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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: ___________ to ___________
COMMISSION FILE NUMBER: 333-105746
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 Number)
222 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116
(Address of principal executive offices)
(617) 351-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act): Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock as of August
14, 2003 was 1,000 shares.
HOUGHTON MIFFLIN COMPANY
INDEX
PAGE NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets (unaudited) - 3-4
June 30, 2003 and December 31, 2002
Consolidated Statements of Operations (unaudited) - 5
Three Months Ended June 30, 2003 and 2002
Six Months Ended June 30, 2003 and 2002
Consolidated Statements of Cash Flows (unaudited) - 6-7
Six Months Ended June 30, 2003 and 2002
Notes to Consolidated Financial Statements (unaudited) 8-16
Item 2. Management's Discussion and Analysis of Financial Condition 17-31
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 33
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 34
SIGNATURES 34
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOUGHTON MIFFLIN COMPANY
UNAUDITED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 23,791 $ 77,797
Marketable securities and time deposits available for sale 638 638
Accounts receivable, less allowance for bad debts and book
returns of $21,625 at June 30, 2003 and $40,082 at
December 31, 2002 276,126 180,359
Inventories 232,673 207,926
Deferred income taxes 84,671 57,390
Prepaid expenses and other current assets 15,781 12,236
Assets of discontinued operations -- 1,551
------------ ------------
TOTAL CURRENT ASSETS 633,680 537,897
Property, plant, and equipment, net 114,707 117,806
Pre-publication costs, net 77,640 26,506
Royalty advances to authors, net 28,354 25,092
Goodwill 588,607 588,205
Other intangible assets 907,807 980,900
Other assets and long-term receivables 100,845 112,502
Assets of discontinued operations -- 882
------------ ------------
TOTAL ASSETS $ 2,451,640 $ 2,389,790
============ ============
See accompanying Notes to Unaudited Consolidated Financial Statements
3
HOUGHTON MIFFLIN COMPANY
UNAUDITED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2003 2002
------------ ------------
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Short-term debt $ 73,000 $ --
Current portion of long-term debt 319 317
Accounts payable 105,527 85,148
Due to parent 6,639 --
Royalties payable 34,741 58,816
Salaries, wages, and commissions 39,591 43,420
Other 60,802 52,748
Interest payable 41,888 7,848
Accrued restructuring 11,789 12,649
Liabilities of discontinued operations -- 1,620
------------ ------------
TOTAL CURRENT LIABILITIES 374,296 262,566
Long-term debt 1,134,207 1,034,073
Accrued long-term royalties payable 3,717 3,650
Other long-term liabilities 13,338 17,924
Accrued long-term restructuring 6,323 10,015
Accrued pension benefits 88,783 86,245
Accrued postretirement benefits 53,443 52,724
Deferred income taxes 271,728 307,593
------------ ------------
TOTAL LIABILITIES 1,945,835 1,774,790
COMMITMENTS AND CONTINGENCIES (SEE NOTE 10)
STOCKHOLDERS' EQUITY
Common stock, $1 par value; 1,000 shares authorized and
issued 1 1
Capital in excess of par value 614,999 614,999
Accumulated deficit (109,436) --
Other 241 --
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 505,805 615,000
------------ ------------
$ 2,451,640 $ 2,389,790
============ ============
See accompanying Notes to Unaudited Consolidated Financial Statements
4
HOUGHTON MIFFLIN COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(successor (predecessor (successor (predecessor
basis) basis) basis) basis)
NET SALES $ 361,317 $ 309,267 $ 494,140 $ 434,324
COSTS AND EXPENSES
Cost of sales excluding pre-publication and
publishing rights amortization 142,311 123,145 220,540 193,310
Pre-publication and publishing rights
amortization 41,116 38,284 77,923 70,342
------------ ------------ ------------ ------------
Cost of sales 183,427 161,429 298,463 263,652
Selling and administrative 140,020 121,201 261,381 227,795
Intangible asset amortization 249 33 498 783
------------ ------------ ------------ ------------
323,696 282,663 560,342 492,230
------------ ------------ ------------ ------------
OPERATING INCOME (LOSS) 37,621 26,604 (66,202) (57,906)
------------ ------------ ------------ ------------
OTHER EXPENSE
Net interest (28,799) (12,784) (56,604) (20,584)
Debt extinguishment costs -- -- (48,427) --
Other income (loss), net -- (2) 18 --
------------ ------------ ------------ ------------
(28,799) (12,786) (105,013) (20,584)
------------ ------------ ------------ ------------
Income (loss) from continuing operations before
income taxes 8,822 13,818 (171,215) (78,490)
Income tax provision (benefit) 3,253 5,879 (63,000) (32,916)
------------ ------------ ------------ ------------
Income (loss) from continuing operations 5,569 7,939 (108,215) (45,574)
Income (loss) from discontinued operations, net
of tax -- 1,160 (1,221) 1,575
------------ ------------ ------------ ------------
NET INCOME (LOSS) 5,569 9,099 (109,436) (43,999)
------------ ------------ ------------ ------------
Preferred stock dividend, net of tax -- (979) -- (1,959)
------------ ------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ 5,569 $ 8,120 $ (109,436) $ (45,958)
============ ============ ============ ============
See accompanying Notes to Unaudited Consolidated Financial Statements
5
HOUGHTON MIFFLIN COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
SIX MONTHS ENDED JUNE 30,
-------------------------------------
2003 2002
---------------- ----------------
(successor basis) (predecessor basis)
CASH FLOWS USED IN OPERATING ACTIVITIES
Net loss from continuing operations $ (108,215) $ (45,574)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization expense 93,725 84,195
Deferred financing amortization and
extinguishment 33,776 --
Changes in operating assets and liabilities:
Accounts receivable (94,983) (63,899)
Inventories (24,598) (29,105)
Accounts payable 20,373 37,578
Royalties, net (27,272) (28,319)
Deferred and income taxes payable (58,251) (8,510)
Interest payable/receivable 34,040 6,051
Other, net 9,361 (38,954)
---------------- ----------------
NET CASH USED IN CONTINUING OPERATING
ACTIVITIES (122,044) (86,537)
NET CASH (USED IN) PROVIDED BY DISCONTINUED
OPERATING ACTIVITIES (1,247) (2,653)
---------------- ----------------
NET CASH USED IN OPERATING ACTIVITIES (123,291) (89,190)
---------------- ----------------
CASH FLOWS USED IN INVESTING ACTIVITIES
Pre-publication expenditures (56,418) (40,926)
Acquisition of publishing and technology assets, net of
cash acquired (79) (1,631)
Property, plant, and equipment expenditures (12,189) (20,781)
Purchase of marketable securities -- (638)
---------------- ----------------
NET CASH USED IN CONTINUING INVESTING ACTIVITIES (68,686) (63,976)
NET CASH PROVIDED BY DISCONTINUED INVESTING ACTIVITIES 250 787
---------------- ----------------
NET CASH USED IN INVESTING ACTIVITIES (68,436) (63,189)
---------------- ----------------
See accompanying Notes to Unaudited Consolidated Financial Statements
6
HOUGHTON MIFFLIN COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS OF DOLLARS)
SIX MONTHS ENDED JUNE 30,
-------------------------------------
2003 2002
---------------- ----------------
(successor basis) (predecessor basis)
CASH FLOWS PROVIDED BY FINANCING
ACTIVITIES
Transaction costs paid on behalf of parent (12,096) (3,360)
Issuance (repayment) of short-term
financing, net 73,000 (577)
Proceeds from the issuance of long-term
financing, net 76,817 --
Issuance of intercompany working capital -- 157,108
Dividends paid on preferred stock -- (1,484)
---------------- ----------------
NET CASH PROVIDED BY CONTINUING FINANCING ACTIVITIES 137,721 151,687
NET CASH USED IN DISCONTINUED FINANCING ACTIVITIES -- (963)
---------------- ----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 137,721 150,724
---------------- ----------------
Decrease in cash and cash equivalents (54,006) (1,655)
Cash and cash equivalents at beginning of period 77,797 24,278
---------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 23,791 $ 22,623
================ ================
SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid (refunded) $ 3,716 $ (27,151)
Interest paid $ 17,583 $ 13,338
See accompanying Notes to Unaudited Consolidated Financial Statements
7
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(TABLES IN THOUSANDS)
(1) BASIS OF PRESENTATION
COMPANY
These unaudited consolidated financial statements represent the accounts of
Houghton Mifflin Company and its subsidiaries ("Houghton Mifflin" or the
"Company"). On December 30, 2002, Houghton Mifflin Holdings, Inc. ("HM
Holdings"), a Delaware corporation, acquired all of the outstanding shares of
Houghton Mifflin from Vivendi Communications North America, Inc. ("VCNA"), a
wholly owned subsidiary of Vivendi Universal S.A. ("Vivendi"). Vivendi had
acquired all of the outstanding shares of Houghton Mifflin through a tender
offer on July 7, 2001. The unaudited consolidated financial statements present
the Company for the period January 1, 2003 through June 30, 2003 ("successor
basis" reflecting the HM Holdings ownership of Houghton Mifflin and associated
basis) and the period January 1, 2002 through June 30, 2002 ("predecessor basis"
for the period of Vivendi's ownership of Houghton Mifflin and associated basis).
The accompanying unaudited consolidated financial statements of Houghton Mifflin
Company and its subsidiaries have been prepared in accordance with generally
accepted accounting principles and the rules and regulations of the Securities
and Exchange Commission (the "SEC"). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. The accompanying unaudited consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and the accompanying notes for the year ended December 31,
2002 included in the Company's Registration Statement on Form S-4. All
adjustments (consisting of normal recurring accruals) that, in the opinion of
management, are necessary for the fair presentation of this interim financial
information have been included.
Results of the three and six month periods ended June 30, 2003 and 2002 are not
necessarily indicative of results to be expected for the year as a whole. The
effect of seasonal business fluctuations and the occurrence of many costs and
expenses in annual cycles require certain estimations in the determination of
interim results.
Certain reclassifications have been made to prior period financial statements in
order to conform to the presentation used in the 2003 interim financial
statements.
DISPOSAL
SALE OF CURRICULUM ADVANTAGE, INC.
On March 31, 2003, Houghton Mifflin entered into a Stock Purchase Agreement with
Prime Entertainment, Inc. to sell 100% of the outstanding shares of Curriculum
Advantage, Inc. for $0.3 million in cash and receipt of secured notes and
inventory of $0.5 million. The accompanying unaudited consolidated financial
statements present Curriculum Advantage, Inc. in discontinued operations through
closing on April 1, 2003 and reflect the cash proceeds received at closing as
net cash provided by discontinued investing activities for the six months ended
June 30, 2003.
(2) RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The initial recognition and initial
measurement provisions of FIN 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosure
requirements of FIN 45 are applicable for financial statements of interim
periods ending after December 15, 2002. The adoption of FIN 45 did not have a
material impact on the Company's results of operations or financial condition.
8
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
In November 2002, the FASB Emerging Issues Task Force released Issue No. 00-21
("EITF 00-21"), "Accounting for Revenue Arrangements with Multiple
Deliverables." EITF 00-21 addresses certain aspects of the accounting by a
vendor for arrangements under which it will perform multiple revenue-generating
activities. EITF 00-21 establishes three principles: (a) revenue arrangements
with multiple deliverables should be divided into separate units of accounting;
(b) arrangement consideration should be allocated among the separate units of
accounting based on their relative fair values; and (c) revenue recognition
criteria should be considered separately for separate units of accounting. EITF
00-21 is effective for all arrangements entered into in fiscal periods beginning
after June 15, 2003, with early adoption permitted. The Company is currently
reviewing the impact of EITF 00-21.
On January 17, 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities, an interpretation of ARB 51." The primary objectives of FIN 46 are to
provide guidance on the identification of entities for which control is achieved
through means other than through voting rights ("variable interest entities" or
"VIEs") and how to determine when and which business enterprise should
consolidate the VIE. This new model for consolidation applies to an entity for
which either: (a) the equity investors (if any) do not have a controlling
financial interest; or (b) the equity investment at risk is insufficient to
finance that entity's activities without receiving additional subordinated
financial support from other parties. In addition, FIN 46 requires that both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures. The adoption of FIN 46 on July 1,
2003 is not expected to have any significant impact on the Company's results of
operations or financial position.
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. ("SFAS") 150, "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity." The Statement specifies that
instruments within its scope embody obligations of the issuer and that,
therefore, the issuer must classify them as liabilities. SFAS 150 prohibits
entities from restating financial statements for earlier years presented. SFAS
150 will become effective for Houghton Mifflin at the beginning of the third
quarter of 2003. The Company does not currently have financial instruments with
the characteristics of liabilities and equity. Accordingly, the implementation
of SFAS 150 will not have any impact on the Company's consolidated financial
statements based upon its current position.
(3) GOODWILL AND INTANGIBLE ASSETS
Components of the Company's identifiable intangible assets are as follows:
JUNE 30, 2003 DECEMBER 31, 2002
---------------------------- ----------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION COST AMORTIZATION
------------ ------------ ------------ ------------
Publication rights $ 685,500 $ 72,595 $ 685,500 $ --
Trademarks and trade names 290,200 -- 290,200 --
Customer relationships 5,200 498 5,200 --
------------ ------------ ------------ ------------
$ 980,900 $ 73,093 $ 980,900 $ --
============ ============ ============ ============
9
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
The Company recorded amortization expense for its amortized intangible assets of
$36.6 million and $30.6 million for the three months ended June 30, 2003 and
2002, respectively, and $73.1 million and $61.3 million for the six months ended
June 30, 2003 and 2002, respectively. Estimated amortization expense for the
Company's intangible assets excluding the $73.1 million amortization recorded
through June 30, 2003, is as follows:
Year ended December 31,
2003 $ 73,093
2004 $ 126,230
2005 $ 97,370
2006 $ 77,198
2007 $ 60,578
Thereafter $ 183,138
The changes in the carrying amount of goodwill for each of the Company's
reporting segments for the six months ended June 30, 2003 were:
TRADE AND
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PUBLISHING PUBLISHING PUBLISHING OTHER TOTAL
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 $ 405,877 $ 140,876 $ 2,717 $ 38,735 $ 588,205
Purchase accounting
adjustments on prior period
acquisitions 231 67 93 11 402
------------ ------------ ------------ ------------ ------------
Balance at June 30, 2003 $ 406,108 $ 140,943 $ 2,810 $ 38,746 $ 588,607
============ ============ ============ ============ ============
Adjustments in the six months ended June 30, 2003 were for fair value
adjustments and professional fees paid.
(4) INVENTORY
Inventories are comprised of the following:
JUNE 30, DECEMBER 31,
2003 2002
---------------- ----------------
Finished goods $ 217,414 $ 193,834
Work-in-progress 6,803 7,519
Raw materials 8,456 6,573
---------------- ----------------
$ 232,673 $ 207,926
================ ================
(5) DEBT AND BORROWING AGREEMENTS
On January 3, 2003, Houghton Mifflin purchased $99.2 million of the $100.0
million 7.125% notes due April 1, 2004 ("2004 Senior Notes") through a tender
offer. Houghton Mifflin borrowed $100.0 million as a senior term loan under its
senior credit facility to finance this purchase. The consent fees for this
repurchase totaled approximately $2.3 million and a charge for this amount was
recognized in the six months ended June 30, 2003.
10
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
On January 15, 2003, Houghton Mifflin commenced a tender offer for the $125.0
million of 7.0% notes due March 1, 2006 ("2006 Senior Notes"). On February 13,
2003, Houghton Mifflin purchased nearly all of these notes. The premium paid and
consent fees for this purchase were approximately $12.8 million. A charge of
approximately $16.7 million on this repurchase was recognized in the six months
ended June 30, 2003.
On January 30, 2003, Houghton Mifflin issued $600 million of 8.25% senior
unsecured notes that mature on February 1, 2011. The Company also issued $400
million of 9.875% senior unsecured subordinated notes that mature on February 1,
2013. The senior unsecured subordinated notes were priced at 99.22% of principal
amount to yield an effective interest rate of 10.0%. The net proceeds from these
two notes were approximately $950.9 million after deducting original issue
discounts on the senior subordinated notes and estimated fees and expenses
related to these offerings. The net proceeds from these two notes were used to
purchase the $500 million senior subordinated bridge loan, plus accrued
interest, the $275.0 million borrowed under the senior term loan of the senior
secured credit facility, plus accrued interest, and the subsequent repurchase of
the 2006 Senior Notes. The existing Senior Secured Credit Facility was
terminated and the Company entered into an Amended and Restated Credit and
Guaranty Agreement. As a result of this refinancing, the Company recognized a
charge of approximately $30 million in the six months ended June 30, 2003 for
the deferred financing fees related to these debt instruments.
The Amended and Restated Credit and Guaranty Agreement provides Houghton Mifflin
with a $325 million senior secured revolving credit facility. This revolving
credit facility, for which the Company pays annual commitment fees, expires on
December 30, 2008. The revolving credit facility requires Houghton Mifflin to
maintain certain interest coverage, leverage, and senior leverage ratios, as
defined under the terms of the facility.
Long term debt consists of the following:
JUNE 30, DECEMBER 31,
2003 2002
---------------- ----------------
$150,000 of 7.20% senior secured notes due March 15, 2011 $ 136,320 $ 135,435
$125,000 of 7.00% senior secured notes due March 1, 2006 40 121,138
$100,000 of 7.125% senior secured notes due April 1, 2004 837 102,500
Senior secured credit facility, variable rate -- 175,000
Senior subordinated bridge loan, variable rate -- 500,000
$600,000 of 8.25% senior unsecured notes due February 1, 2011 600,000 --
$400,000 of 9.875% senior unsecured subordinated notes due
February 1, 2013 397,010 --
Other 319 317
---------------- ----------------
1,134,526 1,034,390
Less: current portion of long term debt 319 317
---------------- ----------------
Long term debt, excluding current installments $ 1,134,207 $ 1,034,073
================ ================
11
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
(6) RESTRUCTURING
The following table sets forth the activity in restructuring reserves in the six
months ended June 30, 2003.
WORK-FORCE
FACILITIES RELATED OTHER TOTAL
------------ ------------ ------------ ------------
Balance as of December 31, 2002 $ 3,520 $ 16,754 $ 2,389 $ 22,663
Utilization (229) (3,731) (591) (4,551)
------------ ------------ ------------ ------------
Balance as of June 30, 2003 $ 3,291 $ 13,023 $ 1,798 $ 18,112
============ ============ ============ ============
Of the approximate 460 employees affected by the restructuring actions
identified as part of the acquisition of the Company, 248 employees have been
involuntarily terminated as of June 30, 2003. The Company expects to
substantially complete its restructuring activities by June 30, 2004 and incur
the majority of the work-force related and other expenses by December 31, 2004
with certain facilities related costs attributed to long-term lease obligations
extending beyond that date.
(7) COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) for the Company was primarily computed as the sum of
the Company's net income (loss) and changes in cumulative translation
adjustment. The following table sets forth the calculation of the Company's
comprehensive income (loss) for the three and six months ended June 30, 2003 and
2002.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
(successor (predecessor (successor (predecessor
basis) basis) basis) basis)
Net income (loss) $ 5,569 $ 9,099 $ (109,436) $ (43,999)
Change in cumulative translation adjustment and other 343 -- 241 --
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 5,912 $ 9,099 $ (109,195) $ (43,999)
============ ============ ============ ============
(8) STOCK-BASED COMPENSATION
The Company's former employee stock compensation plans were accounted for in
accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting
for Stock Issued to Employees" and related interpretations. Under this method,
no compensation expense is recognized as long as the exercise price equals or
exceeds the market price of the underlying stock on the date of grant. The
Company elected the disclosure-only alternative permitted under SFAS 123,
"Accounting for Stock-Based Compensation," as amended by SFAS 148, "Accounting
for Stock Based Compensation - Transition and Disclosure," for fixed stock-based
awards to employees. All non-employee stock-based awards were accounted for in
accordance with SFAS 123.
12
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
The Company used the Black-Scholes option pricing model to estimate the fair
value of options granted. The Black Scholes model was developed for use in
estimating the value of traded options that have no vesting restrictions and are
fully transferable. The Company's former employee stock options had
characteristics significantly different from those of traded options; therefore,
the Black-Scholes option pricing model may not provide a reliable measure of the
fair value of the Company's options.
Subsequent to the merger with Vivendi, certain executives and employees of the
Company received stock options representing rights to acquire shares of Vivendi
common stock. These stock options represented the only stock-based compensation
as of and for the interim periods presented. At the time of the sale of Houghton
Mifflin by Vivendi to HM Holdings, Vivendi notified all employees holding the
stock options that the options would continue to vest under the terms and
conditions of the grants. With the change in ultimate parent ownership, any
future financial obligation of in-the-money options presented by a Houghton
Mifflin employee lies with Vivendi, hence no impacts from the fair value
recognition provisions of SFAS 123 have been presented from the date of the HM
Holdings transaction.
The following table illustrates the effect on net loss if the Company had
applied the fair value recognition provisions of SFAS 123, to the option grants
for the prior year comparable periods.
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------------------- ----------------------------------------
JUNE 30, 2003 JUNE 30, 2002 JUNE 30, 2003 JUNE 30, 2002
(successor basis) (predecessor basis) (successor basis) (predecessor basis)
Net income (loss) available to
common stockholders, as reported $ 5,569 $ 8,120 $ (109,436) $ (45,958)
Deduct: Stock-based employee
compensation expense determined
under the fair value method -- (456) -- (911)
----------------- ------------------- ----------------- -------------------
Pro forma net income (loss)
available to common stockholders $ 5,569 $ 7,664 $ (109,436) $ (46,869)
================= =================== ================= ===================
(9) SEGMENT AND RELATED INFORMATION
Houghton Mifflin evaluates the performance of its segments based on the profit
and loss from operations before interest income and expense, income taxes, and
infrequent and extraordinary items.
Summarized financial information concerning Houghton Mifflin's reportable
segments is shown in the following tables. The Other segment includes
Promissor and unallocated corporate-related items, operations which do not meet
the quantitative thresholds of SFAS 131, "Disclosures About Segments of an
Enterprise and Related Information," nonrecurring items, and as it relates to
segment profit (loss), income and expense not allocated to reportable segments.
13
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
THREE MONTHS ENDED JUNE 30:
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PUBLISHING PUBLISHING PUBLISHING OTHER CONSOLIDATED
------------ ------------ ------------ ------------ ------------
2003 (successor basis)
Net sales from external customers $ 280,272 $ 32,940 $ 30,163 $ 17,942 $ 361,317
Segment operating income (loss) 54,115 (14,413) (1,932) (149) 37,621
2002 (predecessor basis)
Net sales from external customers $ 230,993 $ 30,629 $ 27,655 $ 19,990 $ 309,267
Segment operating income (loss) 32,283 (6,773) (2,129) 3,223 26,604
SIX MONTHS ENDED JUNE 30:
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PUBLISHING PUBLISHING PUBLISHING OTHER CONSOLIDATED
------------ ------------ ------------ ------------ ------------
2003 (successor basis)
Net sales from external customers $ 349,895 $ 53,889 $ 57,196 $ 33,160 $ 494,140
Segment operating loss (22,856) (37,141) (3,445) (2,760) (66,202)
2002 (predecessor basis)
Net sales from external customers $ 286,479 $ 50,955 $ 63,138 $ 33,752 $ 434,324
Segment operating loss (37,804) (19,382) (610) (110) (57,906)
Reconciliation of segment income (losses) to the condensed consolidated
statements of operations is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
---------------------------- ----------------------------
(successor (predecessor (successor (predecessor
basis) basis) basis) basis)
Total income (loss) from reportable segments $ 37,621 $ 26,604 $ (66,202) $ (57,906)
Unallocated expense:
Interest expense (28,799) (12,784) (56,604) (20,584)
Debt extinguishment -- -- (48,427) --
Other -- (2) 18 --
----------- ----------- ---------- ----------
Income (loss) from continuing operations before
taxes $ 8,822 $ 13,818 $ (171,215) $ (78,490)
============ =========== =========== ==========
14
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
(10) COMMITMENTS AND CONTINGENCIES
CONTINGENCIES
Houghton Mifflin is involved in ordinary and routine litigation and matters
incidental to its business. There are no such matters pending that Houghton
Mifflin expects to be material in relation to its financial condition, results
of operations, or cash flows.
Houghton Mifflin is contingently liable for $15.6 million in letters of credit
representing performance and surety bonds posted as security for its operating
activities. Under the terms of the Company's Amended and Restated Credit and
Guarantee Agreement (see Note 5), outstanding letters of credit are deducted
from the unused borrowing capacity under the revolving credit facility.
Houghton Mifflin is contingently liable for approximately $30 million in
retention agreements to key employees. These retention agreements expire on or
before June 30, 2004, when the Company will pay amounts then due. The Company is
recording the expense of these arrangements ratably over the retention period
and had accrued $22.1 million and paid $1.0 million as of June 30, 2003.
CONTRACTUAL OBLIGATIONS
The Company continues to routinely enter into standard indemnification
provisions as part of licensee agreements involving use of its intellectual
property. These provisions typically require the Company to indemnify, and hold
harmless, licensees in connection with any infringement claim by a third party
relating to the intellectual property covered by the license agreement.
Riverside and Promissor routinely enter into contracts with customers that
contain provisions requiring the Company to indemnify the customer against a
broad array of potential liabilities resulting from any breach of the contract
or the invalidity of the test. Although the term of these provisions and the
maximum potential amounts of future payments the Company could be required to
make is not limited, the Company has never incurred any costs to defend or
settle claims related to these types of indemnification provisions. The Company
therefore believes the estimated fair value of these provisions is minimal.
Contractual obligations of this nature entered into prior to December 31, 2002
are grandfathered under the provisions of FIN 45. Those arising subsequent to
December 31, 2002 are governed by FIN 45. No liabilities have been recorded as
of June 30, 2003 for any of these contractual obligations as the Company
believes (i) the exposure to liability is minimal based upon historical
experience and (ii) the guarantees provided are normal and customary in the
industry resulting in no premium being received from the counterparty of such
arrangements.
(11) RELATED PARTIES
DEFERRED COMPENSATION PLAN OF HM HOLDINGS
In January 2003, HM Holdings established a Deferred Compensation Plan. The
Deferred Compensation Plan was offered to selected top executives and key
employees of Houghton Mifflin, allowing the employees to defer receipt of all or
a portion of their retention agreement payments (see Note 10) in exchange for an
interest in the common stock of HM Holdings. In January 2003, approximately 30
of the Company's employees elected to participate in the Deferred Compensation
Plan and deferred an aggregate $4.8 million of payments due pursuant to their
respective retention agreements in exchange for common stock ownership in HM
Holdings. The deferred compensation is included on the balance sheet within the
Due to parent balance at June 30, 2003.
15
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(TABLES IN THOUSANDS)
MANAGEMENT AGREEMENT
The Company has entered into a Management Agreement with HM Holdings and its
beneficial owners Thomas H. Lee Partners, L.P. and its affiliates, Bain Capital,
LLC and its affiliates, and The Blackstone Group and its affiliates (together,
the "Sponsors"). The Management Agreement, entered into at the time of the
acquisition of Houghton Mifflin by HM Holdings (the "Acquisition"), requires
Houghton Mifflin to pay the Sponsors an aggregate annual fee of $5.0 million per
year, payable quarterly in advance, in consideration for ongoing consulting and
management advisory services. The annual fee has been prepaid in its entirety
for 2003. In the case of future services provided in connection with any future
acquisition, disposition, or financing transactions, the Management Agreement
requires us to pay the Sponsors an aggregate fee of one percent of the gross
transaction value. The agreement also requires us and our parent to pay the
reasonable expenses of the Sponsors in connection with, and indemnify them for
liabilities arising from, the Management Agreement, the Acquisition and any
related transactions, their equity investment in HM Holdings, our operations,
and the services they provide to us and HM Holdings. The Management Agreement
terminates on December 30, 2012.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of our results of operations includes
periods prior to the consummation of the Transactions, defined as the
acquisition of Houghton Mifflin by HM Holdings, Inc. ("HM Holdings") on December
30, 2002, and the subsequent financing to complete the acquisition. Accordingly,
the discussion and analysis of historical periods prior to January 1, 2003 does
not reflect the significant impact that the Transactions have had and will have
on Houghton Mifflin, including increased leverage and increased liquidity
requirements and higher amortization and acquisition-related costs. You should
read the following discussion of our financial condition and results of
operations with "Selected Historical Consolidated Financial Data" and the
unaudited historical consolidated financial statements and related notes
included elsewhere in this report. In this section, references to "we," "our,"
"us," and "Houghton Mifflin" refer to Houghton Mifflin Company and its
consolidated subsidiaries, unless the context otherwise requires.
"SAFE HARBOR" STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995:
This report includes forward-looking statements that reflect Houghton Mifflin's
current views about future events and financial performance. Words such as
"estimates," "expects," "anticipates," "projects," "plans," "intends,"
"believes," "forecasts," and variations of such words or similar expressions
that predict or indicate future events or trends, or that do not relate to
historical matters, identify forward-looking statements. Our expectations,
beliefs and projections are expressed in good faith and we believe there is a
reasonable basis for them. However, there can be no assurance that management's
expectations, beliefs and projections will result or be achieved. 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, which speak only as of
the date of this report. These factors include, but are not limited to: (i)
market acceptance of new educational and testing products and services,
particularly reading, literature, language arts, mathematics, science, and
social studies programs, criterion-referenced testing, and the Iowa Tests of
Basic Skills; (ii) the seasonal and cyclical nature of educational sales; (iii)
changes in funding in school systems throughout the nation, which may result in
cancellation of planned purchases of educational and testing products and/or
services and shifts in timing of purchases; (iv) changes in educational spending
in key states such as California, Texas, and Florida, and our share of that
spending; (v) changes in purchasing patterns in elementary and secondary schools
and, particularly in college markets, the effect of textbook prices, technology,
and the used book market on sales; (vi) changes in the competitive environment,
including those that could adversely affect cost of sales, such as the increased
amount of materials given away in the elementary and secondary school markets
and increased demand for customized products; (vii) changes in the relative
profitability of products sold; (viii) regulatory changes that could affect the
purchase of educational and testing products and services; (ix) changes in the
strength of the retail market for general interest publications and market
acceptance of newly-published titles and new electronic products; (x) the
ability of Riverside and Promissor to enter into new agreements for testing
services and generate net sales growth; (xi) delays and unanticipated expenses
in developing new programs and other products; (xii) delays and unanticipated
expenses in developing new technology products, and market acceptance and use of
online instruction and assessment materials; (xiii) the success of Riverside's
entry into the scoring business and the criterion-referenced testing business;
(xiv) the potential effect of a continued weak economy on sales of K-12,
college, and general interest publications; (xv) the risk that our well-known
authors will depart and write for our competitors; (xvi) the effect of changes
in accounting, regulatory, and/or tax policies and practices; and (xvii) other
factors detailed from time to time in the Company's filings with the SEC.
17
COMPANY OVERVIEW
We derive approximately 85% 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 late August and early September. Thus, our second quarter net
sales represent almost 75% of June year-to-date sales, making second-quarter
results material to our first half of the year's performance. Also, we realize
approximately 50% of annual net sales in the third quarter, making the second
and third quarters material to the entire year's performance.
Sales of K-12 instructional materials and customized testing products
are also cyclical, with some years offering more sales opportunities than
others. The amount of funding available at the state level for educational
materials also has a significant effect on Houghton Mifflin's year-to-year
revenues. Although the loss of a single customer or a few customers would not
have a material adverse effect on our business, schedules of school adoptions
and market acceptance of our products can materially affect year-to-year revenue
performance.
ACQUISITIONS AND DISPOSITIONS
HM Holdings
On December 30, 2002, we were acquired by, and subsequently merged
with, Versailles Acquisition Corporation, a wholly owned subsidiary of HM
Holdings, a company beneficially owned by Thomas H. Lee Partners, L.P. and its
affiliates, Bain Capital, LLC and its affiliates, and The Blackstone Group and
its affiliates (together, the "Sponsors"). HM Holdings acquired all of our share
capital from Vivendi Universal, S.A. ("Vivendi"). The total cost of this
acquisition (the "Acquisition") was $1.65 billion, including estimated
transaction fees and expenses and $375.4 million of assumed indebtedness.
As a result of the Acquisition, our assets and liabilities were
adjusted to their fair value as of December 30, 2002. These adjustments included
$588.3 million allocated to goodwill, $679.1 million allocated to publishing
rights (with an estimated life of 18 years), $290.2 million to trademarks and
trade names (with an indefinite life), $5.2 million to customer-related
intangibles (with an estimated life of 12 years), $9.9 million step-up to the
fair value of our inventory, and $15.6 million step-down to the fair value of
the assumed debt at the Acquisition date. In conjunction with this assessment,
we included $88.7 million of existing pre-publication costs in the fair value of
publishing rights.
We have entered into retention agreements with key employees that
expire on or before June 30, 2004 that total approximately $30 million, which
will be expensed over the vesting period. We have also significantly increased
our aggregate borrowings in connection with new financing arrangements entered
into to complete the Transactions. As a result, our interest expense will be
significantly higher in periods following the Transactions, our cost of sales
will be temporarily increased in 2003 due to the amortization of inventory fair
value step-up from purchase accounting, and selling and administrative expenses
will increase in 2003 and 2004 due to the expensing of the retention agreements.
18
HM Holdings committed to a formal plan, which we approved, to
restructure our operations. We included costs related to this plan of $22.7
million in the allocation of the purchase price.
During the period that it owned us, Vivendi provided marketing,
finance, tax, administrative, and other services. In 2002, for those services,
Vivendi charged us a management fee totaling $6.0 million. This fee arrangement
was terminated concurrent with the Acquisition. As a result of the Acquisition,
we are an independent entity, which we believe will result in additional selling
and administrative expenses of approximately $3 million per year, and we will
also be charged a management fee of $5.0 million per year by the Sponsors. We
may also incur transition costs to re-establish ourselves as an independent
company. Accordingly, the results described and analyzed in the following
discussion may not necessarily be indicative of our future results.
Vivendi Universal, S.A.
On July 7, 2001, an indirect wholly owned subsidiary of Vivendi
acquired 100% of our common stock for $2.35 billion, including the assumption of
$613.7 million of debt (the "Vivendi Purchase"). We accounted for the Vivendi
Purchase using purchase accounting in our consolidated financial statements.
Prior to the Vivendi Purchase Houghton Mifflin was a public company.
At the time of the Vivendi Purchase, we adjusted our assets and
liabilities to their fair market values. These adjustments included $706.0
million allocated to the fair value of our publishing rights (with an estimated
life of 30 years), $301.0 million to trademarks and trade names (with an
indefinite life), $6.4 million to the fair value of our leases (with an
estimated average life of approximately six years), $26.4 million step-up to the
fair value of our inventory, and $7.3 million step-up to the fair value of the
debt at the acquisition date. In conjunction with this assessment, we included
$143.6 million of existing pre-publication costs in the fair value of publishing
rights. Vivendi also committed to a formal plan to restructure our operations.
We included costs related to this plan of $53.6 million in the allocation of the
acquisition price. Results from operations and cash flows for 2002 were impacted
by the amortization expense and cash payments arising from these adjustments.
OTHER ACQUISITIONS AND DISPOSITIONS
On March 31, 2003, we entered into a stock purchase agreement with
Prime Entertainment, Inc. to sell all of the outstanding shares of Curriculum
Advantage, Inc. ("Curriculum Advantage") for $0.3 million in cash and receipt of
secured notes and inventory of $0.5 million. The assets and liabilities and
results from operations and from cash flows of Curriculum Advantage are
reflected as discontinued operations in our accompanying unaudited consolidated
financial statements.
Subsequent to the Acquisition, we acquired from Vivendi all of the
outstanding stock of Kingfisher Publications plc ("Kingfisher") for $3.9
million. Kingfisher is a U.K.-based company that publishes children's fiction
and non-fiction titles and reference materials for the trade market worldwide.
We accounted for this purchase in our consolidated financial statements and the
results of operations are included for periods subsequent to the acquisition
date. As such, we adjusted our assets and liabilities to fair value including an
increase of $6.4 million in the value of publishing rights (with an estimated
life of 18 years).
19
In October 2002, we sold Sunburst Technology Corporation ("Sunburst")
to Educational Technologies LLC for $22.8 million, subject to post-closing price
adjustments. The assets and liabilities and results from operations and from
cash flows of Sunburst are reflected as discontinued operations in our
accompanying unaudited consolidated financial statements for the three and six
months ended June 30, 2002.
BUSINESS SEGMENTS
Houghton Mifflin's principal business is publishing, and our operations
are classified into four operating segments.
K-12 Publishing
Our K-12 Publishing segment develops and markets for the
pre-kindergarten through grade twelve ("K-12") market comprehensive educational
programs and assessments targeted to the more than 53 million students in over
115,000 elementary and secondary schools in the United States, principally in
the core academic subjects. Our products and services include textbooks,
workbooks, supplemental materials, technology-based products, teaching guides
and other resources, and provide teacher training, as part of a full-service
offering to schools, educators, and students. In addition, through Riverside,
our K-12 Publishing segment offers a wide range of educational, cognitive, and
developmental standardized testing products in print, CD-ROM, and online
formats, targeting the educational and clinical assessment markets.
In the educational publishing industry, materials are often described
as "basal" or "supplemental." Basal materials are comprehensive programs
intended to provide a complete course of study in a subject, either at a single
grade level or across grade levels, and are the primary source of classroom
instruction. Supplemental materials provide focused information about a topic,
or practice in a particular skill, but not the comprehensive system of materials
offered in a basal program. These materials are used both as alternatives and as
supplements to core basal textbooks, enabling local educators to tailor standard
programs to the specific needs of their students cost-effectively.
The process by which public elementary and secondary schools select and
purchase new instructional materials is referred to as the "adoption" process.
The terms "adopt" and "adoption" are often used to describe the overall process
of a state governing body's official approval of instructional programs and
materials for selection and purchase by that state's school districts, as well
as an individual school or school district's selection and purchase of
instructional materials.
Twenty states approve instructional programs and materials on a
statewide basis for a particular subject ("adoption states"). These states
represent approximately one-half of the U.S. elementary and secondary school-age
population. The selections typically occur every five to seven years according
to a schedule publicized many years in advance. The funding for the purchase of
the materials in an adoption state is approved at the state level and is
appropriated by subject. Typically, a school or school district within an
adoption state may use state funding to purchase instructional materials only
from the list of programs that have been adopted by the particular state's
governing body. After the state entities have adopted instructional materials,
individual schools or school districts later decide the quantity and timing of
their purchases. In the other states, referred to as "open states" or "open
territories," each individual school or school district can purchase materials
without restrictions.
20
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 may provide a variety
of ancillary materials 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 materials and services,
usually called "implementation" and "in-service" training, are a cost of doing
business.
College Publishing
Our College Publishing segment publishes textbooks, ancillary products
such as workbooks and study guides, technology-based instructional materials,
teacher materials, and other materials, primarily for introductory college-level
courses. We target the more than 15 million students in over 4,000 institutions
in the post-secondary higher education market. We concentrate on the largest
introductory college courses in core disciplines such as mathematics, chemistry,
history, psychology, modern languages, accounting, business, and remedial
studies, although some recent growth has come from new publications for
upper-level courses. Our library of titles for introductory college courses
enables us to generate significant sales in the high school advanced placement
market.
Trade and Reference Publishing
The Trade and Reference Publishing segment consists of the Trade and
Reference division, a publisher of fiction and non-fiction books for adults and
children, dictionaries and other reference materials, and Kingfisher, a
U.K.-based publisher of childrens' fiction and non-fiction titles and reference
materials for the trade market worldwide.
Other
Promissor is a developer and provider of testing services and products
for professional certification and licensure. In addition, this segment includes
unallocated corporate items. Generally, the professional assessment market has a
highly fragmented customer base with numerous niche participants competing in
various segments. Regulatory and professional associations typically select
vendors based on detailed responses to extensive requests for proposals.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. ("FIN") 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The initial recognition and
initial measurement provisions of FIN 45 are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. The disclosure
requirements of FIN 45 are applicable for financial statements of interim
periods ending after December 15, 2002. The adoption of FIN 45 did not have
a material impact on our results of operations or financial condition.
21
In November 2002, the FASB Emerging Issues Task Force released Issue
No. 00-21 ("EITF 00-21"), "Accounting for Revenue Arrangements with Multiple
Deliverables." EITF 00-21 addresses certain aspects of the accounting by a
vendor for arrangements under which it will perform multiple revenue-generating
activities. EITF 00-21 establishes three principles: (a) revenue arrangements
with multiple deliverables should be divided into separate units of accounting;
(b) arrangement consideration should be allocated among the separate units of
accounting based on their relative fair values; and (c) revenue recognition
criteria should be considered separately for separate units of accounting. EITF
00-21 is effective for all arrangements entered into in fiscal periods beginning
after June 15, 2003, with early adoption permitted. The Company is currently
reviewing the impact of EITF 00-21.
On January 17, 2003, the FASB issued FIN 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB 51." The primary objectives
of FIN 46 are to provide guidance on the identification of entities for which
control is achieved through means other than through voting rights ("variable
interest entities" or "VIEs") and how to determine when and which business
enterprise should consolidate the VIE. This new model for consolidation applies
to an entity for which either: (a) the equity investors (if any) do not have a
controlling financial interest; or (b) the equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, FIN 46 requires
that both the primary beneficiary and all other enterprises with a significant
variable interest in a VIE make additional disclosures. The adoption of FIN 46
on July 1, 2003 is not expected to have any significant impact on the Company's
results of operations or financial position.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. ("SFAS") 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity." The Statement specifies
that instruments within its scope embody obligations of the issuer and that,
therefore, the issuer must classify them as liabilities. SFAS 150 prohibits
entities from restating financial statements for earlier years presented. SFAS
150 will become effective for Houghton Mifflin at the beginning of the third
quarter of 2003. The Company does not currently have financial instruments with
the characteristics of liabilities and equity. Accordingly, the implementation
of SFAS 150 will not have any impact on our consolidated financial statements
based upon the Company's current position.
RESTRUCTURING
The following table sets forth the activity in restructuring reserves in the six
months ended June 30, 2003.
WORK-FORCE
FACILITIES RELATED OTHER TOTAL
------------ ------------ ------------ ------------
Balance as of December 31, 2002 $ 3,520 $ 16,754 $ 2,389 $ 22,663
Utilization (229) (3,731) (591) (4,551)
------------ ------------ ------------ ------------
Balance as of June 30, 2003 $ 3,291 $ 13,023 $ 1,798 $ 18,112
============ ============ ============ ============
Of the approximate 460 employees affected by the restructuring actions
identified as part of the acquisition of the Company, 248 employees have been
involuntarily terminated as of June 30, 2003. We expect to substantially
complete our restructuring activities by June 30, 2004 and incur the majority of
the work-force related and other expenses by December 31, 2004 with certain
facilities related costs attributed to long-term lease obligations extending
beyond that date.
22
RESULTS OF OPERATIONS
The following tables set forth information regarding our Net sales, Operating
income (loss), and other information from our unaudited consolidated statements
of operations.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
(successor (predecessor (successor (predecessor
basis) basis) basis) basis)
(DOLLARS IN MILLIONS)
---------------------
Net sales:
K-12 Publishing .......................................... $ 280.3 $ 231.0 $ 349.9 $ 286.5
College Publishing ....................................... 32.9 30.6 53.9 51.0
Trade and Reference Publishing ........................... 30.2 27.7 57.2 63.1
Other .................................................... 17.9 20.0 33.1 33.7
---------- ---------- ---------- ----------
Total net sales ............................................ 361.3 309.3 494.1 434.3
Cost of sales excluding pre-publication and publishing
rights amortization .................................... 142.3 123.1 220.5 193.3
Pre-publication and publishing rights amortization ....... 41.1 38.3 77.9 70.3
---------- ---------- ---------- ----------
Cost of sales ............................................ 183.4 161.4 298.5 263.7
Selling and administrative ............................... 140.0 121.2 261.4 227.8
Intangible asset amortization ............................ 0.2 - 0.5 0.8
---------- ---------- ---------- ----------
Operating income (loss) .................................... 37.6 26.6 (66.2) (57.9)
Net interest expense ..................................... (28.8) (12.8) (56.6) (20.6)
Debt extinguishment costs ................................ - - (48.4) -
Other income (loss)
Income tax provision (benefit) ............................. 3.3 5.9 (63.0) (32.9)
---------- ---------- ---------- ----------
Income (loss) from continuing operations ................... 5.6 7.9 (108.2) (45.6)
Income (loss) from discontinued operations, net of tax ..... - 1.2 (1.2) 1.6
Preferred stock dividend and redemption costs, net of tax .. - (1.0) - (2.0)
---------- ---------- ---------- ----------
Net income (loss) available to common shareholders ......... $ 5.6 $ 8.1 $ (109.4) $ (46.0)
========== ========== ========== ==========
23
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
(successor (predecessor (successor (predecessor
basis) basis) basis) basis)
------ ------ ------ ------
(AS A PERCENTAGE OF NET SALES)
Net sales .................................................. 100.0% 100.0% 100.0% 100.0%
Cost of sales excluding pre-publication and publishing
rights amortization .................................... 39.4 39.8 44.6 44.5
Pre-publication and publishing rights amortization ....... 11.4 12.4 15.8 16.2
----- ----- ----- -----
Cost of sales ............................................ 50.8 52.2 60.4 60.7
Selling and administrative ............................... 38.8 39.2 52.9 52.4
Intangible asset amortization ............................ - - 0.1 0.2
----- ----- ----- -----
Operating income (loss) .................................... 10.4 8.6 (13.4) (13.3)
Net interest income (expense) ............................ (8.0) (4.1) (11.4) (4.7)
Debt extinguishment costs ................................ - - (9.8) -
Other income (loss) ...................................... - - - -
Income tax provision (benefit) ............................. 0.9 1.9 (12.7) (7.5)
----- ----- ----- -----
Income (loss) from continuing operations ................... 1.5 2.6 (21.9) (10.5)
Income (loss) from discontinued operations, net of tax ..... 0.0 0.3 (0.2) 0.4
Preferred stock dividend and redemption costs, net of tax .. -- (0.3) -- (0.5)
----- ----- ----- -----
Net income (loss) .......................................... 1.5% 2.6% (22.1)% (10.6)%
===== ===== ===== =====
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
Net Sales
Net sales for the quarter ended June 30, 2003 increased $52.0 million,
or 16.8%, to $361.3 million from $309.3 million in the second quarter of 2002.
K-12 Publishing. The K-12 Publishing segment's net sales in the second
quarter of 2003 increased $49.3 million, or 21.3%, to $280.3 million from net
sales of $231.0 million in the second quarter of 2002. The increase in net sales
was due in part to an increase in market share and greater sales opportunities
to date in the second year of the California reading adoption of $17.5 million.
We also benefited from the secondary school social studies and literature
adoptions in other states, and higher testing net sales of $6.1 million due to
the launch of a new version of the Stanford-Binet Intelligence Scales Test and
increased sales from criterion-referenced test contracts.
College Publishing. The College Publishing segment's net sales in the
second quarter of 2003 rose $2.3 million, or 7.5%, to $32.9 million from $30.6
million in the second quarter of 2002. The net sales increase reflected
continuing growth in market share and the success of new textbook titles.
24
Trade and Reference Publishing. The Trade and Reference Publishing
segment's net sales in the second quarter of 2003 increased $2.5 million, or
9.1%, to $30.2 million from $27.7 million in the second quarter of 2002. The
increase was mainly due to results from Kingfisher, which was acquired on
December 30, 2002 and contributed $4.2 million. The increase was partially
offset by lower children's book sales.
Other. The Other segment's net sales in the second quarter of 2003
decreased $2.1 million, or 10.2%, to $17.9 million from $20.0 million in the
second quarter of 2002. The decrease was due mainly to lower sales from
Promissor, our professional testing subsidiary, which reported lower test
volumes mostly due to timing of testing and licensing services, as a number of
customers completed their activities in the first quarter of 2003.
Cost of Sales Excluding Pre-publication and Publishing Rights Amortization
Cost of sales excluding pre-publication and publishing rights
amortization in the second quarter of 2003 increased $19.2 million, or 15.6%, to
$142.3 million from $123.1 million in the second quarter of 2002. The increased
cost of sales was due to higher manufacturing costs and higher implementation
costs. The higher manufacturing costs of $10.3 million were due to the higher
sales as well as a higher inventory step-up charge of $3.1 million as a result
of the Acquisition. The higher implementation costs of $5.7 million were due to
increased sales as well as higher implementation rates in certain state
adoptions. Cost of sales decreased as a percentage of net sales to 39.4% in the
second quarter of 2003 from 39.8% in the second quarter of 2002. The decrease in
cost of sales as a percentage of net sales was primarily due to higher sales and
lower unit manufacturing costs resulting from our successful negotiations with
vendors to bring down the costs of printing and paper.
Pre-publication and Publishing Rights Amortization
Pre-publication and publishing rights amortization in the second
quarter of 2003 increased $2.8 million, or 7.4%, to $41.1 million from $38.3
million in the second quarter of 2002. The increase was primarily the result of
the Acquisition. As a result of the related purchase price study, the publishing
rights amortization increased to $36.3 million in the second quarter of 2003
compared to $30.3 million in the second quarter of 2002. Overall, due to
increased net sales, pre-publication and publishing rights amortization
decreased as a percentage of net sales to 11.4% in the second quarter of 2003
from 12.4% in the second quarter of 2002.
Selling and Administrative
Selling and administrative expenses in the second quarter of 2003
increased $18.8 million, or 15.5%, to $140.0 million from $121.2 million in the
second quarter of 2002. Higher selling and administrative expenses were due
mainly to the incremental costs for retention agreements with key employees of
$7.1 million, severance costs of $3.2 million, the acquisition of Kingfisher,
which increased selling and administrative by $1.5 million, stand-alone costs of
$0.8 million, and higher employee benefit costs.
Operating Income
Operating income for the three months ended June 30, 2003 increased
$11.0 million, or 41.4%, to $37.6 million from $26.6 million for the same period
in 2002.
25
K-12 Publishing. The K-12 Publishing segment's operating income in the
second quarter of 2003 increased $21.8 million, or 67.6%, to $54.1 million from
$32.3 million in the second quarter of 2002. The increase in the operating
income was mainly due to higher net sales and lower manufacturing costs as a
percent of sales, partially offset by higher implementation costs, higher
inventory step-up amortization, and the incremental cost of retention agreements
with key employees.
College Publishing. The College Publishing segment's operating loss in
the second quarter of 2003 increased $7.6 million, or 112.8%, to $14.4 million
from $6.8 million in the same period for 2002. The increase in the operating
loss was primarily due to the employee retention charge, higher publishing
rights amortization, and higher depreciation expense for technology initiatives
in digitizing our content.
Trade and Reference Publishing. The Trade and Reference Publishing
segment's operating loss in the second quarter of 2003 decreased $0.2 million,
or 9.3%, to a loss of $1.9 million from a loss of $2.1 million in the same
period for 2002. The lower operating loss was due to higher net sales, partially
offset by higher employee retention charges and increased royalty costs.
Other. The Other segment's operating loss in the second quarter of 2003
was $0.1 million compared to operating income of $3.2 million in the second
quarter of 2002. The decrease in operating results was primarily due to the
lower sales and higher employee retention charges and higher depreciation due to
the fair valuing of assets related to the Acquisition.
Net Interest Expense
Net interest expense in the second quarter of 2003 increased $16.0
million, or 125.3%, to $28.8 million from $12.8 million in the second quarter of
2002. This increase reflected higher borrowings and interest rates during the
second quarter of 2003 due to debt incurred to fund the Acquisition.
Income Taxes
The income tax provision in the second quarter of 2003 decreased $2.6
million, or 44.7%, to $3.3 million from $5.9 million in the second quarter of
2002. This decrease was due to the lower operating income and a decrease in the
effective tax rate to 36.8% in the second quarter of 2003 from 42.0% in the
second quarter of 2002. The decrease in the effective tax rate was due to a
higher percentage of non-deductible expenses in 2003.
Discontinued Operations
Discontinued operations for the second quarter of 2002 was income of
$1.2 million, reflecting the results of Curriculum Advantage, which was sold in
April 2003, and Sunburst, which was sold in October 2002.
Preferred Stock Dividend and Redemption Costs
The preferred shares of a subsidiary were auctioned and redeemed on
December 30, 2002. There were no preferred stock dividends during the second
quarter of 2003 and $1.0 million of dividends for the second quarter of 2002.
26
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
We derive almost 85% of annual net sales from educational publishing in
the K-12 and College 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 late
August and early September. Thus, our second quarter net sales represent almost
three quarters of year-to-date sales, making second-quarter results material to
our six month performance.
Net Sales
Net sales for the six months ended June 30, 2003 increased $59.8
million, or 13.8%, to $494.1 million from $434.3 million in the same period for
2002.
K-12 Publishing. The K-12 Publishing segment's net sales for the six
months ended June 30, 2003 increased $63.4 million, or 22.1%, to $349.9 million
from $286.5 million in the same period for 2002. The increase in net sales was
due to an increase in market share and greater sales opportunities to date in
the second year of the California reading adoption of $24.1 million. We also
benefited from the secondary school social studies and literature adoptions in
other states, and higher testing net sales of $12.0 million due to the launch of
a new version of the Stanford-Binet Intelligence Scales Test and increased sales
from criterion-referenced test contracts.
College Publishing. The College Publishing segment's net sales for the
six months ended June 30, 2003 increased $2.9 million, or 5.8%, to $53.9 million
from $51.0 million in the same period for 2002. The net sales increase reflected
continuing growth in market share and the success of new textbook titles.
Trade and Reference Publishing. The Trade and Reference Publishing
segment's net sales for the six months ended June 30, 2003 decreased $5.9
million, or 9.4%, to $57.2 million from $63.1 million in the same period for
2002. The decrease was mainly due to lower demand for J.R.R. Tolkien products
and lower children's book sales. These decreases were offset by increased sales
due to results from Kingfisher, which was acquired on December 30, 2002 and
contributed net sales of $7.5 million.
Other. The Other segment's net sales for the six months ended June 30,
2003 decreased $0.6 million, or 1.8%, to $33.2 million from $33.8 million in the
same period for 2002.
Cost of Sales Excluding Pre-publication and Publishing Rights Amortization
Cost of sales excluding pre-publication and publishing rights
amortization for the six months ended June 30, 2003 increased $27.2 million, or
14.1%, to $220.5 million from $193.3 million for the same period in 2002. The
increased cost of sales was due to higher manufacturing costs, higher
implementation costs, and increased editorial expenses. The higher manufacturing
costs of $13.6 million were primarily due to the higher sales as well as a
higher inventory step-up charge of $4.0 million as a result of the Acquisition.
The higher implementation costs of $6.2 million were due to increased sales as
well as higher implementation rates in certain state adoptions. Increased
editorial expenses of $6.7 million was incurred for new program development and
product revisions in preparation for sales opportunities in 2004 and beyond.
Cost of sales increased as a percentage of net sales to 44.6% in the six months
ended June 30, 2003 from 44.5% in the same period in 2002. The slight increase
in cost of sales as a percentage of net sales was due to higher editorial
expenses, higher implementation costs, and inventory step-up charge offset by
lower unit manufacturing costs. The lower unit manufacturing costs as a
percentage of net sales was due to our successful negotiations with vendors to
bring down the costs of printing and paper.
27
Pre-publication and Publishing Rights Amortization
Pre-publication and publishing rights amortization for the six months
ended June 30, 2003 increased $7.6 million, or 10.8%, to $77.9 million from
$70.3 million during the same period for 2002. This increase was primarily due
to having higher publishing rights amortization during 2003 compared to the six
months ended 2002 as a result of an increase in the fair value of the publishing
rights due to the Acquisition. As a percentage of net sales, pre-publication and
publishing rights amortization decreased to 15.8% in 2003 from 16.2% in 2002 due
to increased net sales.
Selling and Administrative
Selling and administrative expenses for the six months ended June 30,
2003 increased $33.6 million, or 14.7%, to $261.4 million from $227.8 million
during the same period for 2002. As a percentage of net sales, selling and
administrative expenses increased to 52.9% for the six month period ended June
30, 2003 compared to 52.4% for the same period in 2002. Higher selling and
administrative expenses were due mainly to the incremental costs for retention
agreements with key employees of $18.5 million, severance costs of $3.2 million,
the acquisition of Kingfisher, which increased selling and administrative by
$2.6 million, stand-alone costs of $1.2 million and higher employee benefit
costs.
Intangible Asset Amortization
Intangible asset amortization for the six months ended June 30, 2003
decreased $0.3 million, or 36.4%, to $0.5 million from $0.8 million during the
same period for 2002. The decrease in intangible asset amortization was due to
the Acquisition. As a result, intangible assets amortization as a percentage of
net sales decreased to 0.1% for the six month period ended June 30, 2003 from
0.2% for the comparable period in 2002.
Operating Loss
Operating loss for the six months ended June 30, 2003 increased $8.3
million to $66.2 million from $57.9 million during the same period for 2002.
K-12 Publishing. The K-12 Publishing segment's operating loss for the
six months ended June 30, 2003 decreased $14.9 million to $22.9 million from a
loss of $37.8 million for the same period in 2002. The decrease in the operating
loss was mainly due to higher net sales and lower manufacturing costs as a
percentage of net sales, partially offset by higher implementation costs, higher
inventory step-up amortization, and the incremental cost of retention agreements
with key employees.
College Publishing. The College Publishing segment's operating loss for
the six months ended June 30, 2003 increased $17.7 million to $37.1 million from
$19.4 million in the same period for 2002. The increase in the operating loss
was primarily due to the employee retention charge, higher publishing rights
amortization, and higher depreciation expense for technology initiatives in
digitizing our content.
28
Trade and Reference Publishing. The Trade and Reference Publishing
segment's operating loss for the six months ended June 30, 2003 increased $2.8
million to a loss of $3.4 million from a loss of $0.6 million in the same period
for 2002. The increase in the operating loss was due to lower sales and the
employee retention charge.
Other. The Other segment's operating loss for the period ended June 30,
2003 increased by $2.7 million to a loss of $2.8 million from a loss of $0.1
million in the same period for 2002. The increase in the operating loss was due
to the employee retention charge.
Net Interest Expense
Net interest expense for the six months ended June 30, 2003 increased
$36.0 million, or 175.0%, to $56.6 million from $20.6 million in the same period
for 2002. The overall increase in net interest expense was due to higher
interest rates and increased level of debt as a result of the Acquisition.
Debt Extinguishment Charge
In the first quarter of 2003, we recorded a $48.4 million debt
extinguishment charge related to the tendering of the 2004 Senior Notes and 2006
Senior Notes and the repayment of the $500.0 million senior subordinated bridge
loan facility and the $275.0 million senior term loan under the senior credit
facility to finance the Acquisition.
Income Taxes
The income tax benefit for the six months ended June 30, 2003 increased
$30.1 million, or 91.4%, to $63.0 million from $32.9 million in the same period
for 2002. The increase in the income tax provision was primarily due to the
higher operating loss partially offset by a decrease in the effective tax rate
to 36.8% in the first six months of 2003 from 41.9% in the first six months of
2002.
Discontinued Operations
Discontinued operations for the six months ended June 30, 2003 was a
loss of $1.2 million compared to income of $1.6 million for the comparable
period in 2002. The results of Curriculum Advantage, which was sold on April 1,
2003, are presented in discontinued operations for the six months ended June 30,
2003 and the results of Curriculum Advantage and Sunburst, which was sold in
October 2002, are presented in discontinued operations for the comparable period
in 2002.
Preferred Stock Dividend and Redemption Costs
The preferred stock shares of a subsidiary were auctioned and redeemed
on December 30, 2002. There were no preferred stock dividends during the six
months ended June 30, 2003 and $2.0 million of dividends for the period ended
June 30, 2002.
LIQUIDITY AND CAPITAL RESOURCES
We derive approximately 85% of annual net sales from educational
publishing in the K-12 and College Publishing segments, which are markedly
seasonal businesses. We realize approximately 50% of net sales in the third
quarter. This sales seasonality affects our operating cash flow. We normally
incur a net cash deficit from all of our activities through the middle of the
third quarter of the year. We intend to fund the deficit through the drawdown of
cash and marketable securities, supplemented by borrowings under our revolving
senior credit facility in 2003.
29
During the six months ended June 30, 2003, we used $54.0 million of
cash, as well as $149.8 million of net borrowings, to cover our seasonal
operating loss and working capital needs and to fund pre-publication and capital
investments. During the six months of 2002, we used $1.7 million of cash and
$156.5 million of net borrowings to cover our seasonal working capital needs and
to fund pre-publication and capital investments.
Net cash used in operating activities was $123.3 million in the first
six months of 2003, a $34.1 million increase from the $89.2 million of cash used
in operating activities during the first six months of 2002. Net operating
results from continuing operations excluding depreciation, amortization, and
deferred financing amortization and extinguishment decreased by $19.3 million
primarily due to increased costs from retention agreements for key employees,
higher severance costs, higher interest expense, and debt extinguishment costs,
partially offset by higher sales. Changes in operating assets and liabilities
used $16.2 million more cash during the six months ended June 30, 2003 than in
the same period in 2002 mainly due to the tax refund received in 2002.
Cash required for investing activities was $68.4 million for the six
months ended June 30, 2003, an increase of $5.2 million from the $63.2 million
used in the same period in 2002. Higher pre-publication expenditures due to
increased investment in new products for sales opportunities in 2004 and beyond
were partially offset by lower property, plant, and equipment spending due to
lower spending on our new test center operations.
Net proceeds from financing activities decreased by $13.0 million for
the period ended June 30, 2003 compared to the same period in 2002. Our net
borrowings decreased by $6.7 million in the first six months of 2003 as compared
to the same period in 2002. In the first six months of 2003, we issued $600
million of 8-year notes and $400 million of 10-year notes. The net proceeds were
used to repay the $500 million subordinated bridge loan facility, plus accrued
interest, the $275 million senior term loan under the senior credit facility,
plus accrued interest, and $124.96 million of the $125 million 2006 Senior
Notes, plus accrued interest and consent fees. We additionally borrowed $73.0
million under our $325 million revolving senior credit facility.
Our primary source of liquidity will continue to be cash flow generated
from operations. We will also have available funds under our $325.0 million
revolving senior credit facility, subject to certain conditions. We expect that
our primary liquidity requirements will be for debt service, pre-publication
expenditures, capital expenditures, and working capital.
In connection with the Acquisition, we have incurred substantial
amounts of debt. Interest payments on this indebtedness have significantly
increased our funding requirements. On January 3, 2003, we purchased $99.2
million of $100.0 million of our 2004 Senior Notes. We borrowed an additional
$100 million pursuant to our senior term loan under our senior credit facility
to finance this purchase. On January 30, 2003, we issued $600.0 million 8.250%
senior notes that mature on February 1, 2011. We also issued $400 million 9.875%
senior subordinated notes that mature on February 1, 2013. The senior
subordinated notes were priced at 99.22% of principal amount to yield an
effective interest rate of 10.0%. The net proceeds from these notes were
approximately $950.9 million. The net proceeds from these two financings were
used to repay the $500.0 million senior subordinated bridge loan facility in
full and the $275.0 million senior term loan under the senior credit facility.
On February 13, 2003, we repurchased $124.96 million of the 2006 Senior Notes
using the proceeds from the notes issued on January 30, 2003.
30
As of June 30, 2003, we had total funded debt of approximately $1,207.5
million, including $73 million of short term borrowings under our revolving
senior credit facility. Subject to restrictions in our revolving senior credit
facility and the indentures governing the notes, we may incur additional
indebtedness for capital expenditures, acquisitions, and for other purposes.
We are involved in ordinary and routine litigation and matters
incidental to our business. There are no such matters pending that we expect to
be material in relation to our financial condition, results of operations, or
cash flows.
We believe that based on current and anticipated levels of operating
performance and conditions in our industries and markets, cash flow from
operations, together with availability under the revolving senior credit
facility, will be adequate for the foreseeable future to make required payments
of interest on our debt, including the notes, and fund our working capital and
capital expenditure requirements. Any future acquisitions, partnerships, or
similar transactions may require additional capital, and there can be no
assurance that this capital will be available to us.
RISK FACTORS
You should carefully consider the risk factors set forth in our Safe
Harbor Statement contained previously within this document as well as the other
factors detailed from time to time in the Company's filings with the SEC. These
risks are not the only risks facing us. Additional risks and uncertainties not
currently known to us or those we currently view to be immaterial may also
materially and adversely affect our business, financial condition, or results of
operations.
31
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks as part of our on-going business
operations. Our primary exposure following consummation of the Transactions
includes changes in interest rates as borrowings under our senior credit
facility will bear interest at floating rates based on the London InterBank
Offered Rate ("LIBOR") or prime rate, in each case plus an applicable borrowing
margin. We will manage our interest rate risk by balancing the amount of
fixed-rate and floating-rate debt. For fixed rate debt, interest rate changes
affect the fair market value but do not affect earnings or cash flows.
Conversely, for floating-rate debt, interest rate changes generally do not
affect the fair market value but do impact our earnings and cash flows, assuming
other factors are held constant. Up to $325.0 million of floating-rate
borrowings are available under the revolving senior credit facility. Interest
paid on borrowings under the revolving senior credit facility, in the six months
ended June 30, 2003, totaled $0.7 million. At June 30, 2003, there was $73.0
million in short term borrowings outstanding under the revolving senior credit
facility. We may use derivative financial instruments, where appropriate, to
manage our interest rate risks. However, as a matter of policy we will not enter
into derivative or other financial investments for trading or speculative
purposes. We do not have any speculative or leveraged derivative transactions.
Most of our sales are denominated in U.S. dollars; thus our financial results
are not subject to any material foreign currency exchange risks.
We do not have any off-balance-sheet financial instruments and we are
not party to any off-balance-sheet transactions.
32
ITEM 4. CONTROLS AND PROCEDURES
a. During the period covered by this report, the Registrant's
interim Chief Executive Officer ("CEO") and Chief Financial
Officer ("CFO") conducted an evaluation of the effectiveness
of the design and operation of our disclosure controls and
procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the
Securities and Exchange Act of 1934. Based upon that
evaluation such officers concluded that, as of the end of the
period, our disclosure controls and procedures are effective
to ensure that information is gathered, analyzed and disclosed
on a timely basis. The Company's management, including the CEO
and CFO, recognizes that our disclosure controls and our
internal controls cannot prevent all errors or all attempts at
fraud. Any controls system, no matter how well crafted and
operated, can only provide reasonable, and not absolute,
assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact
that there are resource constraints that affect the operation
of any such system and that the benefits of controls must be
considered relative to their costs. Because of the inherent
limitations in any control system, no evaluation or
implementation of a control system can provide complete
assurance that all control issues and all possible instances
of fraud have been or will be detected. These inherent
limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur
because of simple error or mistake.
b. There have been no significant changes in the Registrant's
internal controls or in other factors that have materially
affected or is reasonably likely to materially affect the
Registrant's internal control over financial reporting
subsequent to the date of the evaluation referred to above.
33
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1 Severance Agreement of Mr. Hans Gieskes
31.1 Certification by Sylvia Meyater pursuant to Rule 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification by David R. Caron pursuant to Rule 13a-14(a) and
15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification by Sylvia Metayer pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification by David R. Caron pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
b. The following Current Report on Form 8-K was filed or furnished with
the SEC:
Current Report on Form 8-K dated August 5, 2003 which included
a press release announcing the appointment of a new Chief Executive
Officer and Registrant's results for the quarter ended June 30, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly.
HOUGHTON MIFFLIN COMPANY
(Registrant)
Date: August 14, 2003 /s/ David R. Caron
-------------------------------
Chief Financial Officer
34