 million was paid to the former
shareholders of CAT and $2.7 million was expended to repay debt, cash out
certain warrants, and pay other acquisition related fees. The acquisition
agreement allowed for up to an additional $6 million of consideration,
contingent upon the achievement of certain operational and financial targets. In
January 1999, an additional $2 million was paid to the former shareholders of
CAT based on the achievement of operational targets set forth in the acquisition
agreement, which resulted in additional goodwill. The remaining additional
contingent consideration of up to $4 million was contingent upon the achievement
of certain financial targets which were not achieved, and accordingly, no
additional consideration is owed. A charge for acquired in-process research and
development of $3.5 million was also recorded as part of the acquisition. As of
the acquisition date, CAT had only one product that qualified as in-process
research and development, CAT Software System Version 7. This project
represented an integrated application suite of products whose functionality
included test development, automated assembly and test production, test
administration, scoring, automated test reporting, and test security. The amount
of the charge represented the calculated value based on residual cash flows
related to this in-process research and development project. At the date of
acquisition, the development of this project had not yet reached technological
feasibility, and the research and development in progress had no alternative
uses. Accordingly, these costs were expensed as of the acquisition date. The
cost of the acquisition was allocated on the basis of the estimated fair market
value of the assets acquired and the liabilities assumed, including the acquired
in-process research and development. Including the contingent payment made in
1999, goodwill and other intangible assets of $9.4 million have been recorded as
part of the acquisition and are being amortized on a straight-line basis over
periods ranging from approximately 3 to 10 years.
On September 10, 1997, Houghton Mifflin, through its subsidiary The
Riverside Publishing Company, acquired the assets of Wintergreen/Orchard House,
Inc., a publisher of guidance products for the elementary and secondary school
markets. The acquisition was accounted for as a purchase, and the net assets and
results of operations are included in Houghton Mifflin's consolidated financial
statements from the date of the acquisition. Net cash consideration for the
acquisition amounted to approximately $3.6 million. The cost of the acquisition
was allocated on the basis of the estimated
39
42
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
fair market value of the assets acquired and the liabilities assumed. The excess
of the net assets acquired, or goodwill, is being amortized on a straight-line
basis over a period of 15 years.
On May 12, 1997, Houghton Mifflin acquired the assets of Chapters
Publishing Ltd., predominantly a publisher of cookbooks. The acquisition was
accounted for as a purchase, and the net assets and results of operations are
included in Houghton Mifflin's consolidated financial statements from the date
of the acquisition. Net cash consideration for the acquisition amounted to
approximately $3.3 million. The cost of the acquisition was allocated on the
basis of the estimated fair market value of the assets acquired and the
liabilities assumed. The excess of the net assets acquired, or goodwill, is
being amortized on a straight-line basis over a period of 10 years.
None of the above acquisitions materially affect consolidated results;
therefore, no pro forma information is provided.
NOTE 3. TAXES ON INCOME
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of the net deferred tax assets are shown in the following table:
1999 1998
------- -------
(IN THOUSANDS)
Tax asset-related:
Pension and postretirement benefits................. $23,658 $20,620
Publishing expense.................................. 27,025 29,316
Allowance for book returns.......................... 5,046 4,004
Deferred compensation............................... 3,962 5,155
Other, net.......................................... 5,838 6,104
------- -------
65,529 65,199
------- -------
Tax liability-related:
Depreciation and amortization expense............... (35,334) (27,050)
Intangible assets................................... (16,171) (12,474)
INSO Corporation basis and related differences...... -- (6,061)
INSO Corporation shares unrealized gain............. -- (13,309)
Deferred income..................................... (666) (420)
Other, net.......................................... (5,770) (5,500)
------- -------
(57,941) (64,814)
------- -------
Net deferred tax asset................................... $ 7,588 $ 385
======= =======
The net deferred tax asset balance is stated at prevailing statutory income
tax rates. Houghton Mifflin currently does not anticipate any change in
valuation methodology applied to the determination of net deferred tax assets.
In 1999, the net deferred tax asset balance included a $5.9 million
deferred tax liability due to differences between the book and tax basis of the
intangible assets acquired from Sunburst Communications, Inc. In 1998, the net
deferred tax asset balance included a $13.3 million deferred tax liability on
the unrealized gain related to Houghton Mifflin's investment in INSO
Corporation, or INSO, which is accounted for in accordance with SFAS 115.
40
43
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the provision for income taxes attributable to
income before taxes consist of the following:
1999 1998 1997
------- ------- -------
(IN THOUSANDS)
Current:
Federal.................................... $26,865 $29,034 $14,539
State and other............................ 4,041 2,434 1,963
------- ------- -------
Total current......................... 30,906 31,468 16,502
Deferred:
Federal.................................... 171 1,520 14,315
State and other............................ 29 642 2,894
------- ------- -------
Total deferred........................ 200 2,162 17,209
------- ------- -------
$31,106 $33,630 $33,711
======= ======= =======
The reconciliation of the income tax rate computed at the U.S. federal
statutory tax rate to reported income tax expense (benefit) attributable to
income before taxes is as follows:
1999 1998 1997
---- ---- ----
Federal statutory rate................................. 35.0% 35.0% 35.0%
State income taxes, net of federal benefit............. 3.0 3.1 3.8
Non-deductible goodwill amortization................... 2.5 2.7 2.5
Acquired in-process research and development........... 0.0 1.5 0.0
Other.................................................. (0.1) 0.1 (0.9)
---- ---- ----
Effective tax rate..................................... 40.4% 42.4% 40.4%
==== ==== ====
In 1998 and 1997, Houghton Mifflin recorded a provision for deferred taxes
on the undistributed earnings of INSO. Accumulated undistributed earnings of
INSO on which taxes have not been provided were approximately $1.0 million at
December 31, 1998 and $2.0 million at December 31, 1997. Houghton Mifflin
recorded a provision for deferred income taxes on the gains recognized as result
of the additional equity issuances of INSO.
41
44
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. DEBT AND BORROWING AGREEMENTS
At December 31, 1999, Houghton Mifflin had a $300 million unsecured
revolving credit facility for which it pays annual commitment fees. Borrowings
under the revolving credit facility are outstanding under a five-year revolving
commitment which expires on October 31, 2000. The revolving credit facility
requires Houghton Mifflin to comply with certain covenants, the most restrictive
of which include maintenance of a specific level of net worth, fixed-charge
coverage ratio, and debt-to-equity ratio. At December 31, 1999, the outstanding
balance on the revolving credit facility was $20 million, at a weighted average
interest rate of 6.75%. At December 31, 1998, the outstanding balance on the
revolving credit facility was $50 million, at a weighted average interest rate
of 5.5875%. Management routinely evaluates interest rates available to Houghton
Mifflin under the revolving credit facility as compared to those available
through the issuance of commercial paper. The amount outstanding under the
revolving credit facility at December 31, 1998 was excluded from current
liabilities because Houghton Mifflin intended that at least that amount would
remain outstanding under the revolving credit facility, or would be issued as
additional commercial paper, for an uninterrupted period extending beyond one
year from the balance sheet date.
1999 1998
-------- --------
(IN THOUSANDS)
7.00% Notes due March 1, 2006, interest payable
semi-annually............................................. $124,859 $124,836
7.125% Notes due April 1, 2004, interest payable
semi-annually............................................. 99,745 99,685
6% Exchangeable Notes, due August 1, 1999, Stock
Appreciation Income-Linked Securities (SAILS)............. -- 63,322
Borrowings from financial institutions, unsecured, under
committed five-year credit facility, expiring October 31,
2000...................................................... 20,000 50,000
6.29% Notes due December 1, 1999, interest payable
semi-annually............................................. -- 20,000
Floating Rate Notes due December 1, 2000, interest payable
quarterly................................................. 50,000 --
5.99% Notes due December 3, 2001, interest payable
semi-annually............................................. 30,000 --
18.4% Capital lease obligation, interest and principal paid
monthly through August 2001............................... 71 --
-------- --------
324,675 357,843
Less: portion included in current liabilities............... 70,037 83,322
-------- --------
Total long-term debt........................................ $254,638 $274,521
======== ========
Long-term debt due in each of the next five years is as follows:
YEARS IN THOUSANDS
- ----- ------------
2000........................................................ $70,037
2001........................................................ 30,034
2002........................................................ --
2003........................................................ --
2004........................................................ 99,745
Houghton Mifflin had approximately $21.4 million of commercial paper
outstanding at December 31, 1999 at an interest rate of 6.42%. At the end of
1998, the amount of Houghton Mifflin's outstanding commercial paper was
approximately $11.9 million, with a weighted average interest rate of 5.95%.
Houghton Mifflin has issued $125 million of non-callable unsecured 7.00%
notes that mature on March 1, 2006. Houghton Mifflin also issued $20 million
with a stated interest rate of 6.29%, which
42
45
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
matured on December 1, 1999. In April 1999, Houghton Mifflin issued $50 million
of floating rate notes and $30 million of 5.99% medium-term notes through a
public offering. The $50 million floating rate notes mature on December 1, 2000.
The floating rate notes bear interest at a rate which is reset quarterly at the
three-month LIBOR plus 0.40%. At December 31, 1999, the interest rate on these
notes was 6.52%. The $30 million medium-term notes mature on December 3, 2001
and were priced at $100 to yield an effective rate of 5.99%. The proceeds from
these issuances were used to repay existing commercial paper debt. At December
31, 1999, Houghton Mifflin had two interest-rate swaps in place, each with a
notional amount of $25 million and terminating on December 1, 2000. Houghton
Mifflin pays the fixed rate on both swaps (5.90% and 5.95%) and receives a
variable rate based upon a commercial paper index.
Houghton Mifflin has issued $100 million of 7.125% 10-year notes in a
public debt offering. The notes, which mature on April 1, 2004, were priced at
99.4% of principal amount to yield an effective interest rate of 7.21%.
In May 1999, Houghton Mifflin filed a shelf registration statement with the
Securities and Exchange Commission covering up to $200 million of debt
securities and common stock, which may be issued in one or more offerings from
time to time. As of December 31, 1999, there had not been any issuances of debt
securities or common stock under this registration statement.
In prior years, Houghton Mifflin issued in a public offering 6%
Exchangeable Notes due in 1999, Stock Appreciation Income Linked Securities, or
SAILS, at a public offering price of $34 per SAILS at issue. Net proceeds of
approximately $126.6 million were used for general corporate purposes, including
the repayment of seasonal borrowings and the partial funding of the acquisition
of Heath. In August 1998, Houghton Mifflin redeemed 50%, or $65.3 million in
aggregate principal amount, of its outstanding SAILS. Redemption of the SAILS
was made at the option of Houghton Mifflin pursuant to Section 1301 (b) of the
Indenture dated as of March 15, 1994, between Houghton Mifflin and State Street
Bank and Trust Company (as successor to the First National Bank of Boston) as
Trustee, as supplemented by a First Supplemental Indenture dated as of July 27,
1995.
The SAILS were redeemed at an exchange rate equal to two shares of the
common stock of INSO, par value $0.01 per share, for each SAILS, or
approximately 1.9 million shares, and cash of $2.0 million for the payment of
all accrued and unpaid interest at the date of the redemption. The surrender of
the INSO shares to redeem the SAILS generated a non-cash gain of $15.4 million
($8.9 million after tax), or $0.31 per diluted share. Houghton Mifflin also
recognized an $18.0 million extraordinary after-tax gain, or $0.62 per diluted
share, on the extinguishment of the debt resulting from the redemption.
The remaining 50%, or $65.3 million in aggregate principal amount, of the
outstanding SAILS matured on August 2, 1999. In accordance with the terms of
SAILS, Houghton Mifflin elected to deliver two shares of the common stock of
INSO for each SAILS, or approximately 1.9 million shares, and cash of $2.0
million for the payment of all accrued and unpaid interest on the outstanding
SAILS. The transaction represented a disposition of the shares and generated a
non-cash loss of $5.6 million ($3.2 million after tax), or $0.11 per diluted
share. Houghton Mifflin also recognized an extraordinary gain of $52.3 million
($30.3 million after tax), or $1.03 per diluted share, on the extinguishment of
debt resulting from the maturity.
Houghton Mifflin from time to time enters into transactions involving
financial instruments for purposes of managing its exposure to interest rate
risks and funding costs. Through the use of interest
43
46
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
rate products such as interest rate swap agreements and interest rate locks,
Houghton Mifflin attempts to achieve a predetermined mix of fixed- and
floating-rate debt.
Each interest rate swap agreement is designated with all or a portion of
the principal balance and term of a specific debt obligation. These agreements
involve the exchange of amounts based on a variable interest rate for amounts
based on a fixed interest rate over the life of the agreement without an
exchange of the notional amount upon which the payments are based. The
differential to be paid or received as interest rates change is recognized as an
adjustment to interest expense in the current period. The fair market value of
the swap agreements and changes in the fair market value as a result of changes
in market interest rates are not recognized in the financial statements.
Gains and losses on terminations of interest rate swap agreements are
deferred as an adjustment to the carrying amount of the outstanding designated
debt and amortized as an adjustment to interest expense related to the debt over
the remaining term of the original contract life of the terminated swap
agreement. In the event of the early extinguishment of a designated debt
obligation, any realized or unrealized gain or loss from the swap would be
recognized in income coincident with the extinguishment gain or loss.
Any swap agreements that are not designated with outstanding debt, or
notional amounts (or durations) of interest rate swap agreements in excess of
the principal amounts (or maturities) of the underlying debt obligations, are
recorded as an asset or liability at fair market value, with changes in fair
market value recorded in other income or expense (the fair market value method).
There were no such agreements at December 31, 1999 or December 31, 1998.
NOTE 5. RETIREMENT AND POSTRETIREMENT BENEFITS PLANS
Houghton Mifflin has a noncontributory, qualified defined-benefit pension
plan, the Retirement Plan, that covers substantially all employees. The
Retirement Plan is a cash balance plan which accrues benefits based on pay,
length of service, and interest rates. The funding policy is to contribute
amounts subject to minimum funding standards set forth by the Employee
Retirement Income Security Act of 1974 and the Internal Revenue Code. The plan's
assets consist principally of common stocks, fixed income securities,
investments in registered investment companies, and cash and cash equivalents.
Houghton Mifflin also has a nonqualified defined-benefit plan, or nonqualified
plan, that covers employees who earn over the qualified pay limit. The
nonqualified plan accrues benefits for the executive officers based on service
and pay, and benefits for all other employees accrue based on the cash balance
plan calculation. The nonqualified plan is not funded.
Houghton Mifflin provides postretirement medical benefits to retired
full-time, non-union employees hired before April 1, 1992, who have provided a
minimum of five years of service and attained age 55.
Under the terms of the Benefits Trust agreement formed in 1992, proceeds
from the periodic sale of assets by the trustee, cash dividends received, and
other trust earnings may be used to pay designated compensation and benefit plan
obligations, including retiree healthcare benefit costs. The assets in the
Benefits Trust consist principally of Houghton Mifflin's common stock. The fair
market value of the Benefits Trust net assets was $54.8 million at December 31,
1999 and $61.4 million at December 31, 1998.
For the Retirement Plan, Houghton Mifflin uses a September 30 measurement
date and adjusts for any contributions made after the measurement date to
disclose the accrued pension liability at December 31. For postretirement
benefits, a December 31 measurement date is used to disclose
44
47
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accrued postretirement benefit liability. The following tables, prepared in
accordance with SFAS 132, set forth the pension and postretirement benefit
liability recognized in the consolidated balance sheet at December 31:
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------- -----------------------
1999 1998 1999 1998
-------- -------- ---------- ----------
(IN THOUSANDS)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at January 1....................... $127,521 $115,727 $ 29,741 $ 25,533
Service cost (benefits earned during the year)........ 5,382 4,639 436 498
Interest cost on projected benefit obligation......... 8,300 8,182 1,918 1,757
Plan amendment........................................ -- 554 (840) --
Actuarial (gain) loss................................. (5,433) 7,412 (452) 3,457
Benefits paid......................................... (12,502) (8,993) (1,979) (1,504)
-------- -------- -------- --------
Benefit obligation at December 31..................... $123,268 $127,521 $ 28,824 $ 29,741
======== ======== ======== ========
CHANGE IN PLAN ASSETS
Fair market value at beginning of year................ $114,736 $120,417 $ -- $ --
Actual return......................................... 14,056 3,247 -- --
Company contribution.................................. 383 65 1,979 1,504
Benefits paid......................................... (12,502) (8,993) (1,979) (1,504)
-------- -------- -------- --------
Fair market value at end of year $116,673 $114,736 $ -- $ --
======== ======== ======== ========
FUNDED STATUS......................................... $ (6,595) $(12,785) $(28,824) $(29,741)
Unrecognized items:
Net (gain) loss.................................. (21,442) (11,046) 463 915
Prior service cost............................... 1,796 1,974 (852) (13)
Transition asset................................. (509) (692) -- --
-------- -------- -------- --------
Net amount recognized................................. $(26,750) $(22,549) $(29,213) $(28,839)
======== ======== ======== ========
AMOUNTS RECOGNIZED IN THE BALANCE SHEET CONSIST OF:
Accrued benefit liability............................. $(28,045) $(23,475) $(29,213) $(28,839)
Intangible asset...................................... 1,295 926 -- --
-------- -------- -------- --------
Net amount recognized................................. $(26,750) $(22,549) $(29,213) $(28,839)
======== ======== ======== ========
Net periodic pension cost for 1999, 1998, and 1997 included the following
components:
PENSION BENEFITS
---------------------------
1999 1998 1997
------- ------- -------
(IN THOUSANDS)
Service cost...................................... $ 5,382 $ 4,639 $ 4,335
Interest cost on projected benefit obligation..... 8,300 8,182 8,020
Expected return on plan assets.................... (9,168) (8,967) (8,308)
Amortization of unrecognized:
Net (gain) loss.............................. 79 89 45
Prior service cost........................... 174 133 137
Transition (asset)........................... (183) (183) (182)
------- ------- -------
Net pension expense............................... $ 4,584 $ 3,893 $ 4,047
======= ======= =======
45
48
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net periodic postretirement benefit cost included the following components
for the twelve months ended December 31:
POSTRETIREMENT BENEFITS
--------------------------
1999 1998 1997
------ ------ ------
(IN THOUSANDS)
Service cost..................................... $ 436 $ 498 $ 526
Interest cost on accumulated postretirement
benefit obligation............................. 1,918 1,757 1,844
Amortization of unrecognized:
Net (gain) loss............................. -- -- (35)
Prior service cost.......................... (1) (1) (1)
------ ------ ------
Net periodic postretirement benefit expense...... $2,353 $2,254 $2,334
====== ====== ======
Significant actuarial assumptions:
POSTRETIREMENT
PENSION BENEFITS BENEFITS
---------------- --------------
1999 1998 1999 1998
------ ------ ----- -----
Discount rate................................ 7.50% 6.75% 7.75% 6.75%
Increase in future compensation.............. 4.75 4.75 N/A N/A
Expected long-term rate of return on
assets..................................... 9.00 9.00 N/A N/A
Ultimate medical inflation trend factor...... N/A N/A 4.50 3.50
Assumed healthcare trend rates have a significant effect on the amounts
reported for the healthcare plans. A one-percentage-point change in assumed
healthcare cost trend rates would have the following effects:
ONE PERCENTAGE ONE PERCENTAGE
POINT INCREASE POINT DECREASE
-------------- --------------
(IN THOUSANDS)
Effect on total service and interest cost
components.................................... $ 159 $ (159)
Effect on postretirement benefit obligation..... 2,058 (1,955)
In addition, Houghton Mifflin maintains a defined contribution retirement
plan, the Houghton Mifflin 401(k) Savings Plan, which conforms to Section 401(k)
of the Internal Revenue Code and covers substantially all of Houghton Mifflin's
employees. Participants may elect to contribute up to 15% of their compensation
subject to an annual limit ($10,000 in 1999) to eleven funds: seven equity
funds, a balanced fund, a fixed income fund, a managed income fund, and a fund
invested solely in Houghton Mifflin's common stock.
Effective January 1, 1997, the Houghton Mifflin 401(k) Savings Plan
provides a Company match in amounts up to 4 1/2% of employee compensation. The
contribution expense, which is invested solely in shares of Houghton Mifflin's
common stock, amounted to approximately $4.0 million in 1999; $3.6 million in
1998; and $3.2 million in 1997.
NOTE 6. STOCK COMPENSATION PLANS
At December 31, 1999, Houghton Mifflin had two stock-based compensation
plans which are described below. Houghton Mifflin applies APB Opinion 25 and
related Interpretations in accounting for its plans. Houghton Mifflin has
adopted the disclosure-only provision of SFAS 123. Accordingly, no compensation
cost has been recognized for its fixed stock compensation plans. Had
compensation
46
49
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
cost for Houghton Mifflin's two stock-based compensation plans been determined
based on the fair market value at the grant dates for awards under those plans
consistent with the method of SFAS 123, Houghton Mifflin's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
1999 1998 1997
-------- -------- --------
(IN MILLIONS, EXCEPT PER-SHARE
AMOUNTS)
NET INCOME
As reported.................................... $76.3 $63.6 $49.8
Pro forma...................................... 73.4 62.3 48.7
EARNINGS PER SHARE
As reported -- basic........................... $2.65 $2.22 $1.76
Pro forma -- basic............................. 2.55 2.17 1.72
As reported -- diluted......................... 2.60 2.19 1.73
Pro forma -- diluted........................... 2.50 2.14 1.69
The effects on pro forma net income and earnings per share of expensing the
estimated fair market value of stock options are not necessarily representative
of the effects on reported net income for future years due to such factors as
the vesting period of the stock options and the potential for issuance of
additional stock options in future years.
FIXED STOCK COMPENSATION PLANS:
Houghton Mifflin maintains two fixed stock compensation plans, the 1995
Stock Compensation Plan, and the 1998 Stock Compensation Plan, or 1998 Plan.
Options outstanding include some granted under the 1995 Stock Compensation Plan,
under which no further options may be granted. Houghton Mifflin had authorized
1.8 million common shares under the 1995 Stock Compensation Plan. A total of 1.8
million shares of common stock are authorized for issuance under the 1998 Plan,
plus any shares authorized but unused under the prior plans. The plans may be
used to grant incentive and non-qualified stock options, awards of restricted or
bonus stock, or other performance awards to eligible employees. The plans may
also be used to grant options to non-employee members of the Board of Directors
and to issue shares to Directors as part of their compensation. Recipients of
restricted stock awards may not sell or transfer the shares until the
restriction period lapses, and shares may be forfeited due to termination of
employment. During the restriction period, the recipient is entitled to vote and
receive dividends. In 1999, grants of 43,594 shares of restricted stock were
made; at December 31, 1999, a total of 82,444 restricted shares were not yet
vested. In 1998, grants of 11,060 shares of restricted stock were made; at
December 31, 1998, a total of 84,861 restricted shares were not yet vested. The
plans provide that the exercise price for stock options shall not be less than
the fair market value of the shares on the date of grant. Options granted under
both plans become exercisable at such times as the Compensation & Nominating
Committee determines, but not later than ten years from the date of the grant.
47
50
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair market value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 1999, 1998, and 1997:
1999 1998 1997
------------- ------------- -------------
Dividend yield................ 1.63% 1.69% 1.75%
Range of expected lives
(years)..................... 3.1 - 8.6 3.2 - 8.7 3.9 - 4.7
Expected volatility........... 27.28% 26.59% 22.17%
Range of risk-free interest
rates....................... 5.38% - 6.63% 5.38% - 6.63% 5.70% - 5.72%
A summary of the status of Houghton Mifflin's two fixed stock compensation
plans as of December 31, 1999, 1998, and 1997 and changes during the years
ending on those dates is presented below:
1999 1998 1997
------------------ ------------------ ------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
(000) PRICE (000) PRICE (000) PRICE
------ --------- ------ --------- ------ ---------
FIXED OPTIONS
Outstanding at beginning of year... 2,612 $33 1,652 $25 1,718 $23
Granted............................ 139 42 1,270 42 314 34
Exercised.......................... (463) 23 (267) 23 (335) 22
Forfeited.......................... (97) 35 (43) 28 (45) 22
------ ------ -----
Outstanding at end of year......... 2,191 36 2,612 33 1,652 25
====== ====== =====
Options exercisable at year-end.... 772 1,008 951
Weighted-average fair market value
of options granted during the
year............................. $10.80 $13.27 $6.37
====== ====== =====
The following table summarizes information about fixed stock options at
December 31, 1999:
OPTIONS OUTSTANDING
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED- -----------------------
NUMBER AVERAGE WEIGHTED- NUMBER WEIGHTED-
RANGE OF OUTSTANDING REMAINING AVERAGE OUTSTANDING AVERAGE
EXERCISE AT 12/31/99 CONTRACTUAL EXERCISE AT 12/31/99 EXERCISE
PRICES (000) LIFE PRICE (000) PRICE
- ---------- ----------- ----------- --------- ----------- ---------
$20 to $23 400 0.9 years $21 359 $21
24 to 29 236 1.8 25 166 25
30 to 36 285 2.9 35 175 35
37 to 43 1,248 8.3 43 71 42
44 to 47 22 9.0 46 1 45
----- ---
2,191 5.5 36 772 27
===== ===
EXECUTIVE STOCK PURCHASE PLAN:
In August 1994, pursuant to the 1994 Executive Stock Purchase Plan, whose
purpose was to increase stock ownership of Houghton Mifflin's executive
officers, Houghton Mifflin granted 248,544 options under the 1992 Stock
Compensation Plan to certain corporate officers for exercise at the then market
price of $21.313. These options were exercisable only on the date granted and
stock was
48
51
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
issued from treasury shares. A note was obtained from the officers and
collateralized by the stock (see Note 11).
NOTE 7. STOCKHOLDERS' RIGHTS PLAN
In December 1988, Houghton Mifflin adopted a Stockholders' Rights Plan,
which was renewed in July 1997, and declared a dividend distribution of one
Right (as defined in the renewed rights plan) for each outstanding share of
common stock of Houghton Mifflin effective upon expiration of the original plan
in December 1998. The Rights are attached to the common stock, do not have
voting or dividend rights and, until they become exercisable, they can have no
dilutive effect on Houghton Mifflin's earnings. Each Right, when exercisable,
entitles the holder to purchase one ten-thousandth of a share of Series A Junior
Participating Preferred Stock at an exercise price of $125. The Rights will
become exercisable after (a) a person or group has acquired beneficial ownership
of 20% or more of the outstanding common stock of Houghton Mifflin, (b) the
commencement of a tender or exchange offer that would result in a person or
group beneficially owning 30% or more of the outstanding common stock of
Houghton Mifflin, or (c) the determination by the Board of Directors (with the
concurrence of a majority of the Outside Directors (as defined in the renewed
rights plan)) that a person or group which has acquired a substantial amount (at
least 15%) of the outstanding common stock of Houghton Mifflin is an Adverse
Person (as defined in the renewed rights plan).
In the event that (i) the Board of Directors (with the concurrence of a
majority of the Outside Directors) declares that a person is an Adverse Person,
(ii) Houghton Mifflin is the surviving corporation in a merger or other business
combination transaction with a person or group beneficially owning 20% or more
of the outstanding common stock of Houghton Mifflin and Houghton Mifflin's
common stock is not changed or exchanged as a result of such merger or business
combination transaction, (iii) a person or group acquires beneficial ownership
of 30% or more of the outstanding common stock of Houghton Mifflin (except
pursuant to an offer the Outside Directors have determined is fair to, and in
the best interest of, Houghton Mifflin and its stockholders, or a transaction
described in the succeeding paragraph), (iv) Houghton Mifflin engages in certain
"self-dealing" transactions (as set forth in the renewed rights plan) with a
person or group beneficially owning 20% or more of the outstanding common stock
of Houghton Mifflin, or (v) during such time a person or group beneficially owns
20% or more of the outstanding common stock of Houghton Mifflin, an event
(except pursuant to a transaction described in the succeeding paragraph) occurs
which results in such person's or group's beneficial ownership interest
increasing by more than 1% (e.g., a reverse stock split), then each Right
holder, other than the potential acquirer, may be entitled to receive upon
exercise of each Right an amount of common stock of Houghton Mifflin having a
market value equal to twice the exercise price of the Right.
In the event that Houghton Mifflin, after a person or group has acquired
beneficial ownership of 20% or more of the outstanding common stock of Houghton
Mifflin, (i) engages in a merger or other business combination transaction (with
certain exceptions) and Houghton Mifflin is not the surviving entity, (ii)
engages in a merger or other business combination transaction (with certain
exceptions) in which all or part of Houghton Mifflin's outstanding common stock
is changed or exchanged, or (iii) sells or transfers 50% or more of its assets
or earning power, then each Right holder, other than the potential acquirer, may
be entitled to receive upon exercise of each Right an amount of common stock of
the acquirer having a market value equal to twice the exercise price of the
Right.
49
52
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In general, the Board of Directors may redeem the Rights in whole at a
price of $0.01 per Right at any time prior to the tenth business day after a
person or group acquires beneficial ownership of 20% or more of the outstanding
common stock of Houghton Mifflin. The Board of Directors may not redeem the
Rights if it has declared (with the concurrence of a majority of the Outside
Directors) someone to be an Adverse Person. The Rights will expire on July 30,
2007, subject to adjustment.
NOTE 8. COMMITMENTS AND CONTINGENCIES
OPERATING LEASE OBLIGATIONS:
Houghton Mifflin has leases for various real property, office facilities,
and warehouse equipment which expire at various dates. Certain leases contain
renewal and escalation clauses for a proportionate share of operating expenses.
The future minimum rental commitments under all noncancelable leases for
real estate and equipment are payable as follows:
YEARS IN THOUSANDS
- ----- ------------
2000........................................................ $ 21,089
2001........................................................ 19,836
2002........................................................ 18,465
2003........................................................ 17,654
2004........................................................ 11,311
Thereafter.................................................. 32,423
--------
Total minimum lease payments................................ $120,778
========
Rent expense, net of sublease income, was approximately $21.8 million in
1999; $17.6 million in 1998; and $17.5 million in 1997.
CONTINGENCIES:
Houghton Mifflin is involved in ordinary and routine litigation incidental
to its business. There are no such matters pending that Houghton Mifflin expects
to be material in relation to its financial condition or results of operations.
NOTE 9. INSO CORPORATION
In March 1994, Houghton Mifflin spun off its former Software Division in an
initial public offering. Houghton Mifflin's equity interest in INSO, the
successor company, was approximately 40% after the offering. Houghton Mifflin
recognized earnings from its investment in INSO based upon the equity method of
accounting.
During 1998, Houghton Mifflin used 1.9 million shares of INSO common stock
to redeem 50%, or $65.3 million in aggregate principal amount, of its SAILS.
Houghton Mifflin's equity ownership in INSO after the surrender of INSO common
stock was reduced to approximately 13%. Because Houghton Mifflin's ownership of
INSO dropped below 20%, it no longer recorded its investment in INSO under the
equity method. Instead, Houghton Mifflin accounted for the remaining shares held
of INSO common stock in accordance with Statement of Financial Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities." These
securities were classified as available for sale and were carried at fair market
value based on the quoted market price.
50
53
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1999, Houghton Mifflin elected to deliver approximately 1.9 million
shares of INSO common stock to repay the remaining SAILS. In December 1999,
Houghton Mifflin sold its remaining shares of INSO common stock.
When Houghton Mifflin recorded its pro-rata share of income and losses and
the impact of INSO's equity activities, if any, on a quarterly basis, it did so
one quarter in arrears.
NOTE 10. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair market values of Houghton Mifflin's
financial instruments as of December 31, 1999 and 1998 were as follows:
1999 1998
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
(IN THOUSANDS)
FINANCIAL ASSETS:
Cash, cash equivalents,
and marketable
securities........... $12,679 $12,679 $4,591 $4,591
Investments:
INSO Corporation....... -- -- 48,565 48,565
Other.................. 4,634 4,634 2,500 2,500
FINANCIAL LIABILITIES:
SAILS.................. -- -- (63,322) (44,160)
7.00% notes............ (124,859) (119,925) (124,836) (128,525)
7.125% notes........... (99,745) (97,958) (99,685) (104,400)
Credit facility........ (20,000) (20,000) (50,000) (50,000)
6.29% notes............ -- -- (20,000) (20,094)
Commercial paper....... (21,358) (21,358) (11,894) (11,894)
Floating Rate notes.... (50,000) (49,988) -- --
5.99% notes............ (30,000) (29,358) -- --
18.40% Capital lease... (71) (71) -- --
The fair market values of financial instruments were estimates based on
market conditions and perceived risks at December 31, 1999 and 1998, and require
varying degrees of management judgment. The factors used to estimate these
values may not be valid on any subsequent date. Accordingly, the fair market
values of the financial instruments presented may not be indicative of their
future values. The following methods and assumptions were used to estimate the
fair market value of each class of financial instrument:
CASH, CASH EQUIVALENTS, MARKETABLE SECURITIES, AND COMMERCIAL PAPER:
The carrying amount approximated fair market value due to the short-term
maturity of the instruments.
INVESTMENTS:
The fair market value of Houghton Mifflin's investments was estimated based
on the quoted market prices, if available, for these securities at December 31,
1999 and 1998, and may thus change as market prices change.
51
54
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LONG-TERM DEBT:
The fair market value of the SAILS and notes is estimated based on quoted
market prices. The carrying amount of the credit facility approximates fair
market value because of the renewing feature of the facility.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS GAINS (LOSSES):
Houghton Mifflin does not have any speculative or leveraged derivative
transactions. At December 31, 1999 and December 31, 1998, Houghton Mifflin had
two interest rate swaps on commercial paper which were entered into in 1997 (see
Note 4). The fair market value represents the amount Houghton Mifflin would
receive or pay to terminate the agreement taking into consideration current
interest rates. The fair market value of these agreements, representing the
estimated amount that Houghton Mifflin would receive from a third party assuming
Houghton Mifflin's obligations under the interest rate agreements ceased at
December 31, 1999, was approximately $108,000.
NOTE 11. RELATED PARTIES
Houghton Mifflin presently holds notes receivable for a total of $4.6
million from certain corporate officers and members of the Board of Directors.
Houghton Mifflin provided financing in 1994 to effect the purchase of an
aggregate of 276,544 shares of Houghton Mifflin's common stock pursuant to the
1994 Executive Stock Purchase Plan and the 1994 Non-Employee Director Stock
Purchase Plan at the fair market value on August 27, 1994 of $21.313 per share.
The original loans made to Houghton Mifflin's current officers were amended in
1998; those made to directors were amended in 1999. The amended loans have an
interest rate of 6.25%. Loans to employees are due in the third quarter of 2003;
loans to directors are due in October following normal retirement or six months
after ceasing to serve as a director for any other reason. Loans made to
officers are collateralized by the shares of common stock purchased, while those
loans provided to members of the Board of Directors are unsecured. All loans
have full recourse against the borrower. The notes receivable are shown as a
reduction in stockholders' equity in the consolidated financial statements. In
1999, Houghton Mifflin recognized approximately $0.3 million in interest income
in connection with the outstanding loans.
NOTE 12. SEGMENT AND RELATED INFORMATION
Houghton Mifflin has eight divisions with separate management teams and
infrastructures that offer different products and services. These divisions have
been aggregated in three reportable segments based on the similar nature of
their products and services, the nature of the production process, class of
customers, and distribution method, as follows:
K-12 Publishing: This segment consists of five divisions: The School Division,
McDougal Littell Inc., Great Source Education Group, Inc., Sunburst Technology
Corporation (formerly Houghton Mifflin Interactive Corporation), and The
Riverside Publishing Company. Beginning in 1999, Houghton Mifflin focused
Sunburst Technology's business on the growing educational technology marketplace
rather than on the retail market. Sunburst Technology's products are sold
primarily in the K-12 school marketplace; therefore, the 1999 information
relating to Sunburst is included in the K-12 Publishing segment. This operating
segment includes textbooks and instructional materials, tests for measuring
achievement and aptitude, clinical/special needs testing products, multimedia
instructional programs for the K-12 market, and a computer-based career and
college guidance
52
55
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
information system in versions for both junior and senior high school students.
The principal markets for these products are elementary and secondary schools.
College Publishing: The College Division is the sole business unit reported in
this segment. This operating segment includes textbooks, ancillary products such
as workbooks and study guides, technology-based instructional materials, and
services for introductory and upper level courses in the post-secondary
education market. Products may be in print or electronic form. The principal
markets for these products are two- and four-year colleges and universities.
Other markets in which these products are sold include high school advanced
placement courses and for-profit, certificate-granting institutions that offer
skill-based training and job placement.
Other: This segment consists of the Trade Division, CAT, and unallocated
corporate-related items. In 1998, Sunburst Technology's products, chiefly CD-ROM
titles sold in the retail children's, reference, and adult-hobby markets, were
included in the Other segment. The Trade Division publishes fiction and
nonfiction for adults and children, dictionaries, and other reference works. The
division also licenses book rights and content to paperback publishers, book
clubs, Web sites, and other publishers and electronic businesses in the United
States and abroad. Its principal markets are retail stores, including Internet
bookstore sites, and wholesalers. It also sells reference materials to schools,
colleges, office supply distributors, and businesses. CAT specializes in the
development and delivery of computer-based testing solutions. Its principal
markets are organizations worldwide.
Houghton Mifflin's geographic area of operation is predominantly the United
States. Export sales for locations outside the United States are not significant
to Houghton Mifflin's three business segments. Houghton Mifflin does not have
any customers which exceed 10% of net sales, and the loss of a single customer,
in management's opinion, would not have a material adverse effect on net sales.
Houghton Mifflin evaluates the performance of its operating segments based
on the profit and loss from operations before interest income and expense,
income taxes, and infrequent and extraordinary items. The accounting policies of
the reportable segments are the same as those described in Note 1.
Summarized financial information concerning Houghton Mifflin's reportable
segments is shown in the following table. The "Other" column includes
unallocated corporate-related items, operations which do not meet the
quantitative thresholds of SFAS 131, nonrecurring items and, as it relates to
segment profit (loss), income and expense not allocated to reportable segments.
K-12 COLLEGE
PUBLISHING PUBLISHING OTHER CONSOLIDATED
---------- ---------- -------- ------------
(IN THOUSANDS)
1999
Net sales from external customers............. $657,289 $172,240 $ 90,589 $ 920,118
Depreciation and amortization................. 69,043 21,630 3,442 94,115
Segment operating income (loss)............... 97,114 23,746 (8,900) 111,960
Identifiable assets........................... 653,211 196,655 143,611 993,477
Acquired assets............................... 39,988 1,650 3,628 45,266
Total assets.................................. 693,199 198,305 147,239 1,038,743
Purchase of property, plant, and equipment,
including book plates....................... 72,864 17,394 8,056 98,314
53
56
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
K-12 COLLEGE
PUBLISHING PUBLISHING OTHER CONSOLIDATED
---------- ---------- -------- ------------
(IN THOUSANDS)
1998
Net sales from external customers............. $611,770 $160,677 $ 89,210 $ 861,657
Depreciation and amortization................. 72,672 20,761 2,248 95,681
Segment operating income (loss)............... 97,944 19,734 (15,658) 102,020
Identifiable assets........................... 624,095 195,681 139,047 958,823
Acquired assets............................... 10,640 -- 14,205 24,845
Total assets.................................. 634,735 195,681 153,252 983,668
Purchase of property, plant, and equipment,
including book plates....................... 54,518 16,931 2,535 73,984
1997
Net sales from external customers............. $560,259 $148,969 $ 88,092 $ 797,320
Depreciation and amortization................. 68,342 19,759 1,638 89,739
Segment operating income (loss)............... 96,807 15,854 (6,103) 106,558
Identifiable assets........................... 647,974 196,429 147,196 991,599
Acquired assets............................... 5,959 -- 3,090 9,049
Total assets.................................. 653,933 196,429 150,286 1,000,648
Purchase of property, plant, and equipment,
including book plates....................... 50,609 15,380 1,914 67,903
RECONCILIATION OF SEGMENT INCOME (LOSS) TO CONSOLIDATED STATEMENTS OF
INCOME:
1999 1998 1997
-------- -------- --------
(IN THOUSANDS)
Total income from reportable segments................. $111,960 $102,020 $106,558
Unallocated income (expense):
Net interest expense.................................. (29,770) (33,981) (38,926)
Gains (losses) on INSO Corporation common stock and
equity in earnings (losses) of INSO Corporation..... (5,100) 18,797 15,901
Loss on sale of investment............................ -- (3,017) --
Acquired in-process research and development.......... -- (3,500) --
Other expense......................................... -- (1,050) --
-------- -------- --------
Income before taxes and extraordinary item................. $ 77,090 $ 79,269 $ 83,533
======== ======== ========
54
57
HOUGHTON MIFFLIN COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
1999 1998 1997
-------- -------- --------
(IN THOUSANDS, EXCEPT PER-SHARE
AMOUNTS)
Numerator:
Net income............................................. $76,304 $63,649 $49,822
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding.................. 28,823 28,689 28,237
Effect of dilutive securities:
Employee stock options................................. 464 389 407
Restricted stock....................................... 21 33 146
Performance shares..................................... -- -- 36
------- ------- -------
485 422 589
Dilutive potential common shares:
Denominator for diluted earnings per share:
Adjusted weighted-average shares outstanding and
assumed conversions.................................. 29,308 29,111 28,826
======= ======= =======
Basic earnings per share.................................... $ 2.65 $ 2.22 $ 1.76
======= ======= =======
Diluted earnings per share.................................. $ 2.60 $ 2.19 $ 1.73
======= ======= =======
Options to purchase 22,000 shares of common stock at December 31, 1999,
1,429,534 shares of common stock at December 31, 1998, and 267,300 shares of
common stock at December 31, 1997 were outstanding but were not included in the
computation of diluted earnings per share because the options' exercise prices
were greater than the average market price of the common shares, and therefore,
the effect would be antidilutive.
NOTE 14. SUBSEQUENT EVENTS
In January 2000, the Board of Directors declared a quarterly dividend of
$0.13 per share, payable on February 23, 2000, to shareholders of record on
February 9, 2000.
On February 29, 2000, Houghton Mifflin provided financing to effect the
purchase of an aggregate of 281,430 shares of Houghton Mifflin's common stock
pursuant to the 2000 Senior Management and Director Stock Purchase Plan. The
purchases were made at the fair market value of $39.813 per share. The loans,
which totaled approximately $11.2 million, have an interest rate of 8.0% and are
due on February 28, 2005. The loans are collateralized by the shares of common
stock purchased. All loans have full recourse against the borrower.
55
58
SUMMARY OF QUARTERLY RESULTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS OF DOLLARS EXCEPT PER-SHARE AMOUNTS)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER YEAR
-------- -------- -------- -------- --------
1999
Net sales............................... $ 84,281 $220,883 $457,790 $157,164 $920,118
Gross profit (net sales less cost of
sales)................................ 27,044 119,257 288,406 74,297 509,004
Income (loss) before extraordinary
item.................................. $(36,953) $ 8,373 $ 90,316 $(15,752) $ 45,984
Extraordinary gain on extinguishment of
debt, net of tax of $21,956........... -- -- 30,323 (3) 30,320
-------- -------- -------- -------- --------
Net income (loss)....................... $(36,953) $ 8,373 $120,639 $(15,755) $ 76,304
======== ======== ======== ======== ========
Per share:
Basic
Income (loss) before
extraordinary item............ $ (1.29) $ 0.29 $ 3.13 $ (0.55) $ 1.60
Extraordinary gain on
extinguishment of debt........ -- -- 1.05 -- 1.05
-------- -------- -------- -------- --------
Net income (loss)................ $ (1.29) $ 0.29 $ 4.18 $ (0.55) $ 2.65
======== ======== ======== ======== ========
Diluted (except when anti-dilutive)
Income (loss) before
extraordinary item............ $ (1.29) $ 0.29 $ 3.07 $ (0.55) $ 1.57
Extraordinary gain on
extinguishment of debt........ -- -- 1.03 -- 1.03
-------- -------- -------- -------- --------
Net income (loss)................ $ (1.29) $ 0.29 $ 4.10 $ (0.55) $ 2.60
======== ======== ======== ======== ========
1998
Net sales............................... $ 71,632 $202,740 $446,860 $140,425 $861,657
Gross profit (net sales less cost of
sales)................................ 18,409 107,449 278,849 66,028 470,735
Income (loss) before extraordinary
item.................................. $(36,715) $ 6,885 $ 95,910 $(20,441) $ 45,639
Extraordinary gain on extinguishment of
debt, net of tax of $13,042........... -- -- 18,010 -- 18,010
-------- -------- -------- -------- --------
Net income (loss)....................... $(36,715) $ 6,885 $113,920 $(20,441) $ 63,649
======== ======== ======== ======== ========
Per share:
Basic
Income (loss) before
extraordinary item............ $ (1.29) $ 0.24 $ 3.35 $ (0.71) $ 1.59
Extraordinary gain on
extinguishment of debt........ -- -- 0.63 -- 0.63
-------- -------- -------- -------- --------
Net income (loss)................ $ (1.29) $ 0.24 $ 3.98 $ (0.71) $ 2.22
======== ======== ======== ======== ========
Diluted (except when anti-dilutive)
Income (loss) before
extraordinary item............ $ (1.29) $ 0.24 $ 3.31 $ (0.71) $ 1.57
Extraordinary gain on
extinguishment of debt........ -- -- 0.62 -- 0.62
-------- -------- -------- -------- --------
Net income (loss)................ $ (1.29) $ 0.24 $ 3.93 $ (0.71) $ 2.19
======== ======== ======== ======== ========
The above quarterly information indicates the seasonal fluctuations of
Houghton Mifflin's educational publishing business.
56
59
The 1999 first-quarter seasonal net loss was the same as 1998's first
quarter because higher net sales in the first quarter of 1999 were offset by
higher selling costs related to greater sales opportunities in 1999, operating
expenses and goodwill amortization of CAT (acquired in July 1998), increases in
product development spending, and additional costs related to information
systems initiatives and the Year 2000 computer issue. The increase in net income
for the second quarter of 1999 compared to the same period in 1998 was primarily
due to higher net sales and lower interest expense, partially offset by
increases in product development spending, higher selling costs related to
greater sales opportunities in 1999, the operating expenses of CAT, higher
intangible asset amortization, and higher distribution expense. The increase in
net income for the third quarter of 1999 compared to the same period in 1998 was
primarily due to higher sales, a decrease in manufacturing and distribution
costs, lower plate amortization, due to the accounting change regarding book
plate amortization (see Note 1), and lower interest expense, partially offset by
increases in editorial expenses incurred for new program development and product
revisions, higher selling costs related to greater sales opportunities in 1999
and beyond, and higher intangible asset amortization. The decreased 1999
fourth-quarter loss was attributable to higher net sales, lower royalty and
distribution costs, and lower interest expense, partially offset by increased
product development costs and selling costs associated with sales opportunities
in 2000 and beyond.
During the third quarter of 1999, Houghton Mifflin recorded a non-cash loss
of 5.6 million ($3.2 million after tax), or $0.11 per diluted share, resulting
from the surrender of INSO common stock upon maturity of the remaining
outstanding SAILS. Houghton Mifflin also recognized an extraordinary gain of
$52.3 million ($30.3 million after tax), $1.03 per diluted share, on the
extinguishment of the SAILS indebtedness. In the fourth quarter of 1999,
Houghton Mifflin sold its remaining shares of INSO common stock. The sale
generated a one-time gain of $0.5 million ($0.3 million after tax), or $0.01 per
diluted share.
During the first quarter of 1998, Houghton Mifflin recognized a charge of
$0.2 million ($0.1 million after tax) related to INSO's acquisition of Henderson
Software, Incorporated. In the second quarter of 1998, Houghton Mifflin
recognized a charge of $0.6 million ($0.3 million after tax), or $0.01 per
diluted share, related to INSO's acquisition of ViewPort Development AB. During
the third quarter of 1998, Houghton Mifflin recognized a non-cash gain of $15.4
million ($8.9 million after tax), or $0.31 per diluted share, which represented
the gain on the surrender of INSO common stock to redeem one-half of the
outstanding SAILS. Houghton Mifflin also recognized an extraordinary gain of
$31.1 million ($18.0 million after tax), or $0.62 per diluted share, on the
extinguishment of the SAILS indebtedness. The acquisition of CAT in July 1998
included the purchase of certain technology under research and development which
resulted in a restated charge of $3.5 million, or $0.12 per diluted share.
Houghton Mifflin also recognized a one-time gain of $3.2 million ($1.9 million
after tax), or $0.06 per diluted share, related to INSO's sale of its linguistic
software net assets in the third quarter of 1998. In the fourth quarter of 1998,
Houghton Mifflin recognized a one-time loss of $3.0 million ($2.0 million after
tax), or $0.07 per diluted share, on the sale of its investment in Cassell Plc.
57
60
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF HOUGHTON MIFFLIN
Information about directors is incorporated by reference to the Proxy
Statement for the 2000 Annual Meeting of Stockholders, and information about
Executive Officers follows Part I, Item 4 of this report under the heading
"Executive Officers of Houghton Mifflin" on pages 7 through 8.
ITEM 11. EXECUTIVE COMPENSATION
This information is incorporated by reference to the Proxy Statement for
the 2000 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is incorporated by reference to the Proxy Statement for
the 2000 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is incorporated by reference to the Proxy Statement for
the 2000 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULE, AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements are listed in the accompanying
Index to Consolidated Financial Statements on page 25.
2. Financial Statement Schedule for the three years ended December 31,
1999: Schedule II -- Consolidated Valuation and Qualifying
Accounts, page 59.
Houghton Mifflin has omitted all other schedules because we have
included the required information in the consolidated financial
statements or notes or are not required to submit the schedules.
3. Houghton Mifflin has filed the Exhibits listed in the accompanying
Index to Exhibits on page 61 as part of this Report. They are
included only on the Form 10-K filed with the Securities and
Exchange Commission.
(b) Reports on Form 8-K filed in the fourth quarter of 1999:
None
58
61
HOUGHTON MIFFLIN COMPANY
SCHEDULE II -- CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
(IN THOUSANDS OF DOLLARS)
ADDITIONS
--------------------
CHARGED CHARGED
BALANCE AT TO COST TO OTHER BALANCE
BEGINNING AND ACCOUNTS DEDUCTIONS AT END
OF YEAR EXPENSE -DESCRIBE -DESCRIBE OF YEAR
---------- ------- --------- ---------- -------
1999
Allowance for bad debt.............. $ 4,875 $ 747 $ 150(1) $ 7(5) $ 5,765
Allowance for book returns.......... 23,094 67,994 -- 65,646(3) 25,442
Allowance for authors' advances..... 23,589 6,869 -- 827(4) 29,631
1998
Allowance for bad debt.............. $ 4,356 $ 2,411 $ 105(1) $ 1,997(5) $ 4,875
Allowance for book returns.......... 20,734 71,967 -- 69,607(3) 23,094
Allowance for authors' advances..... 24,290 4,598 -- 5,299(4) 23,589
1997
Allowance for bad debt.............. $ 4,684 $ 1,985 $ 139(1) $ 2,452(5) $ 4,356
Allowance for book returns.......... 25,166 68,682 (6,837)(2) 66,277(3) 20,734
Allowance for authors' advances..... 20,975 3,849 -- 534(4) 24,290
- ---------------
(1) Reflects additions to the allowance from acquisitions made during the year.
(2) This amount represents the estimated book returns for products published by
DK Publishing, Inc. and distributed by Houghton Mifflin. In 1997, these book
returns reduced payments to DK Publishing, Inc.
(3) Books actually returned during the year.
(4) Write-offs of unearned author advances.
(5) Write-offs of uncollectible customer receivables, net of recoveries.
59
62
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Houghton Mifflin has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
HOUGHTON MIFFLIN COMPANY
Registrant
By: /s/ NADER F. DAREHSHORI
----------------------------------
Nader F. Darehshori
Chairman of the Board, President,
and
Chief Executive Officer
February 23, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
/s/ NADER F. DAREHSHORI Chairman of the Board, President, and
- --------------------------------------- Chief Executive Officer, Director
NADER F. DAREHSHORI February 23, 2000
/s/ GAIL DEEGAN Executive Vice President and Chief
- --------------------------------------- Financial Officer
GAIL DEEGAN February 23, 2000
/s/ DAVID R. CARON Vice President and Controller
- ---------------------------------------
DAVID R. CARON February 23, 2000
/s/ JOSEPH A. BAUTE Director
- ---------------------------------------
JOSEPH A. BAUTE February 23, 2000
/s/ JAMES O. FREEDMAN Director
- ---------------------------------------
JAMES O. FREEDMAN February 23, 2000
/s/ MICHAEL GOLDSTEIN Director
- ---------------------------------------
MICHAEL GOLDSTEIN February 23, 2000
/s/ GAIL H. KLAPPER Director
- ---------------------------------------
GAIL H. KLAPPER February 23, 2000
/s/ CHARLES R. LONGSWORTH Director
- ---------------------------------------
CHARLES R. LONGSWORTH February 23, 2000
/s/ CLAUDINE B. MALONE Director
- ---------------------------------------
CLAUDINE B. MALONE February 23, 2000
/s/ ALFRED L. MCDOUGAL Director
- ---------------------------------------
ALFRED L. MCDOUGAL February 23, 2000
/s/ RALPH Z. SORENSON Director
- ---------------------------------------
RALPH Z. SORENSON February 23, 2000
/s/ ROBERT J. TARR, JR. Director
- ---------------------------------------
ROBERT J. TARR, JR. February 23, 2000
60
63
HOUGHTON MIFFLIN COMPANY
INDEX TO EXHIBITS
(ITEM 14(a)(3))
EXHIBIT NO. DESCRIPTION OF DOCUMENT PAGE NUMBER IN THIS REPORT
- ----------- ----------------------- --------------------------
(3)(i) Restated Articles of Organization of the Filed as Exhibits (4.1) and (4.2) to
Company Registration Statement No. 33-14850 as
amended, and incorporated by reference into
this report
Amendment to Restated Articles of Filed as Exhibit (3)(i) to Form 10-K for
Organization of the Company in the form of the year ended December 31, 1998, and
a certificate of vote of directors incorporated by reference into this report
establishing a series of a class of stock
(3)(ii) By-laws of the Company Filed as Exhibit (3)(ii) to Form 10-K for
the year ended December 31, 1995, and
incorporated by reference into this report
(4) Registration Statement under the Securities Filed on June 20, 1967, and incorporated by
Exchange Act of 1934 on Form 10 dated June reference into this report
20, 1967, as amended, with particular
reference to the description of the common
stock of the Company
Renewed Rights Agreement between the Filed as Exhibit (4) to Form 10-Q for the
Company and BankBoston, N.A., as Rights quarter ended June 30, 1997, and
Agent incorporated by reference into this report
Indenture dated as of March 15, 1994 Filed as Exhibit (4.1) to Registration
between the Company and State Street Bank Statement No. 33-51700 as amended, and
and Trust Company, as successor trustee to incorporated by reference into this report
the First National Bank of Boston
First Supplemental Indenture dated as of Filed as Exhibit (4.2) to Registration
July 27, 1995 between the Company and State Statement No. 33-64903 as amended, and
Street Bank and Trust Company, as successor incorporated by reference into this report
trustee to the First National Bank of
Boston
(10)(ii) Lease between Two Twenty Two Berkeley Filed as Exhibit (10)(ii)(D) to Form 10-K
(D) Venture, as landlord, and Houghton Mifflin for the year ended December 31, 1996, and
Company, as tenant incorporated by reference into this report
Lease between New England Mutual Life Filed as Exhibit (10)(ii)(D) to Form 10-K
Insurance Company, as sublandlord, and for the year ended December 31, 1996, and
Houghton Mifflin Company, as subtenant incorporated by reference into this report
(10)(iii) Benefits Trust Agreement between Houghton Filed as Exhibit (10)(iii)(A) to Form 10-K
(A) Mifflin Company and State Street Bank and for the year ended December 31, 1997, and
Trust Company dated June 3, 1992* incorporated by reference into this report
(10)(iii) Severance Agreement between the Company and Filed as Exhibit (10)(iii)(A) to Form 10-K
(A) Mr. Darehshori* for the year ended December 31, 1995, and
incorporated by reference into this report
Form of Senior Executive Severance Filed as Exhibit (10)(iii)(A) to Form 10-K
Agreement* for the year ended December 31, 1995, and
incorporated by reference into this report
Form of Key Managers' Severance Agreement* Filed as Exhibit (10)(iii)(A) to Form 10-K
for the year ended December 31, 1995, and
incorporated by reference into this report
Supplemental Benefits Plan* Filed as Exhibit (10)(iii)(A) to Form 10-K
for the year ended December 31, 1995, and
incorporated by reference into this report
Non-Employee Directors Retirement Benefit Filed as Exhibit (10)(iii)(A) to Form 10-K
Plan* for the year ended December 31, 1995, and
incorporated by reference into this report
- ---------------
* Denotes a management contract or compensatory plan.
61
64
EXHIBIT NO. DESCRIPTION OF DOCUMENT PAGE NUMBER IN THIS REPORT
- ----------- ----------------------- --------------------------
1999 Senior Executive Incentive Filed as Exhibit (10)(iii)(A) to Form 10-Q
Compensation Plan* for the quarter ended March 31, 1999, and
incorporated by reference into this report
1999 Chief Executive Officer Incentive Filed as Exhibit (10)(iii)(A) to Form 10-Q
Plan* for the quarter ended March 31, 1999, and
incorporated by reference into this report
Restricted Stock Agreement between the Filed as Exhibit (10)(iii)(A) to Form 10-K
Company and Mr. Darehshori* for the year ended December 31, 1996, and
incorporated by reference into this report
Restricted Stock Agreement between the Filed as Exhibit (10)(iii)(A) to Form 10-K
Company and Ms. Deegan* for the year ended December 31, 1996, and
incorporated by reference into this report
1995 Stock Compensation Plan* Filed as Exhibit (10)(iii)(A) to Form 10-K
for the year ended December 31, 1996, and
incorporated by reference into this report
1998 Stock Compensation Plan* Filed as Exhibit (3)(i) to Form 10-K for
the year ended December 31, 1998, and
incorporated by reference into this report
Form of Non-Qualified Option Agreement* Filed as Exhibit (3)(i) to Form 10-K for
the year ended December 31, 1998, and
incorporated by reference into this report
(10)(iii) 1997 -- 1998 Restricted Share Plan* Filed as Exhibit (10)(iii)(A) to Form 10-K
(A) for the year ended June 30, 1997, and
incorporated by reference into this report
(12) Computation of Ratio of Earnings to Fixed Page 63
Charges
(21) List of Subsidiaries Page 64
(23) Consent of Experts and Counsel Page 65
(27) Financial Data Schedule Page 66
- ---------------
* Denotes a management contract or compensatory plan.
62