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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 FROM APRIL 1, 1999 TO JUNE 30, 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
NOT APPLICABLE
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
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 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of July 31, 1999.
Class Outstanding at July 31, 1999
- ------------------------------------- ----------------------------------
Common Stock, $1 par value 31,026,078
Preferred Stock Purchase Rights 31,026,078
1 of 37
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HOUGHTON MIFFLIN COMPANY
INDEX
<TABLE>
<CAPTION>
Page No.
Part I. Financial Information
<S> <C>
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
June 30, 1999 and 1998 and December 31, 1998 3 - 4
Consolidated Condensed Statements of Operations, Comprehensive
Income, and Retained Earnings -- Three Months Ended
June 30, 1999 and 1998 5
Consolidated Condensed Statements of Operations, Comprehensive
Income, and Retained Earnings -- Six Months Ended
June 30, 1999 and 1998 6
Consolidated Condensed Statements of Cash Flows
Six Months Ended June 30, 1999 and 1998 7
Notes to Unaudited Consolidated Condensed
Financial Statements 8 - 15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16 - 34
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 35
Part II. Other Information
Item 4. Submission of Matters to a Vote of
Security Holders 36
Item 6. Exhibits and Reports on Form 8-K 36
Signatures 37
</TABLE>
<PAGE> 3
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED BALANCE SHEETS
(unaudited; in thousands except share amounts)
<TABLE>
<CAPTION>
June 30, June 30, December 31,
1999 1998 1998
---------- ---------- ------------
ASSETS
<S> <C> <C> <C>
Current assets
Cash and cash equivalents $ 7,698 $ 6,567 $ 3,953
Marketable securities and time deposits
available for sale, at fair value 11,079 614 49,203
Accounts receivable 197,834 201,183 170,706
Less: allowance for bad debts and book returns 17,450 15,980 27,969
---------- ---------- ----------
180,384 185,203 142,737
Inventories
Finished goods 183,308 177,237 141,457
Work in process 4,009 5,773 4,294
Raw materials 5,739 7,112 5,918
---------- ---------- ----------
193,056 190,122 151,669
Deferred income taxes 28,721 34,061 --
Prepaid expenses 9,005 6,463 2,279
---------- ---------- ----------
Total current assets 429,943 423,030 349,841
Property, plant, and equipment
and book plates (net of accumulated
depreciation and amortization of
$194,649 in 1999, $186,709 in 1998
and $193,277 at December 31, 1998) 151,248 130,210 130,265
Goodwill and other intangible assets, net 460,150 449,497 445,223
Deferred income taxes 8,394 3,807 7,885
Other assets 50,507 73,615 42,353
---------- ---------- ----------
$1,100,242 $1,080,159 $ 975,567
========== ========== ==========
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
3
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HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED BALANCE SHEETS
(unaudited; in thousands except share amounts)
<TABLE>
<CAPTION>
June 30, June 30, December 31,
1999 1998 1998
----------- ----------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C> <C>
Current liabilities
Accounts payable $ 62,622 $ 51,568 $ 39,029
Commercial paper 185,586 218,427 11,894
Royalties 25,948 23,234 48,371
Salaries, wages, and commissions 9,610 7,635 27,177
Deferred income taxes -- -- 7,500
Other 32,865 27,573 27,019
Current portion of long-term debt 83,468 40,000 83,322
----------- ----------- -----------
Total current liabilities 400,099 368,437 244,312
Long-term debt 304,630 371,123 274,521
Accrued royalties payable 1,157 1,239 1,148
Other liabilities 30,210 26,350 28,459
Accrued postretirement medical benefits 29,144 28,389 28,839
Stockholders' equity
Preferred stock, $1 par value;
500,000 shares authorized, none issued -- -- --
Common stock, $1 par value;
(70,000,000 shares authorized; 30,930,077 shares
issued in 1999, 30,423,079 shares issued in 1998, and
30,549,706 shares issued at December 31, 1998) 30,930 30,423 30,550
Capital in excess of par value 105,194 71,509 95,740
Retained earnings 294,882 244,398 330,672
----------- ----------- -----------
431,006 346,330 456,962
Notes receivable from stock purchase agreements (4,665) (4,513) (4,621)
Unearned compensation related to
restricted stock (2,674) (6,385) (2,318)
Common shares held in treasury, at cost
(718,843 shares in 1999, 346,997
shares in 1998 and 374,052 shares
at December 31, 1998) (23,468) (7,555) (8,681)
Benefits Trust assets, at market (61,496) (41,628) (61,432)
Accumulated other comprehensive income (loss) (3,701) (1,628) 18,378
----------- ----------- -----------
Total stockholders' equity 335,002 284,621 398,288
----------- ----------- -----------
$ 1,100,242 $ 1,080,159 $ 975,567
=========== =========== ===========
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
4
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HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS,
COMPREHENSIVE INCOME, AND RETAINED EARNINGS
THREE MONTHS ENDED JUNE 30, 1999 AND 1998
(unaudited; in thousands except per share amounts)
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Net sales by industry segment:
K-12 Publishing $ 178,105 $ 161,297
College Publishing 21,861 21,265
Other 20,917 20,178
--------- ---------
220,883 202,740
Costs and expenses:
Cost of sales 101,626 95,291
Selling and administrative 96,688 84,596
--------- ---------
198,314 179,887
Operating income 22,569 22,853
Other income (expense):
Net interest expense (8,450) (9,806)
Equity in earnings (losses) of INSO Corporation -- (522)
Other expense -- (1,050)
--------- ---------
(8,450) (11,378)
--------- ---------
Income before taxes 14,119 11,475
Income tax provision 5,746 4,590
--------- ---------
Net income 8,373 6,885
Other comprehensive income (loss), net of tax:
Unrealized loss on available for sale securities (2,465) 271
--------- ---------
Comprehensive income $ 5,908 $ 7,156
========= =========
Retained earnings at beginning of period $ 290,116 $ 241,108
Net income 8,373 6,885
Dividends paid (3,607) (3,595)
--------- ---------
Retained earnings at end of period $ 294,882 $ 244,398
========= =========
Earnings per share:
Net income per share - basic $ 0.29 $ 0.24
Net income per share - diluted $ 0.29 $ 0.24
Cash dividends paid per common share $ 0.125 $ 0.125
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
5
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HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS,
COMPREHENSIVE INCOME, AND RETAINED EARNINGS
SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(unaudited; in thousands except per share amounts)
<TABLE>
<CAPTION>
1999 1998
---------- ---------
<S> <C> <C>
Net sales by industry segment:
K-12 Publishing $ 230,076 $ 200,549
College Publishing 36,726 36,659
Other 38,362 37,165
--------- ---------
305,164 274,373
Costs and expenses:
Cost of sales 158,863 148,515
Selling and administrative 178,549 156,393
--------- ---------
337,412 304,908
Operating loss (32,248) (30,535)
Other income (expense):
Net interest expense (15,220) (18,106)
Equity in earnings (losses) of INSO Corporation -- (25)
Other expense -- (1,050)
--------- ---------
(15,220) (19,181)
--------- ---------
Loss before taxes (47,468) (49,716)
Income tax benefit (18,889) (19,886)
--------- ---------
Net loss (28,579) (29,830)
Other comprehensive income (loss), net of tax:
Unrealized loss on available for sale securities (22,079) 270
--------- ---------
Comprehensive loss $ (50,658) $ (29,560)
========= =========
Retained earnings at beginning of period $ 330,672 $ 281,411
Net loss (28,579) (29,830)
Dividends paid (7,211) (7,183)
--------- ---------
Retained earnings at end of period $ 294,882 $ 244,398
========= =========
Earnings per share:
Net loss per share - basic $ (0.99) $ (1.05)
Net loss per share - diluted (except when anti-dilutive) $ (0.99) $ (1.05)
Cash dividends paid per common share $ 0.250 $ 0.250
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
6
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HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(unaudited; in thousands)
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net loss $ (28,579) $ (29,830)
Adjustments to reconcile net loss to net cash
used in operating activities:
Equity in earnings (losses) of INSO Corporation -- 25
Depreciation and amortization 35,085 38,231
Amortization of unearned compensation on restricted stock 496 1,110
Changes in operating assets and liabilities:
Accounts receivable, net (34,270) (25,696)
Inventories (40,115) (45,079)
Accounts payable 22,661 3,956
Royalties, net (25,667) (18,290)
Deferred and income taxes payable (22,876) (22,009)
Salaries, wages, and commissions (18,175) (13,990)
Other, net 1,631 (3,578)
--------- ---------
NET CASH USED IN OPERATING ACTIVITIES (109,809) (115,150)
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Book plate expenditures (22,150) (23,814)
Acquisition of publishing and technology assets (42,760) (1,302)
Property, plant, and equipment expenditures (11,201) (9,500)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (76,111) (34,616)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Dividends paid on common stock (7,211) (7,183)
Issuance of commercial paper 123,692 157,081
Issuance of long-term financing 80,000 --
Payment of long-term financing (38) --
Exercise of stock options 759 1,078
Purchase of treasury stock (7,580) --
Other 44 (264)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 189,666 150,712
Increase in cash and cash equivalents 3,745 946
Cash and cash equivalents at beginning of period 3,953 5,621
--------- ---------
Cash and cash equivalents at end of period $ 7,698 $ 6,567
========= =========
Supplementary disclosure of cash flow information:
Income taxes paid $ 1,216 $ 1,583
Interest paid $ 14,779 $ 19,050
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
7
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements of
Houghton Mifflin Company and its subsidiaries have been prepared in accordance
with generally accepted accounting principles for interim financial information.
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 interim periods 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.
The information contained in the interim financial statements should be
read in conjunction with Houghton Mifflin's latest Annual Report on Form 10-K,
as amended by Form 10-K/A, filed with the Securities and Exchange Commission.
Certain reclassifications have been made to prior period financial
statements in order to conform to the presentation used in the 1999 interim
financial statements.
(2) INSO CORPORATION
During the third quarter of 1998, Houghton Mifflin's ownership of INSO
Corporation, or INSO, dropped below 20%; therefore, Houghton Mifflin no longer
records its investment in INSO under the equity method. Instead, Houghton
Mifflin accounts for the remaining shares held of INSO common stock in
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." These securities are
classified as available for sale and are carried at fair market value based on
the quoted market price.
The fair market value of these securities, $10.4 million, is included in
current assets under marketable securities, due to Houghton Mifflin's use of
them to redeem the remaining outstanding 6% Exchangeable Notes due 1999 - Stock
Appreciation Income Linked Securities, or SAILS, due on August 2, 1999. See Note
11 for the disclosure of the subsequent event transaction.
Prior to the third quarter of 1998, these securities were included in other
assets and carried at cost, adjusted for Houghton Mifflin's proportionate share
of INSO's undistributed earnings and losses and the effects of INSO's equity
activity.
(3) 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 $33.7 million, of which $32.0 million was paid to the former
shareholders of Sunburst and $1.7 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 $23.4 million were recorded as
part of the acquisition.
8
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(3) ACQUISITIONS - continued
On January 8, 1999, Houghton Mifflin acquired the assets of 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 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 $4.9 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, will be
amortized on a straight-line basis over a period of eight years.
On December 16, 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 twelve 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 at the time of 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. In January 1999, an
additional $2.0 million was paid to the former shareholders of CAT based on the
achievement of operational targets set forth in the acquisition agreement. In
addition, based on the acquisition agreement, there remains up to $4 million of
additional consideration that is contingent upon the achievement of certain
future financial targets. 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 represents
an integrated application suite of products whose functionality includes test
development, automated assembly and test production, test administration,
scoring, automated test reporting, and test security. The amount of the charge
represents 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. Goodwill and other intangible assets of $9.4 million
were recorded as part of the acquisition and are being amortized on a
straight-line basis over periods ranging from approximately three to ten years.
Additional goodwill will be recorded if the contingent consideration is earned.
None of the above acquisitions materially affect consolidated results;
therefore, no pro forma information is provided.
9
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(4) GOODWILL AND INTANGIBLE ASSETS
Goodwill and other intangible assets consist of the following:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998 1998
--------- ------------- ------------
(in thousands)
<S> <C> <C> <C>
Goodwill and other
intangible assets $ 555,598 $ 515,129 $ 525,279
Publishing rights 17,724 17,724 17,724
Other 4,000 4,000 4,000
Less: accumulated amortization (117,172) (87,356) (101,780)
--------- --------- ---------
Total $ 460,150 $ 449,497 $ 445,223
========= ========= =========
</TABLE>
The carrying values of goodwill and other intangibles are periodically
reviewed to determine recoverability based on projected net cash flows over the
remaining life of the related business unit. If the analysis indicates that
impairment has occurred, Houghton Mifflin will adjust the book value of the
intangible asset to the undiscounted net cash flow amount.
(5) EARNINGS PER SHARE
The table below sets forth the computation of basic and diluted earnings
per share for the three months ended June 30, 1999 and June 30, 1998 (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
Three months ended
June 30,
---------------------------
1999 1998
------- -------
<S> <C> <C>
Numerator:
Net income $ 8,373 $ 6,885
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding 28,788 28,524
Effect of dilutive securities:
Employee stock options 534 355
Restricted stock 27 37
Performance shares -- --
------- -------
561 392
Denominator for diluted earnings per share:
Adjusted weighted-average shares
outstanding and assumed conversions 29,349 28,916
======= =======
Basic earnings per share: $ 0.29 $ 0.24
======= =======
Diluted earnings per share: $ 0.29 $ 0.24
======= =======
</TABLE>
10
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(5) EARNINGS PER SHARE - continued
The table below sets forth the computation of basic and diluted earnings
per share for the six months ended June 30, 1999 and June 30, 1998 (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
Six months ended
June 30,
----------------------------
1999 1998
-------- --------
<S> <C> <C>
Numerator:
Net loss $(28,579) $(29,830)
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding 28,772 28,494
Effect of dilutive securities: -- --
Denominator for diluted earnings per share:
Adjusted weighted-average shares
outstanding and assumed conversions 28,772 28,494
======== ========
Basic loss per share: $ (0.99) $ (1.05)
======== ========
Diluted loss per share (except when anti-dilutive): $ (0.99) $ (1.05)
======== ========
</TABLE>
Options to purchase 22,000 shares of common stock at June 30, 1999 were not
included in the computation of diluted earnings per share for the three months
ended June 30, 1999 because the options' exercise prices were greater than the
average market prices of the common shares, and therefore, the effect would be
anti-dilutive. Options to purchase 247,534 shares of common stock at June 30,
1998 were not included in the computation of diluted earnings per share for the
three months ended June 30, 1998 for the same reason.
For the six months ended June 30, 1999 and 1998, no dilutive securities
were included in the computation of diluted earnings per share because Houghton
Mifflin had a net loss, and the effect would have been anti-dilutive.
(6) ACCOUNTING CHANGE
In the first quarter of 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 to a specific identification method by which
amortization will commence in the year of publication and is being made
prospectively for book plate additions beginning in 1999. The change reflects a
better match of amortization expense with the related revenue and is consistent
with the method used by other major publishers. This change did not have a
material effect on results for six months ended June 30, 1999.
11
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(7) COST OF START-UP ACTIVITIES
In 1998, the Accounting Standards Executive Committee issued Statement of
Position 98-5, "Reporting on the Costs of Start-up Activities," which was
required to be adopted for fiscal years beginning after December 15, 1998. This
statement requires costs of start-up activities to be expensed as incurred. The
adoption of this Statement had no effect on Houghton Mifflin's results.
(8) COST OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE
In 1998, the Accounting Standards Executive Committee issued Statement of
Position 98-1, or SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," which was required to be adopted for
fiscal years beginning after December 15, 1998. This statement requires costs of
software for internal use, which includes software that is acquired, internally
developed, or modified solely to meet the entity's internal needs, to be
capitalized. Prior to the adoption of SOP 98-1, Houghton Mifflin had expensed
internally incurred costs in the application development stage relating to
software for internal use. This change did not have a material effect on results
for the six months ended June 30, 1999.
(9) SEGMENT AND RELATED INFORMATION
In 1998, Houghton Mifflin adopted the Financial Accounting Standards
Board's Statement No. 131, "Disclosure About Segments of an Enterprise and
Related Information," which requires public companies to report financial and
descriptive information about their operating segments in interim financial
reports to shareholders.
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: School Division,
McDougal Littell Inc., Great Source Education Group, Inc., Houghton Mifflin
Interactive Corporation, or HMI, and The Riverside Publishing Company. Beginning
in 1999, Houghton Mifflin focused HMI's business on the growing educational
technology marketplace rather than on the retail market. HMI's products are sold
primarily in the K-12 school marketplace; therefore, the 1999 information
relating to HMI is included in the K-12 Publishing segment. This operating
segment includes textbooks and instructional materials and services, tests for
measuring achievement and aptitude, clinical/special needs testing products,
computer-assisted as well as computer-managed 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.
12
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(9) SEGMENT AND RELATED INFORMATION - continued
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, and technology-based instructional materials and
services for introductory and upper level courses in the post-secondary
education market. 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 & Reference Division, CAT, and
unallocated corporate-related items. In 1998, HMI'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 & Reference Division publishes fiction
and nonfiction for adults and children, dictionaries, and other reference works.
The division also sells book reprint rights to paperback publishers, book clubs,
and other publishers 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 Unites 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 following tables summarize financial information concerning Houghton
Mifflin's reportable segments. 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 income
(loss), income and expense not allocated to reportable segments.
13
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(9) SEGMENT AND RELATED INFORMATION - continued
THREE MONTHS ENDED JUNE 30, 1999 AND JUNE 30, 1998:
<TABLE>
<CAPTION>
K-12 COLLEGE
PUBLISHING PUBLISHING OTHER CONSOLIDATED
---------- ---------- --------- --------------
(in thousands)
<S> <C> <C> <C> <C>
1999
Net sales from external customers $ 178,105 $ 21,861 $ 20,917 $ 220,883
Segment operating income (loss) 33,186 (6,101) (4,516) 22,569
1998
Net sales from external customers 161,297 21,265 20,178 202,740
Segment operating income (loss) 31,063 (4,680) (3,530) 22,853
</TABLE>
RECONCILIATION OF SEGMENT INCOME (LOSS) TO THE CONSOLIDATED CONDENSED
STATEMENTS OF OPERATIONS:
<TABLE>
<CAPTION>
June 30,
1999 1998
---------- --------
(in thousands)
<S> <C> <C>
Total income from reportable segments $ 22,569 $ 22,853
Unallocated income (expense):
Net interest expense (8,450) (9,806)
Equity in earnings of INSO Corporation -- (522)
Other expense -- (1,050)
======== ========
Income before taxes $ 14,119 $ 11,475
======== ========
</TABLE>
SIX MONTHS ENDED JUNE 30, 1999 AND JUNE 30, 1998:
<TABLE>
<CAPTION>
K-12 COLLEGE
PUBLISHING PUBLISHING OTHER CONSOLIDATED
---------- ---------- --------- -------------
(in thousands)
<S> <C> <C> <C> <C>
1999
Net sales from external customers $ 230,076 $ 36,726 $ 38,362 $ 305,164
Segment operating loss (8,498) (15,001) (8,749) (32,248)
1998
Net sales from external customers 200,549 36,659 37,165 274,373
Segment operating loss (10,687) (14,002) (5,846) (30,535)
</TABLE>
14
<PAGE> 15
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(9) SEGMENT AND RELATED INFORMATION - continued
RECONCILIATION OF SEGMENT LOSSES TO THE CONSOLIDATED CONDENSED STATEMENTS OF
OPERATIONS:
<TABLE>
<CAPTION>
June 30,
1999 1998
-------- --------
(in thousands)
<S> <C> <C>
Total loss from reportable segments ($32,248) ($30,535)
Unallocated income (expense):
Net interest expense (15,220) (18,106)
Equity in earnings of INSO Corporation -- (25)
Other expense -- (1,050)
======== ========
Loss before taxes ($47,468) ($49,716)
======== ========
</TABLE>
(10) DEBT AND BORROWING AGREEMENTS
In April 1999, Houghton Mifflin issued $50 million of floating rate and $30
million of 5.99% medium-term notes through a public offering. The $50 million
medium-term notes mature on December 1, 2000. The $50 million of floating rate
debt was swapped to a fixed rate using the two interest-rate swaps (5.90% and
5.95%) that were available, each with a notional amount of $25 million. 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.
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.
(11) SUBSEQUENT EVENTS
At its July 28, 1999 meeting, the Board of Directors declared a quarterly
dividend of $0.13 per share, payable on August 25, 1999, to shareholders of
record on August 11, 1999.
On August 1, 1999 all of the Outstanding 6% Exchangeable Notes Due 1999 or
Stock Appreciation Income Linked Securities ("SAILS") having an aggregate face
value of Sixty-Five Million Two-Hundred and Eighty Thousand Dollars
($65,280,000) issued by Houghton Mifflin Company matured. In accordance with the
terms of the SAILS, on August 2, 1999, Houghton Mifflin Company delivered (i)
two shares of the common stock of INSO Corporation for each SAILS and (ii) cash
in an amount equal to all accrued and unpaid interest on the outstanding SAILS.
15
<PAGE> 16
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Houghton Mifflin's principal business is publishing, and its operations are
classified in three operating segments: K-12 Publishing, College Publishing, and
Other.
K-12 Publishing
This operating segment includes textbooks and instructional materials and
services, tests for measuring achievement and aptitude, clinical/special needs
testing products, computer-assisted as well as computer-managed 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, 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;
* Houghton Mifflin Interactive 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.
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
16
<PAGE> 17
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 district's selection and purchase of instructional materials.
After adopting, or selecting, instructional materials, schools later decide the
quantity and timing of their purchases.
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, high school advanced placement
courses, and for-profit, certificate-granting institutions that offer
skill-based training and job placement.
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 products 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, college-level products are selected through the adoption process.
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.
17
<PAGE> 18
The Trade Division publishes fiction and nonfiction for adults and
children, dictionaries, and other reference works. 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 sells book reprint rights to
paperback publishers, book clubs, and other publishers in the United States and
abroad, and reference materials to schools, colleges, office supply
distributors, and businesses. CAT specializes in developing and delivering
computer-based testing solutions to organizations worldwide.
Company Business as a Whole
Houghton Mifflin derives almost 90% of its 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, Houghton Mifflin realizes more than 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.
Houghton Mifflin also characteristically posts 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 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 Houghton
Mifflin's business, schedules of school adoptions and market acceptance of its
products can affect year-to-year revenue performance.
18
<PAGE> 19
RESULTS OF OPERATIONS:
SECOND QUARTER 1999 COMPARED TO SECOND QUARTER 1998
IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS
NET INCOME:
<TABLE>
<CAPTION>
Three months ended June 30,
------------------------------------------
Earnings per share
1999 1998 1999 1998
------- ------- ------ ------
<S> <C> <C> <C> <C>
Income after tax, but excluding infrequent items: $ 8,373 $ 7,222 $ 0.29 $ 0.25
Other losses, net of taxes -- (337) -- (0.01)
------- ------- ------ ------
Net income $ 8,373 $ 6,885 $ 0.29 $ 0.24
======= ======= ====== ======
</TABLE>
For the quarter ended June 30, 1999, consolidated net income was $8.4
million, or $0.29 per share, compared to net income of $6.9 million, or $0.24
per share, for the same period in 1998.
Income after tax, but excluding infrequent items, for the second quarter of
1999 was $8.4 million, or $0.29 per share, compared to income after tax, but
excluding infrequent items, of $7.2 million, or $0.25 per share, in the second
quarter of 1998. The primary reasons for the increase were 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 (acquired in July 1998), higher intangible asset
amortization, and higher distribution expenses.
In the second quarter of 1998, Houghton Mifflin recognized an infrequent
charge of $0.6 million ($0.3 million after tax) related to INSO's acquisition of
ViewPort Development AB.
NET SALES:
<TABLE>
<CAPTION>
Three months ended June 30,
-------------------------------------------------
Increase(decrease)
1999 1998 $ %
-------- -------- --------- ------
<S> <C> <C> <C> <C>
K-12 Publishing $178,105 $161,297 $ 16,808 10.4%
College Publishing 21,861 21,265 596 2.8
Other 20,917 20,178 739 3.7
======== ======== =========
Total net sales $220,883 $202,740 $ 18,143 8.9%
======== ======== =========
</TABLE>
19
<PAGE> 20
Net sales of $220.9 million for the quarter ended June 30, 1999 increased
$18.1 million, or 8.9%, from $202.7 million reported in the second quarter of
1998. The K-12 Publishing segment's net sales of $178.1 million in the second
quarter of 1999 increased $16.8 million, or 10.4%, from net sales of $161.3
million in the second quarter of 1998. The increase was attributable to strong
sales of the School Division's reading and science programs, Great Source
Education Group's Write Source products, The Riverside Publishing Company's
custom testing products, and HMI's Sunburst products. The net sales gain was the
result of positive customer response to Houghton Mifflin's products; the
continued strength of the market for instructional materials; and sales of
DiscoveryWorks, the elementary school science program acquired in December 1998,
and of multimedia instructional products acquired with Sunburst in May 1999.
McDougal Littell reported slightly lower sales than in the same period last
year, when results benefited from strong early sales in adoption and open
territory states. The College Publishing segment's net sales of $21.9 million in
the second quarter of 1999 were slightly higher than the second quarter of 1998.
The Other segment's net sales in the second quarter of 1999 increased $0.7
million, or 3.7%, to $20.9 million from last year's second-quarter net sales of
$20.2 million. This was primarily due to the Trade Division's higher sales of
adult trade and children's titles.
COSTS AND EXPENSES:
<TABLE>
<CAPTION>
Three months ended June 30,
--------------------------------------------------
Increase(decrease)
1999 1998 $ %
-------- -------- -------- ------
<S> <C> <C> <C> <C>
Cost of sales $101,626 $ 95,291 $ 6,335 6.6%
Selling and administrative, excluding
intangible asset amortization 88,828 77,570 11,258 14.5
Intangible asset amortization 7,860 7,026 834 11.9
-------- -------- --------
Total costs and expenses $198,314 $179,887 $ 18,427 10.2%
======== ======== ========
</TABLE>
20
<PAGE> 21
Cost of sales:
Cost of sales in the second quarter of 1999 increased $6.3 million, or
6.6%, to $101.6 million from $95.3 million in the second quarter of 1998. The
increased cost of sales was due to higher editorial expenses, incurred for the
development of new programs and services and product revisions in preparation
for the sales opportunities in 2000 and beyond, and increased manufacturing
costs, which are the result of higher sales. Lower plate amortization partially
offset these increases. As a result of higher net sales, cost of sales decreased
as a percentage of sales, to 46.0% in the second quarter of 1999 from 47.0% in
the second quarter of 1998.
Selling and administrative:
In the second quarter of 1999, selling and administrative expenses,
excluding intangible asset amortization, were $88.8 million, an increase of
$11.3 million, or 14.5%, from $77.6 million in the second quarter of 1998. This
increase was due to higher selling, distribution, and administrative expenses.
Selling expense increased due to expansion of the sales staff and higher
promotional expense relating to the greater number of sales opportunities in our
markets in 1999. Distribution expenses increased due to the higher sales volume
and warehousing fees. In addition, the acquisitions of CAT and Sunburst
contributed to increased selling and administrative expenses in 1999. As a
percentage of sales, selling and administrative expenses, excluding intangible
asset amortization, increased to 40.2% in the second quarter of 1999 from 38.3%
in the second quarter of 1998.
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 $7.9 million in the
second quarter of 1999 from $7.0 million in the same period last year.
21
<PAGE> 22
OTHER INCOME AND EXPENSE:
In the second quarter of 1998, Houghton Mifflin recognized $0.5 million in
equity losses of INSO Corporation, representing $0.1 million of INSO's earnings
offset by an infrequent charge of $0.6 million related to INSO's acquisition of
ViewPort Development AB.
Houghton Mifflin recognized a $1.1 million charge in the second quarter of
1998 related to its unsuccessful bid for a portion of Simon & Schuster's
publishing assets.
NET INTEREST EXPENSE:
Net interest expense of $8.4 million for the second quarter of 1999 was
$1.4 million lower than in the same period in 1998. The reduction was primarily
due to the redemption on August 1, 1998 of $63.3 million of SAILS and the
repayment of $39.5 million of debt at the end of 1998.
INCOME TAXES:
The income tax provision increased $1.2 million over the same period last
year. This increase was due to the increase in operating income and an increase
in the effective tax rate to 40.7% in the second quarter of 1999 from 40.0% in
the second quarter of 1998. The increase in the effective tax rate was primarily
due to an increase in non-deductible goodwill amortization.
K-12 PUBLISHING:
Operating income for the K-12 Publishing segment increased $2.1 million, or
6.8%, to $33.2 million in the second quarter of 1999 compared to $31.1 million
in the second quarter of 1998. The higher operating income was due to higher
sales partially offset by higher cost of sales and selling and administrative
expenses. Cost of sales increased due to higher editorial expenses, incurred for
new program development and product revisions in preparation for sales
opportunities in 2000 and beyond, and higher manufacturing costs, which are the
result of higher sales. Lower plate amortization partially offset these
increases. The increase in selling expenses was due to expansion of the sales
staff and higher promotional expense related to the increase
22
<PAGE> 23
in sales opportunities in 1999 over 1998. Distribution expenses increased due to
higher sales volume. Administrative expenses rose as spending on efforts to
improve customer support systems and to address the Year 2000 computer issue
increased.
COLLEGE PUBLISHING:
The College Publishing segment's operating loss was $6.1 million in the
second quarter of 1999, compared to $4.7 million for the same period in 1998.
The increase in the operating loss was primarily due to higher cost of sales and
selling and administrative costs. The higher cost of sales was due to higher
manufacturing costs. The increase in selling expenses was due to expansion of
the sales staff for sales opportunities in 1999 and beyond. Administrative
expenses rose as spending on efforts to improve customer support systems and to
address the Year 2000 computer increased.
OTHER:
The Other segment's net sales in the second quarter of 1999 increased $0.7
million, or 3.7%, to $20.9 million from last year's second-quarter net sales of
$20.2 million. The increase was primarily due to the Trade Division, which had
increased sales from its adult trade and children's titles. The sales increase
was also due to the inclusion of CAT, which was acquired in July 1998. Partially
offsetting these increases was lower revenue due to the shift of HMI to the K-12
Publishing segment beginning in 1999.
The Other segment's operating loss was $4.5 million in the second quarter
of 1999 compared to $3.5 million in the same period in 1998. The increased
operating loss was primarily due to the operating expenses and intangible asset
amortization of CAT, higher distribution expenses, and higher administrative
expenses, partially offset by higher sales. Distribution expenses increased due
to higher sales volume and warehousing fees; administrative expenses rose due to
higher costs related to information systems initiatives and the Year 2000
computer issue.
23
<PAGE> 24
SIX MONTHS ENDED JUNE 30, 1999 AND 1998
IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS
NET INCOME:
<TABLE>
<CAPTION>
Six months ended June 30,
-------------------------------------------
Loss per share
1999 1998 1999 1998
-------- --------- -------- -------
<S> <C> <C> <C> <C>
Loss after tax, but excluding infrequent items: $(28,579) $(29,379) $ (0.99) $ (1.03)
Other losses, net of taxes -- (451) -- (0.02)
-------- --------- -------- -------
Net loss $(28,579) $(29,830) $ (0.99) $ (1.05)
======== ========= ======== =======
</TABLE>
The consolidated net loss for the six months ended June 30, 1999 was $28.6
million, or $0.99 per share, compared to a net loss of $29.8 million, or $1.05
per share, for the same period in 1998.
The loss after tax, but excluding infrequent items, for the six months
ended June 30, 1999 was $28.6 million, or $0.99 per share, compared to $29.4
million, or $1.03 per share, for the same period in 1998. The improvement in
first-half 1999 results was due to higher sales and lower interest expense,
offset by increased editorial costs, higher selling and administrative expense,
CAT's losses, and additional intangible asset amortization.
During the six months ended June 30, 1998, Houghton Mifflin recorded an
infrequent charge of $0.8 million ($0.5 million after tax), or $0.02 per share,
related to INSO's acquisitions of Henderson Software and ViewPort Development
AB.
NET SALES:
<TABLE>
<CAPTION>
Six months ended June 30,
---------------------------------------------------
Increase(decrease)
1999 1998 $ %
-------- -------- ------- -----
<S> <C> <C> <C> <C>
K-12 Publishing $230,076 $200,549 $29,527 14.7%
College Publishing 36,726 36,659 67 0.2
Other 38,362 37,165 1,197 3.2
-------- -------- -------
Total net sales $305,164 $274,373 $30,791 11.2%
======== ======== =======
</TABLE>
24
<PAGE> 25
Net sales for the six months ended June 30, 1999 were $305.2 million, an
increase of 11.2% from the $274.4 million reported in the same period in 1998.
The K-12 Publishing segment's net sales increased $29.5 million, or 14.7%, to
$230.1 million in the six months ended June 30, 1999, from net sales of $200.5
million in the same period in 1998. The increase was due to higher net sales in
all divisions in the K-12 Publishing segment. The net sales gain was the result
of positive customer response to Houghton Mifflin's products; continued strength
of the market for instructional materials; and sales of DiscoveryWorks, the
elementary school science program acquired in December 1998, and of multimedia
instructional materials acquired with Sunburst in May 1999. The College
Publishing segment's net sales of $36.7 million in the first half of 1999 were
flat compared to last year. The Other segment's net sales for the six months
ended June 30, 1999 increased $1.2 million, or 3.2%, to $38.4 million from $37.2
million in the first half of 1998. This was primarily due to the Trade
Division's increased sales from its adult list.
COSTS AND EXPENSES:
<TABLE>
<CAPTION>
Six months ended June 30,
-------------------------------------------------
Increase (decrease)
1999 1998 $ %
-------- -------- -------- -----
<C> <C> <C> <C>
Cost of sales $158,863 $148,515 $ 10,348 7.0%
Selling and administrative, excluding
intangible asset amortization 163,156 142,308 20,848 14.6
Intangible asset amortization 15,393 14,085 1,308 9.3
-------- -------- -------- -----
Total costs and expenses $337,412 $304,908 $ 32,504 10.7%
======== ======== ======== =====
</TABLE>
Cost of sales:
During the six months ended June 30, 1999, cost of sales increased $10.3
million, or 7.0%, to $158.9 million from $148.5 million during the same period
in 1998. The increased cost of sales was due to higher net sales and increased
editorial expense related to new program development and product revisions in
preparation for the sales opportunities in 2000 and beyond. Lower plate
amortization
25
<PAGE> 26
partially offset these increases. As a percent of sales, cost of sales decreased
to 52.1% in 1999 from 54.1% in 1998.
Selling and administrative:
For the six months ended June 30, 1999, selling and administrative
expenses, excluding intangible asset amortization, were $163.2 million, an
increase of $20.8 million, or 14.6%, from $142.3 million for the same period in
1998. The primary reasons for this increase were higher selling costs related to
significant sales opportunities in 1999, higher distribution expenses due to
higher sales volume and warehousing fees, and increased spending on efforts to
improve customer support systems and to address the Year 2000 computer issue.
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,
intangible asset amortization increased to $15.4 million in the six months ended
June 30, 1999 from $14.1 million in the same period last year.
OTHER INCOME AND EXPENSE:
During the six months ended June 30, 1998, Houghton Mifflin recognized $0.8
million of INSO's earnings offset by infrequent charges of $0.8 million related
to INSO's acquisitions of Henderson Software and ViewPort Development AB.
Houghton Mifflin also recognized a $1.1 million charge, related to its
unsuccessful bid for a portion of Simon & Schuster's publishing assets.
NET INTEREST EXPENSE:
Net interest expense for the six months ended June 30, 1999 decreased by
$2.9 million to $15.2 million from $18.1 million for the same period in 1998.
The reduction was primarily due to the redemption on August 1, 1998 of $63.3
million of SAILS and the repayment of $39.5 million of debt at the end of 1998.
26
<PAGE> 27
INCOME TAX PROVISION:
The income tax benefit decreased $1 million, or 5.0%, during the six months
ended June 30, 1999 compared to the same period last year, primarily due to the
lower operating loss in 1999 than in 1998. The effective tax rate for the six
months ended June 30, 1999 was 39.8% compared to 40.0% for the same period in
1998.
K-12 PUBLISHING:
The K-12 Publishing segment's net sales of $230.1 million during the six
months ended June 30, 1999 increased $29.5 million, or 14.7%, from net sales of
$200.5 million in the same period of 1998. The increase was attributable to
strong sales of the School Division's reading and science programs, McDougal
Littell's social studies products, Great Source Education Group's Write Source
products, The Riverside Publishing Company's custom testing products, and HMI's
Sunburst products.
As a result of higher net sales, the operating loss for the K-12 Publishing
segment was $8.5 million in the first half of 1999 compared to $10.7 million in
the same period of 1998. Cost of sales and selling and administrative expenses
increased in the first half of 1999. Cost of sales rose due to higher editorial
expenses, incurred for new program development and product revisions for the
sales opportunities in 2000 and beyond. Lower plate amortization partially
offset these increases. The increase in selling expenses was due to expansion of
the sales staff and higher promotional expense related to the increase in sales
opportunities in 1999 over 1998. Distribution expenses increased due to higher
sales volume and warehousing fees. Administrative expenses rose as spending on
efforts to improve customer support systems and to address the Year 2000
computer issue increased.
COLLEGE PUBLISHING:
The College Publishing segment's operating loss was $15.0 million in the
first half of 1999, compared to $14.0 million for the same period in 1998. The
increase in the operating loss was primarily caused by higher cost of sales and
selling and administrative expenses.
27
<PAGE> 28
OTHER:
The Other segment's net sales for the six months ended June 30, 1999
increased $1.2 million, or 3.2%, to $38.4 million from $37.2 million in the same
period of 1998. The increase was primarily due to the Trade Division, which had
increased sales of its adult titles. The sales increase was also due to the
inclusion of CAT, which was acquired in July 1998. Partially offsetting these
increases was lower revenue due to the shift of HMI to the K-12 Publishing
segment beginning in 1999.
The Other segment's operating loss was $8.7 million during the six months
ended June 30, 1999 compared to $5.8 million in the same period of 1998. The
increased operating loss was primarily due to the operating expenses and
intangible asset amortization of CAT, higher distribution expenses, and higher
administrative expenses, partially offset by higher sales.
LIQUIDITY AND CAPITAL RESOURCES
Houghton Mifflin's principal businesses are seasonal, with almost 90% of
its revenues derived from educational publishing in the K-12 and College
Publishing segments, markedly seasonal businesses. Houghton Mifflin realizes
more than 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 Houghton Mifflin's operating cash flow.
Houghton Mifflin normally incurs a net cash deficit from all of its activities
through the middle of the third quarter of the year. Houghton Mifflin funds the
deficit through the draw-down of cash and marketable securities, supplemented by
short-term borrowings, principally commercial paper.
During the six months ended June 30, 1999, Houghton Mifflin used $203.7
million of net borrowings to cover its seasonal operating loss and working
capital needs and to fund publishing and capital investments. During the six
months ended June 30, 1998, Houghton Mifflin used $157.1 million of net
borrowings to cover its seasonal operating loss and working capital needs and to
fund publishing and capital investments.
28
<PAGE> 29
Net cash used in operating activities was $109.8 million during the six
months ended June 30, 1999, a $5.3 million improvement from the $115.2 million
of cash used in operating activities during the same period in 1998. Net income
excluding non-cash items decreased by $2.5 million. Changes in operating assets
and liabilities provided $7.8 million more cash during the six months ended June
30, 1999 than in the same period in 1998.
Cash required for investing activities was $76.1 million during the six
months ended June 30, 1999, an increase of $41.5 million from the $34.6 million
required in the same period in 1998. The increase was principally due to the
acquisitions of Sunburst Communications and the Little Planet Literacy Series
and a contingent consideration payment related to the 1998 acquisition of CAT.
Net proceeds from financing activities increased by $39.0 million during
the six months ended June 30, 1999 from the same period in 1998. In the first
quarter of 1999, Houghton Mifflin made common stock repurchases totaling
approximately $7.6 million.
In January 1999, Houghton Mifflin refinanced $50 million outstanding under
its Revolving Credit Facility by issuing commercial paper. In April 1999,
Houghton Mifflin issued $80 million of medium-term notes; proceeds from this
issuance were used to repay existing commercial paper debt.
Houghton Mifflin believes its existing cash, expected positive cash flow
from operations, proceeds from the issuance of $80 million of medium-term notes,
and its existing credit facilities will be sufficient to finance the Sunburst
acquisition, fund publishing capital expenditures and dividend payments, and
cover working capital requirements for the full year.
On May 7, 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.
29
<PAGE> 30
EFFECT OF THE YEAR 2000 COMPUTER ISSUE
The statements in this section are "Year 2000 Readiness Disclosure" within
the meaning of the Year 2000 Information and Readiness Disclosure Act.
The Year 2000 computer issue is the result of computer programs being
written using two digits rather than four digits to define the applicable year.
Any of Houghton Mifflin's computer programs that have time-sensitive software
may recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, ship products, or engage in similar normal business
activities. In addition to hardware and software, the Year 2000 computer issue
may also affect printers, facsimile machines, security systems, elevators, and
other systems that are controlled by microprocessors. The Year 2000 computer
issue will affect Houghton Mifflin, its vendors and suppliers, customers, and
other third parties with whom Houghton Mifflin does business.
To address this issue, Houghton Mifflin has created a plan under the
direction of a Program Management Office, which consists of a team of Houghton
Mifflin personnel and third-party consultants. The phases of the plan include
assessment, remediation or replacement, testing and certification, and
implementation. As part of this effort, the Program Management Office provides
regular updates to management and the Board of Directors, as well as information
bulletins to the entire company.
Houghton Mifflin is focusing on the following four areas of exposure:
information technology; non-information technology, or non-IT systems (for
example, climate control systems, copy machines, security systems, etc.);
technology products sold by Houghton Mifflin; and third-party relationships.
Houghton Mifflin is using the status-of-completion method to evaluate its
progress on the Year 2000 computer issue. This method compares the level of
effort necessary to complete the task with the level of effort expended to date.
Information technology includes mainframe applications, client server
applications, end-user applications, infrastructure hardware and software,
30
<PAGE> 31
and networks and voice systems. Houghton Mifflin has completed the assessment
of all information technology systems that it believes could be significantly
affected by the Year 2000 computer issue, and has determined that it will have
to modify or replace significant portions of its software and certain hardware
so that those systems will properly utilize dates beyond December 31, 1999. The
assessment also showed that for certain older systems, such as customer order
management, accounts receivable, royalty, and human resources, complete
replacement of the applications was the best alternative. Complete replacement
will not only remediate the Year 2000 computer issue but will expand the current
system capabilities and provide a platform for Houghton Mifflin's future growth.
The replacement of the existing royalty system has been delayed until 2000 due
to a lack of resources to complete the project. Instead, Houghton Mifflin has
remediated the existing system to be Year 2000 compliant. The following chart
(excluding the customer order management system), includes the remediation of
the existing royalty system and presents the estimated average status of
completion for the information technology area and the expected completion date
for each phase.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
ESTIMATED AVERAGE % EXPECTED COMPLETION
RESOLUTION PHASE COMPLETION DATE
<S> <C> <C>
Assessment 100% Completed
Remediation or Replacement 90 September 30, 1999
Testing and Certification 75 November 30, 1999
Implementation 75 November 30, 1999
- ----------------------------------------------------------------------------------------------------------
</TABLE>
The estimated completion date has been extended for the remediation or
replacement phase to September 30, 1999 and the testing and implementation phase
to November 30, 1999. The extension is mainly due to the complexity of
remediating and testing the mainframe operating environment.
The expected completion date of the customer order management system has
been extended due to an increase in the scope of work to complete the project.
Houghton Mifflin has completed the assessment phase of this system and is
approximately 70% complete with the replacement phase and 40% complete with the
testing and certification phase. The replacement, testing, and implementation
31
<PAGE> 32
phases are expected to be completed by October 31, 1999. Houghton Mifflin has
also developed a contingency plan for this system, which includes remediation of
the existing system.
The following chart presents the estimated average status of completion for
critical non-IT systems and the expected completion date of each phase.
<TABLE>
<CAPTION>
ESTIMATED AVERAGE % EXPECTED COMPLETION
RESOLUTION PHASE COMPLETION DATE
<S> <C> <C>
Assessment 100% Completed
Remediation or Replacement 100 Completed
Testing and Certification 100 Completed
Implementation 79 September 30, 1999
</TABLE>
Houghton Mifflin is also in the process of assessing the compliance of its
technology product lines by testing the products in a Year-2000-compliant
environment. The test results will determine any required action, including
remediation, replacement, or retirement. In most cases, Houghton Mifflin
believes there will be no need for remediation or replacement of the product.
Houghton Mifflin has completed the assessment phase and believes that it will be
able to complete any appropriate remedial actions by December 31, 1999. Based on
preliminary results, Houghton Mifflin does not expect that the effect of Year
2000 issues on Houghton Mifflin's technology products presents a material
exposure.
Houghton Mifflin has identified its most important customers, suppliers,
and business partners (for example, printers, paper suppliers, distributors, and
financial institutions), and has contacted them to determine the extent to which
Houghton Mifflin may be vulnerable in the event that those parties fail to
properly correct their own Year 2000 computer issues. Houghton Mifflin
continues to monitor the responses and progress of these parties. In addition,
Houghton Mifflin intends to test critical systems interfaces, such as order
entry and inventory transactions. Houghton Mifflin is in the process of working
with the parties with whom it has these interfaces to reduce the risk of
business interruptions. To date, Houghton Mifflin is not aware of any third
party whose Year 2000 issues would have a material effect on Houghton Mifflin,
but has no independent means of ensuring that third parties will be Year 2000
ready or whether their remediation efforts will be compatible with those of
Houghton Mifflin.
32
<PAGE> 33
Houghton Mifflin is using both internal and external resources to reprogram
or replace and test software for Year 2000 modifications. Management currently
expects the total cost of the Year 2000 computer project, including costs to
enhance the functionality of certain systems as well as to address the Year 2000
computer issue, to be approximately $30-35 million, which is being funded
through operating cash flows. Of this total, approximately $10-14 million is for
the purchase of new software and hardware that will be capitalized. The
remaining $17-21 million will be expensed as incurred. As of June 30, 1999,
Houghton Mifflin had spent approximately $22 million ($12 million expensed and
$10 million capitalized for new systems) on its Year 2000 computer project and
the development of new systems and systems modifications.
Houghton Mifflin is currently evaluating the Year 2000 readiness of
Sunburst Communications, a company acquired in May 1999, and expects its
assessment to be completed by September 30, 1999. The above discussion,
therefore, does not include the effect of Sunburst on Houghton Mifflin's Year
2000 readiness.
Houghton Mifflin believes that it has an effective program in place to
resolve any Year 2000 computer issues in a timely manner. Although Houghton
Mifflin has not yet completed all the necessary phases of its Year 2000 program,
it believes that with modifications to existing software and conversions to new
software, the Year 2000 computer issue will not pose significant operational
problems for its computer systems. However, if such modifications and
conversions are not made or are not completed in time, or if a material third
party fails to properly remediate its computer problems, or if the costs are
higher than expected, the Year 2000 computer issue could have a material effect
on Houghton Mifflin's operations. While Houghton Mifflin is not presently aware
of any significant exposure, it cannot be sure that all Year 2000 remediation
processes will be completed and properly tested before the Year 2000, or that
contingency plans will be sufficient to mitigate the risk of all forms of Year
2000 readiness problems for Houghton Mifflin and its significant customers,
suppliers, and business partners. In the event that Houghton Mifflin or any of
its material suppliers or other third parties do not complete the necessary
33
<PAGE> 34
remediation, Houghton Mifflin could be subject to interruption of its normal
business activities, including its ability to take customer orders, manufacture
and ship products, invoice customers, collect payments, or engage in similar
routine operations, and there could be a material adverse effect on Houghton
Mifflin's revenues. Houghton Mifflin could also be subject to litigation for
computer systems failures or problems with its technology products. In addition,
disruptions in the economy generally resulting from the Year 2000 computer issue
could have a material adverse effect on Houghton Mifflin. The amount of
potential liability and lost revenues cannot reasonably be estimated at this
time.
To prepare for the possibility that it or a third party may be unable to
remediate or replace and properly test critical systems on a timely basis,
Houghton Mifflin will develop appropriate contingency plans after its assessment
of risk is complete. Houghton Mifflin has prepared preliminary contingency plans
for many of its information technology systems and will develop final plans
during 1999 for those areas Houghton Mifflin determines are at risk.
The projected costs and the dates on which Houghton Mifflin believes it
will complete the Year 2000 computer modifications are based on its best
estimates which, in turn, were based on numerous assumptions of future events,
including the continued availability of certain resources, third-party
modification plans, and other factors, many of which are not subject to Houghton
Mifflin's control. Houghton Mifflin cannot be sure that these estimates will be
achieved and actual results could differ materially from those anticipated.
There are many factors that could affect the accuracy of these estimates,
including the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer code, the ability of third
parties to resolve their own Year 2000 computer issues, and other uncertainties
referred to from time to time in Houghton Mifflin's filings with the Securities
and Exchange Commission.
34
<PAGE> 35
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For financial market risks related to changes in interest rates and equity
prices, reference is made to Part II, Item 7A, Quantitative and Qualitative
Disclosures About Market Risk, in the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998.
Due to the seasonal nature of the business, Houghton Mifflin's borrowings
under its commercial paper program typically increase through the third quarter
of each year. The outstanding commercial paper balance was $185.6 million at
June 30, 1999, $11.9 million at December 31, 1998, and $218.4 million at June
30, 1998. The average interest rate on the commercial paper for the six months
ended June 30, 1999 was 5.10%. The carrying value of the commercial paper equals
fair value due to the short-term maturity of the instrument.
During the six months ended June 30, 1999, an additional $30.0 million of
long-term debt was issued at a fixed rate of 5.99%. The fair value of this debt
at June 30, 1999 was $29.5 million.
"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 Houghton
Mifflin's expectations, and Houghton Mifflin expressly does 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 Houghton Mifflin's
educational and testing products and services; (ii) the seasonal and cyclical
nature of Houghton Mifflin's 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
by elementary and secondary schools and colleges; (v) changes in the competitive
environment, including those which would adversely affect selling expenses; (vi)
regulatory changes which would 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; (viii)
unanticipated expenses or delays in resolving Year 2000 computer issues by
either Houghton Mifflin or those with whom Houghton Mifflin does business; and
(ix) other factors detailed from time to time in Houghton Mifflin's filings with
the Securities and Exchange Commission.
35
<PAGE> 36
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Stockholders' Meeting on April 28, 1999, at
which a quorum was present, the stockholders approved the
following proposals by the number of shares of common stock voted
as noted:
Proposal #1 - Election of Class I Directors for a three-year
term:
Number of Shares
Voted For Withheld
---------- --------
Joseph A. Baute 26,086,055 58,996
Nader F. Darehshori 26,072,343 72,708
Michael Goldstein 26,094,657 50,394
The following directors continued their terms in office: James O.
Freedman, Gail H. Klapper, Charles R. Longsworth, Claudine B.
Malone, Alfred L. McDougal, Ralph Z. Sorenson, and Robert J.
Tarr, Jr.
Proposal #2 - Ratification of Ernst & Young LLP as independent
auditors for the fiscal year ended December 31,
1999.
For 26,101,465
Against 28,263
Abstained 15,324
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit No. (27) Financial Data Schedule
(b) Reports on Form 8-K
None
36
<PAGE> 37
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 authorized.
HOUGHTON MIFFLIN COMPANY
------------------------
Registrant
Dated: August 12, 1999 /s/ Gail Deegan
-----------------------------------
Gail Deegan
Executive Vice President,
Chief Financial Officer
Dated: August 12, 1999 /s/ David R. Caron
-----------------------------------
David R. Caron
Vice President,
Corporate Controller
37
<PAGE> 38
Houghton Mifflin Company
Index To Exhibits
Item 6(a)
EXHIBIT NO DESCRIPTION OF DOCUMENT PAGE NUMBER IN THIS REPORT
(27) Financial Data Schedule
38
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 7,698
<SECURITIES> 11,079
<RECEIVABLES> 197,834
<ALLOWANCES> 17,450
<INVENTORY> 193,056
<CURRENT-ASSETS> 429,943
<PP&E> 345,897
<DEPRECIATION> 194,649
<TOTAL-ASSETS> 1,100,242
<CURRENT-LIABILITIES> 400,099
<BONDS> 0
0
0
<COMMON> 30,930
<OTHER-SE> 304,072
<TOTAL-LIABILITY-AND-EQUITY> 1,100,242
<SALES> 220,883
<TOTAL-REVENUES> 220,883
<CGS> 101,626
<TOTAL-COSTS> 198,314
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,450
<INCOME-PRETAX> 14,119
<INCOME-TAX> 5,746
<INCOME-CONTINUING> 8,373
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,373
<EPS-BASIC> 0.29
<EPS-DILUTED> 0.29
</TABLE>
