<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD FROM JULY 1, 1998 TO SEPTEMBER 30, 1998
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 October 31, 1998.
Class Outstanding at October 31, 1998
- ------------------------------- -------------------------------
Common Stock, $1 par value 30,491,531
Preferred Stock Purchase Rights 30,491,531
1 of 34
<PAGE> 2
HOUGHTON MIFFLIN COMPANY
INDEX
This amendment on Form 10-Q/A amends the Registrant's Quarterly Report on Form
10-Q, as filed by the Registrant on November 13, 1998, and is being filed to
reflect the restatement of the Registrant's Consolidated Condensed Financial
Statements. See "Restatement of Quarterly Financial Statements" in Notes to the
Consolidated Condensed Financial Statements for a discussion of the basis for
such restatement.
Part I. Financial Information Page No.
Item 1. Financial Statements:
Consolidated Condensed Balance Sheets
September 30, 1998 and 1997 and December 31, 1997 3 - 4
Consolidated Condensed Statements of Operations,
Comprehensive Income, and Retained Earnings --
Three Months Ended September 30, 1998 and 1997 5
Consolidated Condensed Statements of Operations,
Comprehensive Income, and Retained Earnings --
Nine Months Ended September 30, 1998 and 1997 6
Consolidated Condensed Statements of Cash Flows --
Nine Months Ended September 30, 1998 and 1997 7
Notes to Unaudited Consolidated Condensed
Financial Statements 8 - 14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15 - 32
Part II. Other Information
Item 4. Submission of Matters to a Vote of
Security Holders 33
Item 6. Exhibits and Reports on Form 8-K 33
Signatures 34
<PAGE> 3
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, September 30, December 31,
1998 1997 1997
------------- ------------- ------------
(As restated)*
<S> <C> <C> <C>
ASSETS
- ------
Current assets
Cash and cash equivalents $ 15,828 $ 12,386 $ 5,621
Marketable securities and time deposits
available-for-sale, at fair value 37,957 614 614
Accounts receivable 345,181 322,583 180,241
Less: allowance for book returns 25,330 18,092 20,734
---------- ---------- --------
319,851 304,491 159,507
Inventories
Finished goods 143,173 133,923 130,825
Work in process 5,535 10,281 9,010
Raw materials 4,909 4,452 5,208
---------- ---------- --------
153,617 148,656 145,043
Income taxes 12,160 20,661 12,049
Prepaid expenses 2,496 2,919 1,882
---------- ---------- --------
Total current assets 541,909 489,727 324,716
Property, plant, and equipment
and book plates (net of accumulated
depreciation and amortization of
$183,796 in 1998, $169,293 in 1997
and $176,040 at December 31, 1997) 114,968 114,977 120,388
Intangible assets, net 449,850 469,278 462,884
Other assets 49,029 84,547 73,112
---------- ---------- --------
$1,155,756 $1,158,529 $981,100
========== ========== ========
</TABLE>
* See "Restatement of Quarterly Financial Statements" in Notes to the
Consolidated Condensed Financial Statements.
See accompanying notes to unaudited consolidated condensed financial statements.
3
<PAGE> 4
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, September 30, December 31,
1998 1997 1997
------------- ------------- ------------
(As restated)*
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities
Accounts payable $ 63,764 $ 70,964 $ 47,612
Commercial paper 110,022 94,688 61,346
Royalties 37,849 34,481 41,463
Salaries, wages, and commissions 28,253 20,238 21,625
Income taxes payable 66,389 41,509 -
Other accrued expenses 35,589 32,408 26,680
Current portion of long-term debt 103,322 40,000 40,000
---------- ---------- ---------
Total current liabilities 445,188 334,288 238,726
Long-term debt 244,500 436,061 371,081
Accrued royalties 1,543 1,640 1,430
Other liabilities 27,418 22,650 24,017
Accrued post retirement medical benefits 28,651 28,105 28,089
Stockholders' equity
Preferred stock, $1 par value;
(500,000 shares authorized, none issued) - - -
Common stock, $1 par value;
(70,000,000 shares authorized; 30,472,049 shares
in 1998, 30,162,131 shares in 1997, and 30,219,411
shares issued at December 31, 1997) 30,472 30,162 30,219
Capital in excess of par value 71,596 71,729 75,307
Retained earnings 352,948 300,401 279,640
---------- ---------- ---------
455,016 402,292 385,166
Notes receivable from purchase agreement (4,567) (4,807) (4,628)
Unearned compensation related to
restricted stock (5,130) (7,786) (7,178)
Common shares held in treasury, at cost
(357,575 shares in 1998, 247,644
shares in 1997 and 282,329 shares
at December 31, 1997) (7,973) (4,265) (5,553)
Benefits Trust assets, at market (40,814) (49,548) (49,923)
Unrealized gain (loss) on securities available-for-sale 11,924 (101) (127)
---------- ---------- ---------
Total stockholders' equity 408,456 335,785 317,757
---------- ---------- ---------
$1,155,756 $1,158,529 $ 981,100
========== ========== =========
</TABLE>
* See "Restatement of Quarterly Financial Statements" in Notes to the
Consolidated Condensed Financial Statements.
See accompanying notes to unaudited consolidated condensed financial statements.
4
<PAGE> 5
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS,
COMPREHENSIVE INCOME, AND RETAINED EARNINGS
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997
-------- --------
(As restated)*
<S> <C> <C>
Net sales by industry segment:
Educational publishing $419,022 $370,354
General publishing 27,838 28,740
-------- --------
446,860 399,094
Costs and expenses:
Cost of sales 168,011 149,857
Selling and administrative 122,095 98,201
-------- --------
290,106 248,058
Operating income 156,754 151,036
Other income (expense):
Net interest expense (9,292) (10,776)
Equity in earnings (losses) of INSO Corporation 3,415 (1,831)
Gain on surrender of INSO Corporation common stock
to satisfy indebtedness 15,384 -
Gain on sale of INSO Corporation common stock 42 -
Acquired in-process research and development (3,500) -
-------- --------
6,049 (12,607)
-------- --------
Income before taxes and extraordinary item 162,803 138,429
Income tax provision 66,893 55,372
-------- --------
Income before extraordinary item 95,910 83,057
Extraordinary gain on extinguishment of debt, net of tax of $13,042 18,010 -
-------- --------
Net income 113,920 83,057
Other comprehensive income (loss), net of tax:
Valuation adjustment on marketable equity securities 11,781 (81)
-------- --------
Comprehensive income $125,701 $ 82,976
======== ========
Retained earnings at beginning of period $242,627 $220,914
Net income 113,920 83,057
Two-for-one stock split effected in the form of a stock dividend - (7)
Dividends paid (3,599) (3,563)
-------- --------
Retained earnings at end of period $352,948 $300,401
======== ========
Earnings per share:
Basic
Income before extraordinary item $ 3.35 $ 2.94
Extraordinary gain on extinguishment of debt, net of tax 0.63 -
-------- --------
Net income $ 3.98 $ 2.94
======== ========
Diluted
Income before extraordinary item $ 3.31 $ 2.87
Extraordinary gain on extinguishment of debt, net of tax 0.62 -
-------- --------
Net income $ 3.93 $ 2.87
======== ========
Cash dividends paid per common share $ 0.125 $ 0.125
</TABLE>
* See "Restatement of Quarterly Financial Statements" in Notes to the
Consolidated Condensed Financial Statements.
See accompanying notes to unaudited consolidated condensed financial statements.
5
<PAGE> 6
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS,
COMPREHENSIVE INCOME, AND RETAINED EARNINGS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997
-------- --------
(As restated)*
<S> <C> <C>
Net sales by industry segment:
Educational publishing $656,230 $601,518
General publishing 65,003 68,645
-------- --------
721,233 670,163
Costs and expenses:
Cost of sales 316,526 295,730
Selling and administrative 278,487 247,047
-------- --------
595,013 542,777
Operating income 126,220 127,386
Other income (expense):
Net interest expense (27,398) (30,575)
Equity in earnings of INSO Corporation 3,389 459
Gain on surrender of INSO Corporation common stock
to satisfy indebtedness 15,384 -
Gain on sale of INSO Corporation common stock 42 -
Acquired in-process research and development (3,500) -
Gain on equity transactions of INSO Corporation - 14,904
Other expense (1,050) -
-------- --------
(13,133) (15,212)
-------- --------
Income before taxes and extraordinary item 113,087 112,174
Income tax provision 47,007 45,168
-------- --------
Income before extraordinary item 66,080 67,006
Extraordinary gain on extinguishment of debt, net of tax of $13,042 18,010 -
-------- --------
Net income 84,090 67,006
Other comprehensive income (loss), net of tax:
Valuation adjustment on marketable equity securities 11,924 (101)
-------- --------
Comprehensive income $ 96,014 $ 66,905
======== ========
Retained earnings at beginning of period $279,640 $243,998
Net income 84,090 67,006
Two-for-one stock split effected in the form of a stock dividend - (222)
Dividends paid (10,782) (10,381)
-------- --------
Retained earnings at end of period $352,948 $300,401
======== ========
Earnings per share:
Basic
Income before extraordinary item $ 2.31 $ 2.38
Extraordinary gain on extinguishment of debt, net of tax 0.63 -
-------- --------
Net income $ 2.94 $ 2.38
======== ========
Diluted
Income before extraordinary item $ 2.28 $ 2.34
Extraordinary gain on extinguishment of debt, net of tax 0.62 -
-------- --------
Net income $ 2.90 $ 2.34
======== ========
Cash dividends paid per common share $ 0.375 $ 0.375
</TABLE>
* See "Restatement of Quarterly Financial Statements" in Notes to the
Consolidated Condensed Financial Statements.
See accompanying notes to unaudited consolidated condensed financial statements.
6
<PAGE> 7
HOUGHTON MIFFLIN COMPANY
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED; IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
--------- ---------
(As restated)*
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Income before extraordinary item $ 66,080 $ 67,006
Adjustments to reconcile income before extraordinary gain
to net cash provided by (used in) operating activities:
Depreciation and amortization 78,265 73,684
Equity in earnings of INSO Corporation (3,389) (459)
Gain on surrender of INSO Corporation common stock to satisfy
indebtedness (15,384) -
Gain on sale of INSO Corporation common stock (42) -
Acquired in-process research and development 3,500 -
Gain on equity transactions of INSO Corporation - (14,904)
Changes in operating assets and liabilities:
Accounts receivable (160,299) (138,715)
Inventories (8,574) (8,720)
Accounts payable 15,620 13,089
Royalties (2,465) (3,429)
Deferred and income taxes payable 44,622 41,399
Salaries, wages, and commissions 6,519 797
Other, net 11,741 7,179
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 36,194 36,927
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Proceeds from the sale of INSO Corporation stock 210 -
Book plate expenditures (38,298) (40,926)
Acquisition of publishing and technology assets (14,484) (8,832)
Property, plant, and equipment expenditures (12,787) (10,020)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (65,359) (59,778)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Dividends paid on common stock (10,782) (10,381)
Issuance of commercial paper 48,675 94,688
Repayment of long-term financing - (65,000)
Exercise of stock options 1,765 4,638
Other (286) (242)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 39,372 23,703
Increase in cash and cash equivalents 10,207 852
Cash and cash equivalents at beginning of period 5,621 11,534
--------- ---------
Cash and cash equivalents at end of period $ 15,828 $ 12,386
========= =========
Supplementary disclosure of cash flow information:
Income taxes paid $ 1,812 $ 3,069
Interest paid $ 33,390 $ 29,310
</TABLE>
* See "Restatement of Quarterly Financial Statements" in Notes to the
Consolidated Condensed Financial Statements.
See accompanying notes to unaudited consolidated condensed financial statements.
7
<PAGE> 8
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(1) RESTATEMENT OF QUARTERLY FINANCIAL STATEMENTS
Restatement Related to Acquired In-Process Research and Development:
Houghton Mifflin Company ("the Company") has modified the method used to
value acquired in-process research and development in connection with its July
21, 1998 acquisition of Computer Adaptive Technology, Inc. ("CAT"). The initial
calculation of value of the acquired in-process research and development was
based on the cost required to complete each in-process project, the after-tax
cash flows attributable to each in-process project, and the selection of an
appropriate rate of return to reflect the risk inherent in achieving these
future cash flows. The revised calculation of the value of the acquired
in-process research and development is based on adjusted after-tax cash flows
that give explicit consideration of the Securities and Exchange Commission
("SEC") views on in-process research and development as set forth in its
September 15, 1998 letter to the American Institute of Certified Public
Accountants. The following summarizes the significant changes that were made to
the original valuation of acquired in-process research and development
reflecting the Company's understanding and interpretation of the current views
of the SEC: (1) consideration of the stage of completion for each of the
in-process products; (2) increase in the applicable discount rates to account
for the entity operating on a stand alone basis; and (3) consideration of the
other intangible assets, including customer base. As a result of this change,
the Company has decreased the amount of the purchase price allocated to acquired
in-process research and development in the CAT acquisition from $7.0 million to
$3.5 million. As a result, the Company increased intangible assets by $3.5
million.
Summary of Effect of Restatement:
The effects of the restatement for the acquired in-process research and
development resulted in the following impact on the Company's statement of
operations for the quarter ended September 30, 1998 and the nine months ended
September 30, 1998 and balance sheet as of September 30, 1998:
<TABLE>
<CAPTION>
Three months Nine months
ended ended
September 30, September 30,
1998 1998
------------- -------------
(In thousands)
<S> <C> <C>
Statements of operations:
Income before extraordinary item, as previously reported $ 92,410 $62,580
Adjustment related to acquired in-process research and
development 3,500 3,500
-------- -------
Restated income before extraordinary item $ 95,910 $66,080
======== =======
Net income, as previously reported $110,420 $80,590
Adjustment related to acquired in-process research and
development 3,500 3,500
-------- -------
Restated net income $113,920 $84,090
======== =======
Comprehensive income, as previously reported $122,201 $92,514
Adjustment related to acquired in-process research
and development 3,500 3,500
-------- -------
Restated comprehensive income $125,701 $96,014
======== =======
</TABLE>
<TABLE>
<CAPTION>
Three months Nine months
ended ended
September 30, September 30,
1998 1998
------------- -------------
<S> <C> <C>
Earnings per share:
Basic:
Income before extraordinary item, as previously
reported $ 3.23 $ 2.19
Adjustment related to acquired in-process research and
development 0.12 0.12
Extraordinary gain on extinguishment of debt 0.63 0.63
-------- -------
Restated net income $ 3.98 $ 2.94
======== =======
Diluted:
Income before extraordinary item, as previously
reported $ 3.19 $ 2.16
Adjustment related to acquired in-process research and
development 0.12 0.12
Extraordinary gain on extinguishment of debt 0.62 0.62
-------- -------
Restated net income $ 3.93 $ 2.90
======== =======
</TABLE>
As of
September 30, 1998
------------------
(In thousands)
Balance sheet:
Intangible assets, net, as previously reported $446,350
Adjustment related to acquired in-process research and
development 3,500
--------
Restated intangible assets, net $449,850
========
Retained earnings, as previously reported $349,448
Adjustment related to acquired in-process research and
development 3,500
--------
Restated retained earnings $352,948
========
(2) BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements of
the Company, which includes 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 the Company's latest Annual Report on Form 10-K 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 1998 interim
financial statements.
(3) SHORT-TERM INVESTMENTS
During the third quarter of 1998, the Company's ownership of INSO
Corporation ("INSO") dropped below 20%; therefore, the Company will no longer
record its investment in INSO under the equity method. Instead, the Company
will account for the remaining shares held of INSO common stock in accordance
with Statement of Financial Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." These securities are classified as
available-for-sale and are carried at fair value based on the quoted market
price. As a result, an unrealized investment gain of $20.5 million ($11.9
million after tax) is included as a component of stockholders' equity as of
September 30, 1998.
These securities are classified as short-term due to the Company's option
to use them to redeem 50%, or $65.3 million aggregate principal, of its
outstanding 6% Exchangeable Note due 1999-Stock Appreciation Income Linked
Securities ("SAILS"), due on August 1, 1999. This option is exercisable on
August 1, 1999.
(4) COMPREHENSIVE INCOME
In 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income" ("SFAS 130"), which is required to be
adopted for fiscal years beginning after December 15, 1997. This statement
established new rules for the reporting and display of comprehensive income and
its components. The adoption of this Statement had no impact on the Company's
net income or stockholders' equity. SFAS 130 requires that unrealized gains or
losses on the Company's marketable equity securities be included in other
comprehensive income, as well as certain other components of stockholders'
equity.
Total comprehensive income amounted to $125.7 million for the three months
ended September 30, 1998 and $83.0 million for the same period in 1997. For the
nine months ended September 30, 1998, total comprehensive income amounted to
$96.0 million and $66.9 million for the same period in 1997.
8
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(5) COMMON STOCK SPLIT
On June 25, 1997, the Board of Directors declared a two-for-one split of
the Company's common stock effected in the form of a 100% stock dividend to
shareholders of record on July 11, 1997, which was distributed on July 25, 1997.
The effect of the split is reflected retroactively within stockholders' equity
for all 1997 periods presented by adjusting the par value for the additional
shares due to the stock split from retained earnings. All 1997 share and per
share amounts in this report have been restated to reflect the effect of this
stock split.
(6) ACQUISITIONS
On July 21, 1998, the Company acquired all of the outstanding stock of
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 the Company's consolidated financial statements from the date of
the acquisition. Net cash consideration for the acquisition amounted to
approximately $10.7 million, of which $8.0 million was paid to the former
shareholders of CAT and $2.7 million to repay debt, cash out certain warrants,
and pay other acquisition related fees. In addition, based on the acquisition
agreement, up to $6 million of additional consideration is contingent upon the
achievement of certain future operational and financial targets. Also recorded
as part of the acquisition was a charge for acquired in-process research and
development of $3.5 million (See Note 1). As of the acquisition date, CAT only
had one product that qualified as in-process research and development, CAT
Software System Version 7.0. 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 value of the assets acquired and the liabilities assumed,
including the acquired in-process research and development. Intangible assets of
$7.3 million were recorded as part of the acquisition and are being amortized on
a straight-line basis over periods ranging from 3 to 10 years. Additional
goodwill will be recorded if the contingent considerations are earned.
On September 10, 1997, the Company, through its subsidiary The Riverside
Publishing Company, acquired all of the outstanding stock of Wintergreen/Orchard
House, Inc., a publisher of guidance products for the elementary and secondary
school markets. The acquisition was accounted for as a purchase and the assets
acquired, liabilities assumed, and results of operations are included in the
Company's consolidated financial statements from the date of the acquisition.
Net cash consideration for the acquisition amounted to approximately $3.6
million. The cost of the acquisition was allocated on the basis of the estimated
fair market value of the assets acquired and the liabilities assumed. The excess
of the net assets acquired, or goodwill, is being amortized on a straight-line
basis over a period of fifteen years.
On May 12, 1997, the Company acquired the assets of Chapters Publishing
Ltd., predominantly a publisher of cookbooks. The acquisition was accounted for
as a purchase and the net assets and results of operations are included in the
Company's consolidated financial statements from the date of the acquisition.
Net cash consideration for the acquisition amounted to approximately $3.3
million. The cost of the acquisition was allocated on the basis of the estimated
fair market value of the assets acquired and the liabilities assumed. The excess
of the net assets acquired, or goodwill, is being amortized on a straight-line
basis over a period of ten years.
These acquisitions did not 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--
(7) STOCK APPRECIATION INCOME-LINKED SECURITIES
On August 1, 1998, the Company redeemed 50%, or $65.3 million in aggregate
principal, of its outstanding SAILS. Redemption of the SAILS was made at the
option of the Company pursuant to Section 1301 (b) of the Indenture dated as of
March 15, 1994 between the Company and State Street Bank and Trust Company (as
successor to the First National Bank of Boston), as Trustee, as supplemented by
a First Supplemental Indenture dated as of July 27, 1995.
The SAILS were redeemed at an exchange rate equal to (i) two shares of the
common stock of INSO, par value $0.01 per share, for each SAILS, or
approximately 1.9 million shares, and (ii) cash of $2.0 million for the
payment of all accrued and unpaid interest at the date of the redemption. The
redemption represented a disposition of the shares and generated a one-time
non-cash gain of $15.4 million ($8.9 million after tax), or $0.31 per share. The
Company also recognized an $18.0 million extraordinary after-tax gain, or $0.62
per share, on the early extinguishment of debt resulting from the redemption.
The remaining 50%, or $65.3 million in aggregate principal, of the
outstanding SAILS are due on August 1, 1999 and therefore have been classified
as current debt outstanding.
(8) INSO CORPORATION
In March 1994, the Company spun off its former Software Division in an
initial public offering. The Company's equity interest in INSO, the successor
company, was approximately 40% after the offering. The Company recognized
earnings from its investment in INSO based upon the equity method of accounting.
Accordingly, the Company recorded its pro-rata share of income and losses and
the impact of INSO's equity activities, if any, on a quarterly basis one quarter
in arrears.
In November 1996, INSO completed an additional public offering of 1.2
million shares of common stock at a net offering price of $47.04 for a total
consideration of $56.4 million. As a result, in March 1997, the Company recorded
a gain of $14.9 million ($8.6 million after tax) or $0.30 per share,
representing the Company's portion of the increase in INSO's net assets.
After the redemption of the SAILS using INSO common stock (see Note 7),
the Company's ownership of INSO dropped below 20%; therefore, the Company will
no longer report equity income from its investment in INSO or special charges
related to that investment (see Note 3).
10
<PAGE> 11
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(9) INTANGIBLE ASSETS
Intangible assets consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997 1997
-------- -------- ------------
<S> <C> <C> <C>
Goodwill $522,618 $514,895 $515,532
Publishing rights 17,724 16,623 16,623
Other 4,000 4,000 4,000
Less: accumulated amortization (94,492) (66,240) (73,271)
-------- -------- --------
Total $449,850 $469,278 $462,884
======== ======== ========
</TABLE>
The carrying value of goodwill is periodically reviewed to determine
recoverability based upon projected net cash flows over the remaining life of
the related business unit. If the analysis indicates that impairment has
occurred, the Company will adjust the book value of the intangible asset to the
undiscounted net cash flow amount.
(10) EARNINGS PER SHARE
The table below sets forth the computation of basic and diluted earnings
per share for the three months ended September 30, 1998 and September 30, 1997
(in thousand, except per share amounts):
<TABLE>
<CAPTION>
Three months ended September 30,
--------------------------------
1998 1997
-------- -------
<S> <C> <C>
Numerator:
Income before extraordinary item $ 95,910 $83,057
Extraordinary gain on extinguishment of
debt, net of tax 18,010 --
-------- -------
Net income $113,920 $83,057
======== =======
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding 28,610 28,251
Effect of dilutive securities:
Employee stock options 318 501
Restricted stock 26 153
Performance shares -- 8
-------- -------
344 662
Denominator for diluted earnings per share:
Adjusted weighted-average shares -------- -------
outstanding and assumed conversion 28,954 28,913
======== =======
Basic earnings per share:
Income before extraordinary item $ 3.35 $ 2.94
Extraordinary gain on extinguishment of debt,
net of tax 0.63 --
-------- -------
Net income $ 3.98 $ 2.94
======== =======
Diluted earnings per share:
Income before extraordinary item $ 3.31 $ 2.87
Extraordinary gain on extinguishment of debt,
net of tax 0.62 --
-------- -------
Net income $ 3.93 $ 2.87
======== =======
</TABLE>
11
<PAGE> 12
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- --Continued--
(10) EARNINGS PER SHARE - continued
The table below sets forth the computation of basic and diluted earnings
per share for the nine months ended September 30, 1998 and September 30, 1997
(in thousand, except per share amounts):
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------
1998 1997
------- -------
<S> <C> <C>
Numerator:
Income before extraordinary item $66,080 $67,006
Extraordinary gain on extinguishment of debt,
net of tax 18,010 --
------- -------
Net income $84,090 $67,006
======= =======
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding 28,564 28,170
Effect of dilutive securities
Employee stock options 359 362
Restricted stock 35 118
Performance shares - 18
------- -------
394 498
Denominator for diluted earnings per share:
Adjusted weighted-average shares ------- -------
outstanding and assumed conversions 28,958 28,668
======= =======
Basic earnings per share:
Income before extraordinary item $ 2.31 $ 2.38
Extraordinary gain on extinguishment of debt,
net of tax 0.63 --
------- -------
Net income $ 2.94 $ 2.38
======= =======
Diluted earnings per share:
Income before extraordinary item $ 2.28 $ 2.34
Extraordinary gain on extinguishment of debt,
net of tax 0.62 --
------- -------
Net income $ 2.90 $ 2.34
======= =======
</TABLE>
(11) SUBSEQUENT EVENTS
At its October 28, 1998 meeting, the Board of Directors declared a
quarterly dividend of $0.125 per share, payable on November 25, 1998, to
shareholders of record on November 11, 1998.
12
<PAGE> 13
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's principal business is publishing, and its operations are
classified in two industry segments: (1) textbooks and other educational
materials ("instructional materials") and services for the school and college
markets; and (2) general publishing, including fiction, nonfiction, children's
books, and dictionary and reference materials in a variety of formats and media.
In the school market, which consists of kindergarten through twelfth grade
("K-12"), 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 once approximately every
five to eight years. These twenty-one states are referred to as "adoption
states." Generally, a school or school district within an adoption state may use
state monies to purchase instructional materials only from the list of
publishers' programs that have been approved, or "adopted," by the particular
state's governing body. In the other states, referred to as "open territories,"
individual schools or school districts make the purchasing decisions from the
unrestricted offerings of all publishers. The industry terms "adopted" or
"adoption" are used: (1) to describe a state governing body's approval process,
or (2) to describe a school or school district's selection and purchase of
instructional materials. After adopting, or selecting, instructional materials,
schools later decide how much to purchase and when to purchase in order to
implement the adoption.
Sales of instructional materials are cyclical, with some years offering more
sales opportunities than others. Although the loss of a single customer or a few
customers would not have a material adverse effect on the business of the
Company, schedules of school adoptions and market acceptance of the Company's
products can affect year-to-year revenue performance. The Company originally
expected a modest increase in 1998 revenues due to fewer statewide adoption
opportunities for its products in 1998
13
<PAGE> 14
than in 1997, when a significant number of states and districts adopted reading
and literature products. However, due to the strong performance of the Company's
educational products, combined with the increased funding for educational
materials in both adoption and open territory states, the Company now expects
that net sales will be slightly higher than originally expected.
Almost ninety percent of the Company's revenues are derived from educational
publishing, a markedly seasonal business. 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, the Company
realizes more than forty percent of net sales and a substantial portion of net
income during the third quarter, making third-quarter results material to
full-year performance. The Company usually posts a net loss in the first and
fourth quarters of the year, when fewer educational institutions are making
purchases.
The Company has implemented Statement of Financial Accounting Standards No.
128, "Earnings Per Share," which requires the presentation of both basic and
diluted earnings per share on the Consolidated Statement of Operations. The per
share amounts presented in Management's Discussion and Analysis of Financial
Condition and Results of Operations are diluted earnings per share amounts. For
further discussion of earnings per share and the impact of Statement No. 128,
see Note 10 on page 13.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the Computer Adaptive Technologies, Inc. ("CAT")
acquisition, the Company made an allocation of the purchase price to acquired
in-process research and development. This amount was expensed as a non-recurring
charge on the acquisition date. The charge was necessary because the acquired
research and development had not yet reached technological feasibility and had
no future alternative use. In the previously issued financial statements for the
quarter ended September 30, 1998, the Company recorded a write-off for acquired
in-process research and development of $7.0 million. The Company has revised the
valuation of the in-process research and development cost in consideration of
the Securities and Exchange Commission views on in-process research and
development as set forth in its September 15, 1998 letter to the AICPA. The
Company has reduced the amount of the write-off for acquired in-process research
and development to $3.5 million in the quarter ended September 30, 1998,
resulting in an increase to the intangible asset. This amount represents an
allocation of purchase price related to the development of an application module
called 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 Company anticipates this product using
the acquired in-process research and development will be generally released
during 1999. The Company expects that the acquired in-process research and
development will be successfully developed, but there can be no assurance
that commercial viability of this product will be achieved.
The nature of the efforts required to develop the purchased in-process
research and development into a commercially viable product principally relate
to the completion of all planning, designing, prototyping, verification, and
testing activities that are necessary to establish that the product can be
produced to meet its design specifications, including functions, features and
technical performance requirements.
The value of the purchased in-process research and development was
determined by estimating the projected net cash flow related to the product, and
the stage of completion of the product. These cash flows were discounted back to
their net present value. The resulting projected net cash flows from the project
were based on management's estimates of revenues and operating profits related
to the product. The revenue estimates used to value the in-process research and
development were based on estimates of relevant market sizes and growth factors,
expected trends in the related technology, and the nature and expected timing of
new product introductions by the Company and its competitors. The rates utilized
to discount the net cash flows to their net present value were based on a
discount rate of 30%. This discount rate takes into account the time value of
money and investment risks factors described above.
The estimates used by the Company in valuing the in-process research and
development were based upon assumptions the Company believes to be reasonable
but which are inherently uncertain and unpredictable. The Company's assumptions
may be incomplete or inaccurate, and no assurance can be given that
unanticipated events and circumstances will not occur. Accordingly, actual
results may vary from the projected results. Any such variances may adversely
affect the sales and profitability of future periods. Additionally, the value of
other intangible assets may become impaired.
14
<PAGE> 15
RESULTS OF OPERATIONS:
- ----------------------
Third Quarter 1998 Compared to Third Quarter 1997
- -------------------------------------------------
In thousands of dollars, except per share amounts
Net income:
<TABLE>
<CAPTION>
Three months ended September 30,
--------------------------------------------------
Earnings (loss)
per share
1998 1997 1998 1997
-------- ------- ------- ---------
<S> <C> <C> <C> <C>
Net income before non-recurring items $88,598 $84,239 $3.06 $2.91
Non-recurring items, net of taxes, where applicable:
Extraordinary gain on extinguishment of debt 18,010 -- 0.62 --
Gain on surrender of INSO Corporation common stock
to satisfy indebtedness 8,924 -- 0.31 --
Gain on sale of INSO Corporation common stock 24 -- -- --
Acquired in-process research and development (3,500) -- (0.12) --
Other gains (losses) 1,864 (1,182) 0.06 (0.04)
-------- ------- ----- -----
Net income $113,920 $83,057 $3.93 $2.87
======== ======= ===== =====
</TABLE>
For the quarter ended September 30, 1998, consolidated net income was $113.9
million, or $3.93 per share, compared to net income of $83.1 million, or $2.87
per share, for the same period in 1997. On August 1, 1998, the Company redeemed
one-half, or $65.3 million, of the 6% Exchangeable Notes due 1999 - Stock
Appreciation Income Linked Securities ("SAILS"). The SAILS were redeemed with
approximately 1.9 million shares of INSO Corporation ("INSO") common stock. The
redemption represented a disposition of the INSO shares, and resulted in a
one-time gain of $15.4 million ($8.9 million after tax), or $0.31 per share. In
addition, the Company recorded a $31.1 million ($18.0 million after tax), or
$0.62 per share, extraordinary gain as a result of the early extinguishment of
the SAILS indebtedness. The Company's acquisition of Computer Adaptive
Technologies, Inc. ("CAT") in July 1998 included a one-time write-off acquired
in-process research and development of $3.5 million, or $0.12 per share. Also,
during the third quarter of 1998, the Company recognized a one-time gain of $3.2
million ($1.9 million after tax), or $0.06 per share, related to INSO's sale of
its linguistic software net assets. The third quarter of 1997 included one-time
charges of $2.0 million ($1.2 million after tax), or $0.04 per share, related to
INSO's acquisition of Level
15
<PAGE> 16
Five Research, Inc. and a restructuring charge affecting INSO's information
products and certain of its information management tools products.
Excluding these non-recurring items, net income for the third quarter of 1998
would have been $88.6 million, or $3.06 per share, compared to net income of
$84.2 million, or $2.91 per share, in the third quarter of 1997. The primary
reason for the increase in net income was higher sales, partially offset by
higher editorial costs related to product revisions and new product development,
higher selling and fulfillment costs due to higher net sales, dilution arising
from the acquisition and operations of CAT, and increased investments to improve
operating and support systems and to address the Year 2000 computer issue.
Net sales:
<TABLE>
<CAPTION>
Three months ended September 30,
---------------------------------------------------------
Increase (decrease)
1998 1997 $ %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Educational publishing $419,022 $370,354 $48,668 13.1%
General publishing 27,838 28,740 (902) (3.1)
-------- -------- ------- ----
Total net sales $446,860 $399,094 $47,766 12.0%
======== ======== ======= ====
</TABLE>
Net sales for the third quarter of 1998 were $446.9 million, an increase of
12.0% from the $399.1 million reported in the third quarter of 1997. The
educational publishing segment's net sales increased $48.7 million, or 13.1%, to
$419.0 million in the third quarter of 1998 from last year's third-quarter net
sales of $370.4 million. This increase reflected higher sales in all educational
publishing divisions. Outstanding performance of the educational segment's
programs and increased funding for educational materials more than offset the
fact that 1998 did not offer as many statewide adoption opportunities as 1997.
McDougal Littell, the Company's secondary school division, had increased sales
from its literature, language arts, mathematics and social studies programs. The
School Division had increased sales from its English, reading, mathematics, and
spelling programs. Both the School Division and McDougal Littell benefited from
increased
16
<PAGE> 17
opportunities and additional funding for instructional materials in both
adoption and open territory states. The Riverside Publishing Company's revenues
increased over the same period last year primarily as a result of custom state
contracts won and increased funding for assessment programs. The Great Source
Education Group's sales also increased as a result of increased sales of its
mathematics and Write Source product lines. The College Division reported higher
third-quarter sales due to strong sales of newly published and backlist titles.
The general publishing segment's net sales of $27.8 million for the third
quarter of 1998 decreased $0.9 million, or 3.1%, from net sales of $28.7
million for the third quarter of 1997. The decrease was primarily due to a
decrease in the sales of Houghton Mifflin Interactive ("HMI") products,
partially offset by slightly higher Trade & Reference Division sales. The Trade
& Reference Division reported increased sales of adult and children's books and
dictionary products, partially offset by lower guidebook sales reflecting the
expiration of the Insight Travel Guide distribution arrangement on December 31,
1997. HMI's net sales for the third quarter of 1998 were lower than the same
period last year due to increased competition in the retail channel. The Company
is currently reviewing its strategy for HMI.
Costs and expenses:
<TABLE>
<CAPTION>
Three months ended September 30,
---------------------------------------------------------
Increase (decrease)
1998 1997 $ %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Cost of sales $168,011 $149,857 $18,154 12.1%
Selling and administrative, excluding
goodwill amortization 114,960 91,207 23,753 26.0
Goodwill amortization 7,135 6,994 141 0.2
-------- -------- ------- ----
$290,106 $248,058 $42,048 17.0%
======== ======== ======= ====
</TABLE>
17
<PAGE> 18
Cost of sales:
Cost of sales in the third quarter of 1998 increased $18.2 million, or 12.1%,
to $168.0 million from $149.9 million in the third quarter of 1997. The
increase in cost of sales reflected higher net sales in the quarter and
increased editorial costs and plate amortization incurred for product revisions
and new product development. As a percent of sales, cost of sales increased
slightly to 37.6% in 1998 from 37.5% in 1997.
Selling and administrative:
In the third quarter of 1998, selling and administrative expenses, excluding
goodwill amortization, were $115.0 million, an increase of $23.8 million, or
26.0%, from $91.2 million in the third quarter of 1997. The primary reasons for
this increase were higher selling and fulfillment costs due to higher net sales
and increased expenses incurred related to information systems initiatives and
the Year 2000 computer issue. As a percent of sales, selling and administrative
costs, excluding goodwill amortization, increased to 25.7% in 1998 from 22.9% in
1997.
Equity in earnings (losses) of INSO Corporation:
During the third quarter of 1998, the Company recognized $3.4 million in equity
earnings of INSO, of which $3.2 million related to a one-time gain recognized on
INSO's sale of its linguistic software net assets, and $0.2 million related to
INSO's earnings. During the third quarter of 1997, the Company recognized $1.8
million in equity losses of INSO, of which $2.0 million related to a one-time
charge recognized on INSO's acquisition of Level Five Research, Inc. and a
restructuring charge affecting INSO's information products and certain of its
information management tools products, partially offset by $0.1 million of
INSO's earnings.
Net interest expense:
Net interest expense of $9.3 million for the third quarter of 1998 was $1.5
million lower than in the same period in 1997. The reduction was primarily due
to repayment of $68.7 million of debt in the fourth quarter of 1997 and the
early extinguishment of the SAILS debt in August 1998.
18
<PAGE> 19
Income tax provision:
The income tax provision increased $11.5 million, or 20.8%, over the same period
last year. This increase was the result of higher income and an increase in the
effective tax rate to 41.1% in the third quarter of 1998 from 40.0% in the third
quarter of 1997. The 41.1% effective tax rate includes the $3.5 million for
acquired in-process research and development charge, which is not deductible for
tax purposes. Excluding the charge, the Company's effective tax rate in the
third quarter of 1998 would have been comparable with that of the prior year.
Nine Months Ended September 30, 1998 and 1997
- ---------------------------------------------
In thousands of dollars, except per share amounts
Net income:
<TABLE>
<CAPTION>
Nine months ended September 30,
--------------------------------------------------
Earnings (loss)
per share
1998 1997 1998 1997
----------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Net income before non-recurring items: $59,219 $59,835 $2.04 $2.09
Non-recurring items, net of taxes, where applicable:
Extraordinary gain on extinguishment of debt 18,010 --- 0.62 ---
Gain on surrender of INSO Corporation common stock
to satisfy indebtedness 8,924 --- 0.31 ---
Gain on sale of INSO Corporation common stock 24 --- --- ---
Acquired in-process research and development (3,500) --- (0.12) ---
Gain on equity transaction of INSO Corporation --- 8,644 --- 0.30
Other gains (losses) 1,413 (1,473) 0.05 (0.05)
------- ------- ----- -----
Net income $84,090 $67,006 $2.90 $2.34
======= ======= ===== =====
</TABLE>
For the nine months ended September 30, 1998, consolidated net income was $84.1
million, or $2.90 share, compared to net income of $67.0 million, or $2.34
per share, for the same period in 1997. During 1998, the Company recognized a
non-cash gain of $15.4 million ($8.9 million after tax), or $0.31 per share,
which represented a disposition of INSO common stock used to redeem one-half of
the outstanding SAILS. The Company also recognized an extraordinary gain of
$31.1 million ($18.0 million after
19
<PAGE> 20
tax), or $0.62 per share, on the early extinguishment of the SAILS indebtedness.
The acquisition of CAT included a one-time write-off of acquisition in-process
research and development of $3.5 million, or $0.12 per share. During 1998, the
Company also recorded a one-time gain (net of charges) of $2.4 million ($1.4
million after tax), or $0.05 per share, related to the equity investment in
INSO. During the nine months ended September 30, 1997, the Company recorded a
gain of $14.9 million ($8.6 million after tax), or $0.30 per share, as a result
of INSO's offering of common stock and a one-time charge of $2.5 million ($1.5
million after tax), or $0.05 per share, related to the equity investment in
INSO.
Excluding these non-recurring items, net income for the nine months ended
September 30, 1998 would have been $59.2 million, or $2.04 per share, compared
to net income of $59.8 million, or $2.09 per share, for the same period in 1997.
The decrease was due to a charge related to the Company's unsuccessful bid for a
portion of Simon & Schuster's publishing assets and from the dilution arising
from the acquisition and operations of CAT. The increases in product development
costs, higher selling expenses, and costs related to information systems
initiatives and the Year 2000 computer issue were offset by higher net sales.
Net sales:
<TABLE>
<CAPTION>
Nine months ended September 30,
---------------------------------------------------------
Increase (decrease)
1998 1997 $ %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Educational publishing $656,230 $601,518 $54,712 9.1%
General publishing 65,003 68,645 (3,642) (5.3)
-------- -------- ------- ---
Total net sales $721,233 $670,163 $51,070 7.6%
======== ======== ======= ===
</TABLE>
Net sales for the nine months ended September 30, 1998 were $721.2 million, an
increase of 7.6% from the $670.2 million reported in the same period in 1997.
The educational publishing segment's net sales increased $54.7 million, or 9.1%,
to $656.2 million in the nine months ended September 30, 1998 from
20
<PAGE> 21
net sales of $601.5 million in the same period in 1997. The increase was due to
higher net sales in all educational publishing divisions. All educational
publishing divisions reported higher net sales with McDougal Littell, Great
Source Education Group, and Riverside Publishing Company reporting double-digit
sales growth. These divisions benefited from additional sales and funding
opportunities for instructional and assessment materials and services.
The general publishing segment's net sales of $65.0 million for the nine months
ended September 30, 1998 decreased $3.6 million, or 5.3%, from net sales of
$68.6 million during the same period in 1997. This decrease was primarily due to
the decline in guidebook sales and lower sales of HMI products, partially offset
by increased sales of children's and dictionary products.
Costs and expenses:
<TABLE>
<CAPTION>
Nine months ended September 30,
---------------------------------------------------------
Increase (decrease)
1998 1997 $ %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Cost of sales $316,526 $295,730 $20,796 7.0%
Selling and administrative, excluding
goodwill amortization 257,266 226,164 31,102 13.8
Goodwill amortization 21,221 20,883 338 1.6
-------- -------- ------- ---
Total costs and expenses $595,013 $542,777 $52,236 9.6%
======== ======== ======= ===
</TABLE>
Cost of sales:
During the nine months ended September 30, 1998, cost of sales increased $20.8
million, or 7.0%, to $316.5 million from $295.7 million during the same period
in 1997. The increased cost of sales was due to higher net sales and increased
development costs. As a percent of sales, cost of sales decreased to 43.9% in
1998 from 44.1% in 1997.
21
<PAGE> 22
Selling and administrative:
For the nine months ended September 30, 1998, selling and administrative
expenses, excluding goodwill amortization, were $257.3 million, an increase of
$31.1 million, or 13.8%, from $226.2 million for the same period in 1997. The
primary reasons for this increase were higher selling and fulfillment costs
related to higher net sales, and increased expenses incurred related to
information systems initiatives and the Year 2000 computer issue.
Equity in earnings (losses) of INSO Corporation:
During the nine months ended September 30, 1998, the Company recognized $3.4
million in equity earnings of INSO, of which $3.2 million was a one-time gain,
$1.0 million of INSO's earnings, partially offset by $0.8 million of one-time
charges recognized by INSO. During the nine months ended September 30, 1997, the
Company recognized $0.5 million in equity earnings of INSO, of which $2.5
million related to one-time charges recognized by INSO, and $3.0 million of
INSO's earnings.
Net Interest expense:
Net interest expense for the nine months ended September 30, 1998 decreased by
$3.2 million to $27.4 million from $30.6 million for the same period in 1997.
The reduction was primarily due to repayment of $68.7 million of debt in the
fourth quarter of 1997 and the early extinguishment of the SAILS debt, partially
offset by higher working capital borrowings during the nine months ended
September 30, 1998 compared to the same period in 1997.
Income tax provision:
The income tax provision increased $1.8 million, or 4.1%, during the nine months
ended September 30, 1998 compared to the same period last year. The increase was
due to an increase in the effective tax rate to 41.6% in 1998 from 40.3% in
1997. The increase in the effective tax rate reflects the non-deductible charge
for acquired in-process research and development.
22
<PAGE> 23
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal businesses are seasonal, with almost ninety percent of
the Company's revenues derived from the educational publishing segment, a
markedly seasonal business. The Company realizes more than forty percent 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 the Company's operating cash flow. A net cash
deficit from all the Company's activities is normally incurred through the
middle of the third quarter of the year. This deficit is funded through the use
of cash and sale of marketable securities, supplemented by short-term
borrowings, principally commercial paper.
During the nine months ended September 30, 1998, the Company used $48.7 million
of net borrowings to cover its seasonal working capital needs and to fund
publishing and capital investments. During the nine months ended September 30,
1997, the Company used $29.7 million of net borrowings to cover its working
capital needs and to fund publishing and capital investments.
Net cash provided by operating activities was $36.2 million during the nine
months ended September 30, 1998, a $0.7 million decrease from the $36.9 million
during the same period in 1997. Excluding the non-cash effect of depreciation
and amortization, equity in earnings of INSO Corporation, gain on the
disposition of INSO Corporation common stock, acquired in-process research and
development, and gain on equity transaction of INSO Corporation, income
increased by $3.7 million. Changes in operating assets and liabilities used $4.4
million more cash during the nine months ended September 30, 1998, than in the
same period in 1997.
Cash required for investing activities was $65.4 million during the nine months
ended September 30, 1998, an increase of $5.6 million from the $59.8 million
required in the same period in 1997. This increase was principally due to a $5.7
million increase in acquisition of publishing and technology assets and a $2.8
million increase in property, plant, and equipment expenditures, partially
offset by a $2.6
23
<PAGE> 24
million decrease in book plate expenditures in the first nine months of 1998
compared to the same period in 1997. The Company also received $0.2 million in
proceeds from the sale of 10,000 shares of INSO common stock during 1998.
Net proceeds from financing increased by $15.7 million during the nine months
ended September 30, 1998, from the same period in 1997, primarily due to higher
working capital requirements and to fund publishing and capital investments.
The Company expects that cash flow from operations will be sufficient to finance
the CAT acquisition, fund capital expenditures and dividend payments, meet the
$24 million tax obligation related of the SAILS transaction, and pay down by
year end a portion of the debt outstanding at the beginning of 1998.
OUTLOOK
Due to the strong performance of the Company's educational products, combined
with the increased funding for educational materials, the Company now expects
that net sales for the full year will be slightly higher than originally
anticipated. The sales growth should generate increased gross margin, but this
will be more than offset by increased investment in products and support
systems, the earnings dilution resulting from the 1998 acquisition of CAT and
the cost of the unsuccessful bid for a portion of the Simon & Schuster's
publishing assets. The Company currently expects editorial expense and plate
amortization to increase by approximately 10% to 12% over last year and that the
cost of investments in new systems and to address the Year 2000 issue in 1998 to
be approximately $7.0 million higher than in 1997.
24
<PAGE> 25
EFFECT OF THE YEAR 2000 COMPUTER ISSUE
The statements in this section include "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
the Company'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 also affects
printers, facsimile machines, security systems, and elevators. The Year 2000
computer issue will affect the Company, its vendors and suppliers, customers,
and other third parties with whom the Company does business.
To address this issue, the Company has created a plan under the direction of a
Program Management Office, which consists of a team of internal 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 the Board of
Directors and management, as well as information bulletins to the rest of
the Company.
25
<PAGE> 26
The Company 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;
and third-party relationships. The Company 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, and
networks and voice systems. The Company 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 is 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 the Company's future growth. The
following chart presents the estimated average status of completion for this
area and the expected completion date for each phase.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
RESOLUTION PHASE ESTIMATED AVERAGE % COMPLETION EXPECTED COMPLETION DATE
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Assessment 100% Completed
- ---------------------------------------------------------------------------------------
Remediation or Replacement 50 May 31, 1999
- ---------------------------------------------------------------------------------------
Testing and Certification 40 June 30, 1999
- ---------------------------------------------------------------------------------------
Implementation 10 July 31, 1999
- ---------------------------------------------------------------------------------------
</TABLE>
For critical non-IT systems, the Company is 95% complete on the assessment phase
and expects to complete this phase by November 30, 1998. To date, the Company
has not started the remediation, testing, or implementation phases for these
systems. Completion of the remediation, testing or implementation phases for
non-IT systems is scheduled for June 30, 1999.
The Company 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 many cases, the Company believes there will be
no need for remediation or replacement of the product. The Company
26
<PAGE> 27
expects to complete this assessment by March 31, 1999 and believes that it will
be able to complete any appropriate remedial actions by December 31, 1999.
Based upon preliminary results, the Company does not expect that the effect of
Year 2000 issues on the Company's technology products presents a material
exposure.
The Company has identified its most important customers, as well as suppliers
and business partners (for example, printers, paper suppliers, distributors, and
financial institutions), and has contacted them to determine the extent to which
the Company may be vulnerable in the event that those parties fail to properly
correct their own Year 2000 computer issues. The Company will monitor the
responses and progress of these parties. In addition, the Company intends to
test critical systems interfaces, such as order and inventory transactions. The
Company is in the process of working with the parties with whom it has these
interfaces to reduce the risk of business interruptions. To date, the Company
is not aware of any third party whose Year 2000 issues would have a material
effect on the Company, 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 the Company.
The Company 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. To date, the Company has
spent approximately $13 million ($6 million expensed and $7 million capitalized
for new systems), on its Year 2000 computer project and the development of new
systems and systems modifications.
27
<PAGE> 28
The Company is currently evaluating the Year 2000 readiness of CAT, a company
acquired in July 1998, and expects its assessment to be completed by
December 31, 1998. The above discussion, therefore, does not include the effect
of CAT upon the Company's Year 2000 readiness.
The Company believes it has an effective program in place to resolve any Year
2000 computer issues in a timely manner. Although the Company 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 the Company's
operations. While the Company is not currently 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 the Company and its significant customers, suppliers, and business
partners. In the event that the Company or any of its material suppliers or
other third parties do not complete the necessary remediation, the Company 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 the Company's revenues. The Company 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 materially adversely affect
the Company. 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
28
<PAGE> 29
properly test critical systems on a timely basis, the Company will develop
appropriate contingency plans after its assessment of risk is complete.
Preliminary contingency plans have been developed for many of the Company's
information technology systems. Final plans will be developed during 1999 for
those areas the Company determines are at risk.
The projected costs and the date on which the Company 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 the Company's control. However,
the Company 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 issue, and other uncertainties referred to from time to time
in the Company's filings with the Securities and Exchange Commission.
"SAFE HARBOR" STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995:
This report includes forward-looking statements which reflect the Company's
current views with respect to future events and financial performance. The
words "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 those
expressed in any forward-looking statements made by the Company. These factors
include, but are not limited to: (i) cost of development and market acceptance
of the Company's educational and testing publications; (ii) the seasonal and
cyclical nature of the Company's educational sales; (iii) variable funding in
school systems throughout the nation, which may result in both cancellation of
planned purchases of educational materials and shifts in timing of purchases;
(iv) changes in purchasing patterns in elementary and secondary school and
college markets; (v) changes in the competitive environment, including those
which would adversely affect selling expenses; (vi) regulatory changes which
would affect the purchase of educational materials and services; (vii) strength
of the retail market for general-interest publications and market acceptance of
newly published titles and new electronic products; (viii) unanticipated
expenses or delays in resolving Year 2000 computer issues by either the Company
or those with whom the Company does business; and (ix) other factors referred
to from time to time in the Company's filings with the Securities and Exchange
Commission.
29
<PAGE> 30
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit No. (27) Financial Data Schedule
(b) Reports on Form 8-K
None
30
<PAGE> 31
SIGNATURES
Pursuant to the requirements of the Securities 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: March 12, 1999 /s/ Gail Deegan
--------------------------------------
Gail Deegan
Executive Vice President,
Chief Financial Officer
Dated: March 12, 1999 /s/ David R. Caron
--------------------------------------
David R. Caron
Vice President, Corporate Controller
31
<PAGE> 32
Houghton Mifflin Company
Index To Exhibits
Item 6(a)
Exhibit No Description of Document Page Number in This Report
- ---------- ----------------------- --------------------------
(27) Financial Data Schedule
32
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 15,828
<SECURITIES> 37,957
<RECEIVABLES> 345,181
<ALLOWANCES> 25,330
<INVENTORY> 153,617
<CURRENT-ASSETS> 541,909
<PP&E> 298,764
<DEPRECIATION> 183,796
<TOTAL-ASSETS> 1,155,756
<CURRENT-LIABILITIES> 445,188
<BONDS> 0
0
0
<COMMON> 30,472
<OTHER-SE> 377,984
<TOTAL-LIABILITY-AND-EQUITY> 1,155,756
<SALES> 446,860
<TOTAL-REVENUES> 446,860
<CGS> 168,011
<TOTAL-COSTS> 290,106
<OTHER-EXPENSES> (15,341)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,292
<INCOME-PRETAX> 162,803
<INCOME-TAX> 66,893
<INCOME-CONTINUING> 95,910
<DISCONTINUED> 0
<EXTRAORDINARY> 18,010
<CHANGES> 0
<NET-INCOME> 113,920
<EPS-PRIMARY> 3.98
<EPS-DILUTED> 3.93
</TABLE>
