<PAGE> 1
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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 JULY 1, 2000 TO SEPTEMBER 30, 2000
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)
<TABLE>
<CAPTION>
<S> <C>
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)
</TABLE>
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, 2000.
Class Outstanding at October 31, 2000
------------------------------- -------------------------------
Common Stock, $1 par value 30,041,992
Preferred Stock Purchase Rights 30,041,992
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1 of 38
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HOUGHTON MIFFLIN COMPANY
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
September 30, 2000 and 1999 and December 31, 1999 3 - 4
Condensed Consolidated Statements of Income,
Comprehensive Income, and Retained Earnings --
Three Months Ended September 30, 2000 and 1999 5
Condensed Consolidated Statements of Income,
Comprehensive Income, and Retained Earnings --
Nine Months Ended September 30, 2000 and 1999 6
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2000 and 1999 7
Notes to Unaudited Condensed Consolidated
Financial Statements 8 - 17
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18 - 32
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 33
Part II. Other Information
Item 4. Submission of Matters to a Vote of
Security Holders 34
Item 6. Exhibits and Reports on Form 8-K 34
Signatures 35
<PAGE> 3
HOUGHTON MIFFLIN COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
September 30, September 30, December 31,
2000 1999 1999
---------- ---------- ----------
<S> <C> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 28,597 $ 8,591 $ 12,041
Marketable securities and time deposits
available for sale, at fair value 638 819 638
Accounts receivable 381,654 364,411 178,887
Less: allowance for bad debts and book returns 31,949 29,532 31,207
---------- ---------- ----------
349,705 334,879 147,680
Notes receivable -- 610 1,633
Inventories
Finished goods 190,331 161,828 152,818
Work in process 7,832 6,541 5,584
Raw materials 8,145 5,300 5,826
---------- ---------- ----------
206,308 173,669 164,228
Deferred income taxes 35,982 24,175 35,889
Prepaid expenses 4,916 3,586 3,000
---------- ---------- ----------
Total current assets 626,146 546,329 365,109
Property, plant, and equipment
(net of accumulated depreciation and amortization
of $90,054 at September 30, 2000, $74,755 at
September 30, 1999 and $76,787 at
December 31, 1999) 77,988 65,471 73,342
Book plates
(net of accumulated amortization of $95,530
at September 30, 2000, $115,681 at September 30,
1999 and $115,222 at December 31, 1999) 127,443 82,706 98,894
Goodwill and other intangible assets, net 439,089 452,489 452,338
Other assets 55,440 49,276 49,060
---------- ---------- ----------
$1,326,106 $1,196,271 $1,038,743
========== ========== ==========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
3
<PAGE> 4
HOUGHTON MIFFLIN COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
September 30, September 30, December 31,
2000 1999 1999
----------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C> <C>
Current liabilities
Accounts payable $ 95,073 $ 82,285 $ 55,601
Commercial paper 169,598 89,418 21,358
Notes payable 4,698 -- --
Royalties 45,201 41,122 51,141
Salaries, wages, and commissions 26,809 28,328 29,814
Other accrued expenses 38,461 40,477 27,895
Income taxes payable 46,462 56,028 3,351
Current portion of long-term debt 50,020 20,077 70,037
----------- ----------- -----------
Total current liabilities 476,322 357,735 259,197
Long-term debt 254,706 304,631 254,638
Accrued royalties payable 1,971 1,005 967
Other liabilities 37,483 31,506 33,406
Accrued postretirement benefits 29,742 29,295 29,213
Deferred income taxes 28,301 15,601 28,301
Stockholders' equity
Preferred stock, $1 par value;
500,000 shares authorized, none issued -- -- --
Common stock, $1 par value;
(70,000,000 shares authorized; 31,782,517
shares issued at September 30, 2000, 31,072,823
shares issued at September 30, 1999, and
31,098,023 shares issued at December 31, 1999) 31,783 31,073 31,098
Capital in excess of par value 125,569 100,717 108,627
Retained earnings 452,079 411,755 392,225
----------- ----------- -----------
609,431 543,545 531,950
Notes receivable from stock purchase agreements (15,913) (4,553) (4,645)
Unearned compensation related to
restricted stock (2,524) (3,571) (3,029)
Common shares held in treasury, at cost
(1,183,925 shares at September 30, 2000, 762,497
shares at September 30, 1999 and 1,045,493 shares
at December 31, 1999) (41,889) (25,621) (36,411)
Benefits Trust assets, at market (51,524) (53,293) (54,844)
Accumulated other comprehensive loss -- (9) --
----------- ----------- -----------
Total stockholder's equity 497,581 456,498 433,021
----------- ----------- -----------
$ 1,326,106 $ 1,196,271 $ 1,038,743
=========== =========== ===========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
4
<PAGE> 5
HOUGHTON MIFFLIN COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME,
COMPREHENSIVE INCOME, AND RETAINED EARNINGS
THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED; IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
2000 1999
--------- ---------
<S> <C> <C>
Net sales by industry segment:
K-12 Publishing $ 353,722 $ 342,038
College Publishing 87,853 87,084
Other 34,904 28,668
--------- ---------
476,479 457,790
Costs and expenses:
Cost of sales 171,284 169,398
Selling and administrative 128,008 123,692
Asset impairment charges 2,488 --
--------- ---------
301,780 293,090
Operating income 174,699 164,700
Other income (expense):
Net interest expense (9,372) (8,535)
Equity in losses of Classwell Learning Group Inc. (779) --
Loss on surrender of INSO Corporation common stock -- (5,586)
Write-down of investment (4,553) --
--------- ---------
(14,704) (14,121)
Income before taxes and extraordinary item 159,995 150,579
Income tax provision 64,713 60,263
--------- ---------
Income before extraordinary item 95,282 90,316
Extraordinary gain on extinguishment of debt
net of tax of $21,956 -- 30,323
--------- ---------
Net income 95,282 120,639
Other comprehensive income, net of tax:
Unrealized loss on available for sale securities -- 34
--------- ---------
Comprehensive income $ 95,282 $ 120,673
========= =========
Retained earnings at beginning of period $ 360,605 $ 294,882
Net income 95,282 120,639
Dividends paid (3,808) (3,766)
--------- ---------
Retained earnings at end of period $ 452,079 $ 411,755
========= =========
Earnings per share:
Basic
Income before extraordinary item $ 3.27 $ 3.13
Extraordinary gain on extinguishment of debt, net of tax -- 1.05
--------- ---------
Net income $ 3.27 $ 4.18
========= =========
Diluted
Income before extraordinary item $ 3.22 $ 3.07
Extraordinary gain on extinguishment of debt, net of tax -- 1.03
--------- ---------
Net income $ 3.22 $ 4.10
========= =========
Cash dividends paid per common share $ 0.13 $ 0.13
========= =========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
5
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HOUGHTON MIFFLIN COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME,
COMPREHENSIVE INCOME, AND RETAINED EARNINGS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED; IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
2000 1999
--------- ---------
<S> <C> <C>
Net sales by industry segment:
K-12 Publishing $ 619,776 $ 572,114
College Publishing 126,238 123,810
Other 79,745 67,030
--------- ---------
825,759 762,954
Costs and expenses:
Cost of sales 346,654 328,247
Selling and administrative 325,001 302,257
Asset impairment charges 2,488 --
Acquired in-process research and development 1,300 --
--------- ---------
675,443 630,504
Operating income 150,316 132,450
Other income (expense):
Net interest expense (24,313) (23,754)
Equity in losses of Classwell Learning Group Inc. (779) --
Loss on surrender of INSO Corporation common stock -- (5,586)
Write-down of investment (4,553) --
--------- ---------
(29,645) (29,340)
Income before taxes and extraordinary item 120,671 103,110
Income tax provision 49,489 41,373
--------- ---------
Income before extraordinary item 71,182 61,737
Extraordinary gain on extinguishment of debt
net of tax of $21,956 -- 30,323
--------- ---------
Net income 71,182 92,060
Other comprehensive loss, net of tax:
Unrealized loss on available for sale securities -- (223)
--------- ---------
Comprehensive income $ 71,182 $ 91,837
========= =========
Retained earnings at beginning of period $ 392,225 $ 330,672
Net income 71,182 92,060
Dividends paid (11,328) (10,977)
--------- ---------
Retained earnings at end of period $ 452,079 $ 411,755
========= =========
Earnings per share:
Basic
Income before extraordinary item $ 2.46 $ 2.14
Extraordinary gain on extinguishment of debt, net of tax -- 1.05
--------- ---------
Net income $ 2.46 $ 3.20
========= =========
Diluted
Income before extraordinary item $ 2.43 $ 2.10
Extraordinary gain on extinguishment of debt, net of tax -- 1.03
--------- ---------
Net income $ 2.43 $ 3.14
========= =========
Cash dividends paid per common share 0.39 0.38
========= =========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
6
<PAGE> 7
HOUGHTON MIFFLIN COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED; IN THOUSANDS)
<TABLE>
<CAPTION>
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income $ 71,182 $ 92,060
Adjustments to reconcile net income to net cash
used in operating activities:
Equity in losses of Classwell Learning Group Inc. 779 --
Extraordinary gain on extinguishment of debt, net of tax -- (30,323)
Depreciation and amortization 80,116 72,581
Amortization of unearned compensation on restricted stock 866 846
Loss on surrender of INSO Corporation common stock -- 5,586
Write-down of investment 4,553 --
Acquired in-process research and development 1,300 --
Asset impairment charge 2,488 --
Changes in operating assets and liabilities:
Accounts receivable, net (200,596) (188,785)
Inventories (42,080) (20,728)
Accounts payable 39,407 42,325
Royalties, net (5,451) (9,207)
Deferred and income taxes payable 43,018 39,734
Salaries, wages, and commissions (3,005) 543
Other, net 11,005 13,222
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,582 17,854
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Book plate expenditures (71,127) (39,583)
Acquisition of publishing and technology assets (18,372) (43,201)
Property, plant, and equipment expenditures (16,966) (20,145)
Issuance of notes receivable (1,407) (590)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (107,872) (103,519)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Dividends paid on common stock (11,328) (10,977)
Issuance of commercial paper 148,240 77,524
Issuance of long-term financing -- 80,000
Payment of long-term financing (20,046) (50,128)
Exercise of stock options 8,047 1,397
Purchase of treasury stock (4,734) (7,580)
Other 667 67
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 120,846 90,303
Increase in cash and cash equivalents 16,556 4,638
Cash and cash equivalents at beginning of period 12,041 3,953
--------- ---------
Cash and cash equivalents at end of period $ 28,597 $ 8,591
========= =========
Supplementary disclosure of cash flow information:
Income taxes paid $ 6,127 $ 1,526
Interest paid $ 25,104 $ 22,981
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
7
<PAGE> 8
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated 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
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 2000 interim
financial statements.
(2) INSO CORPORATION
As of September 30, 1999, Houghton Mifflin had 22,600 shares of INSO
Corporation common stock. These shares were classified as available-for-sale
securities accounted for in accordance with Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," or SFAS 115. The fair value of these shares was determined by the
closing price as of September 30, 1999 as traded on the National Association of
Securities Dealers Automated Quotation System. The unrealized gain, net of
taxes, for these shares for the three months ended September 30, 1999 was
$34,409, and the unrealized loss for the nine months ended September 30, 1999
was $222,836. At September 30, 1999, the shares were included as marketable
securities in current assets due to Houghton Mifflin's intent to sell these
shares in the near term.
(3) ACQUISITIONS AND INVESTMENTS
On May 3, 2000, Houghton Mifflin acquired the net assets of Virtual
Learning Technologies, Inc., or VLT, an educational testing company that
specializes in on-line assessments. VLT has been integrated into The Riverside
Publishing Company. This 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 for the acquisition amounted to
approximately $14.6 million paid to the former shareholders of VLT. The cost of
the acquisition was allocated on the basis of the estimated fair market value of
the assets acquired and liabilities assumed, including acquired in-process
research and development. A charge for acquired in-process research and
development of $1.3 million was also recorded as part of the acquisition.
Goodwill and other intangible assets of $12.7 million were recorded as part of
the acquisition and are being amortized on a straight-line basis over periods
ranging from approximately 2 to 7 years.
8
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(3) ACQUISITIONS AND INVESTMENTS - continued
On May 5, 1999, Houghton Mifflin acquired all of the outstanding stock of
Sunburst Communications, Inc., or Sunburst, a leading developer of software and
video instructional materials. This acquisition was accounted for as a purchase,
and the net assets acquired, liabilities assumed, and results of operations are
included in Houghton Mifflin's consolidated financial statements from the date
of the acquisition. Net cash consideration for the acquisition amounted to
approximately $34.4 million, of which $32.0 million was paid to the former
shareholders of Sunburst and $2.4 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 $31.0 million were recorded as
part of the acquisition and are being amortized on a straight-line basis over
periods ranging from approximately 7 to 20 years.
On January 8, 1999, Houghton Mifflin acquired the assets of 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 $4.4 million. The cost of the acquisition was allocated on the
basis of the estimated fair market value of the assets acquired and the
liabilities assumed. The excess of the purchase price over the net assets
acquired, or goodwill, is being amortized on a straight-line basis over a period
of approximately 8 years.
Since none of the above acquisitions materially affects consolidated
results, no pro forma information is provided.
On September 7, 2000, Houghton Mifflin Company, Sylvan Ventures, and
Inception Capital launched Classwell Learning Group Inc., or Classwell, a
start-up on-line education company which will provide K-12 teachers with new
teaching and learning resources to meet their individual classroom needs and
those of their students. Houghton Mifflin will invest $7 million of cash and
contributed other assets for a fully-diluted ownership interest in Classwell of
approximately 32%. Houghton Mifflin accounts for this investment on the equity
method and records its share of Classwell's undistributed earnings and losses.
In the third quarter of 2000, Houghton Mifflin reviewed the value of its
investment in a distance learning company and estimated that the value had
suffered a decline which was other than temporary. The assessment that this
investment was impaired as of September 30, 2000 was due to the following: (1)
changes in the investee's expectation regarding the timing of its profitability,
(2) the investee's present lack of resources to fund future operations, and (3)
an inability of this investee to raise additional capital at valuations
acceptable to its management and board of directors. As a result of these
factors, Houghton Mifflin has decided not to extend additional financing to the
investee in the third quarter of 2000. Houghton Mifflin believes that if the
investee is able to raise additional financing in the future, its investment
will be significantly diluted, reducing our ability to recover this investment.
Therefore, at September 30, 2000, the investment was written down to its
estimated net realizable value, resulting in a charge of $4.6 million ($2.9
million after tax), or $0.10 per diluted share. This amount is reported as
"Write-down of investment" in a separate line item in the accompanying
consolidated financial statements.
9
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(4) GOODWILL AND INTANGIBLE ASSETS
Goodwill and other intangible assets consist of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999 1999
-------- -------- ------------
(in thousands)
<S> <C> <C> <C>
Goodwill $554,878 $555,947 $545,251
Publishing rights 24,634 17,724 24,874
Other 15,330 4,000 15,860
Less: accumulated amortization (155,753) (125,182) (133,647)
-------- --------- --------
Total $439,089 $452,489 $452,338
======== ========= ========
</TABLE>
Houghton Mifflin examines the carrying value of its long-lived assets,
certain identifiable intangibles, and goodwill to determine whether there are
any impairment losses. An impairment assessment is performed if certain
indicators are present, such as a significant decrease in demand for a product
related to an asset, a history of operating cash flow losses, or a projection or
forecast that demonstrates continuing losses associated with a revenue producing
asset. The undiscounted cash flow method is used to determine if impairment has
occurred. If indicators of impairment are present, and the estimated
undiscounted cash flows to be derived from the related assets are not expected
to be sufficient to recover the asset's carrying amount, an impairment loss is
charged to expense in the period identified based upon the difference between
the carrying amount and the discounted cash flows. The rates that would be
utilized to discount the net cash flows to net present value would take into
account the time value of money and investment risk factors. See Note 8 -
Special Charges for the impairment of the value of long-lived assets,
identifiable intangibles, and goodwill recorded as of September 30, 2000.
10
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(5) EARNINGS PER SHARE
The table below sets forth the computation of basic and diluted earnings
per share for the three months ended September 30, 2000 and September 30, 1999
(in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three months ended
September 30,
----------------------
2000 1999
-------- --------
<S> <C> <C>
Numerator:
Income before extraordinary items ....................... $ 95,282 $ 90,316
Extraordinary gain on extinguishment of debt, net of tax. -- 30,323
-------- --------
Net income .................................................. $ 95,282 $120,639
======== ========
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding .................. 29,127 28,876
Effect of dilutive securities:
Employee stock options .................................. 321 508
Restricted stock ........................................ 107 23
-------- --------
428 531
Denominator for diluted earnings per share:
Adjusted weighted-average shares
outstanding and assumed conversions .................. 29,555 29,407
======== ========
Basic earnings per share:
Income before extraordinary item ....................... $ 3.27 $ 3.13
Extraordinary gain on extinguishment of debt, net of tax -- 1.05
-------- --------
Net income .................................................. $ 3.27 $ 4.18
======== ========
Diluted earnings per share:
Income before extraordinary item ....................... $ 3.22 $ 3.07
Extraordinary gain on extinguishment of debt, net of tax -- 1.03
-------- --------
Net income ............................................. $ 3.22 $ 4.10
======== ========
</TABLE>
11
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(5) 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, 2000 and September 30, 1999
(in thousands, except per share amounts):
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------
2000 1999
------- ----------
<S> <C> <C>
Numerator:
Income before extraordinary item ........................ $71,182 $ 61,737
Extraordinary gain on extinguishment of debt, net of tax. -- 30,323
------- ----------
Net income .................................................. $71,182 $ 92,060
======= ==========
Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding .................. 28,943 28,798
Effect of dilutive securities:
Employee stock options .................................. 269 525
Restricted stock ........................................ 105 26
------- ----------
374 551
Denominator for diluted earnings per share:
Adjusted weighted-average shares
outstanding and assumed conversions ............... 29,317 29,349
======= ==========
Basic income per share:
Income before extraordinary item ....................... $ 2.46 $ 2.14
Extraordinary gain on extinguishment of debt, net of tax -- 1.05
------- ----------
Net income ............................................. $ 2.46 $ 3.20
======= ==========
Diluted earnings per share:
Income before extraordinary item ....................... $ 2.43 $ 2.10
Extraordinary gain on extinguishment of debt, net of tax -- 1.03
------- ----------
Net income ............................................. $ 2.43 $ 3.14
======= ==========
</TABLE>
Options to purchase 23,000 shares of common stock were not included in the
computation of diluted earnings per share for the three months ended September
30, 2000 because the options' exercise prices were greater than the average
market price of the common shares, and therefore, the effect would have been
anti-dilutive. There were no options for which the exercise price exceeded the
average market price of the shares for the three months ended September 30,
1999.
Options to purchase 699,878 shares of common stock were not included in the
computation of diluted earnings per share for the nine months ended September
30, 2000 because the options' exercise prices were greater than the average
market price of the common shares, and therefore, the effect would be
anti-dilutive. For the same reason, options to purchase 22,000 shares of common
stock were not included in the computation of diluted earnings per share for the
nine months ended September 30, 1999.
12
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HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(6) SEGMENT AND RELATED INFORMATION
Houghton Mifflin has eight divisions with separate management teams and
infrastructures that offer different products and services. These divisions have
been aggregated in three reportable segments based on the similar nature of
their products and services, the nature of the production process, class of
customers, and distribution method, as follows:
K-12 Publishing: This segment consists of five divisions: School Division,
McDougal Littell Inc., Great Source Education Group, Inc., Sunburst Technology
Corporation and The Riverside Publishing Company. This operating segment
includes textbooks and instructional materials and services, tests for measuring
achievement and aptitude, clinical/special needs testing products, multimedia
instructional programs, and career guidance products and services. The principal
markets for these products are elementary and secondary schools.
College Publishing: The College Division is the sole business unit reported
in this segment. This operating segment includes textbooks, ancillary products
such as workbooks and study guides, technology-based instructional materials,
and services for introductory and upper level courses in the post-secondary
education market. Products may be in print or electronic form. The principal
markets for these products are two- and four-year colleges and universities.
These products are also sold to high schools for advanced placement courses and
to for-profit, certificate-granting institutions that offer skill-based training
and job placement.
Other: This segment consists of the Trade & Reference Division, Computer
Adaptive Technologies, or CAT, and unallocated corporate-related items. The
Trade & Reference Division publishes fiction and nonfiction for adults and
children, dictionaries, and other reference works. The division also licenses
book rights to paperback publishers, book clubs, Web sites, and other publishers
and electronic businesses in the United States and abroad. Its principal markets
are retail stores, including Internet bookstore sites, and wholesalers. It also
sells reference materials to schools, colleges, office supply distributors, and
businesses. CAT specializes in the development and delivery of computer-based
testing solutions. Its principal markets are organizations worldwide.
Houghton Mifflin's geographic area of operation is predominantly the
United States. Export sales for locations outside the United States are not
significant to Houghton Mifflin's three business segments. Houghton Mifflin does
not have any customers which exceed 10% of net sales, and the loss of a single
customer, in management's opinion, would not have a material adverse effect on
net sales.
Houghton Mifflin evaluates the performance of its operating segments based
on the profit and loss from operations before interest income and expense,
income taxes, and nonrecurring and extraordinary items.
Summarized financial information concerning Houghton Mifflin's reportable
segments is shown in the following tables. The "Other" column includes
unallocated corporate-related items, operations which do not meet the
quantitative thresholds of Statement of Financial Accounting Standard No. 131,
"Disclosures About Segments of an Enterprise and Related Information,"
nonrecurring items, and as it relates to segment profit or loss, income and
expense not allocated to reportable segments.
13
<PAGE> 14
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(6) SEGMENT AND RELATED INFORMATION - continued
THREE MONTHS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 30, 1999:
<TABLE>
<CAPTION>
K-12 COLLEGE
PUBLISHING PUBLISHING OTHER CONSOLIDATED
--------------- --------------- -------------- ---------------
(in thousands)
<S> <C> <C> <C> <C>
2000
Net sales from external customers $353,722 $87,853 $34,904 $476,479
Segment operating income 136,956 32,810 4,933 174,699
1999
Net sales from external customers 342,038 87,084 28,668 457,790
Segment operating income 133,988 27,819 2,893 164,700
</TABLE>
RECONCILIATION OF SEGMENT INCOME TO THE CONDENSED CONSOLIDATED STATEMENTS
OF OPERATIONS:
September 30,
--------------------------
2000 1999
--------- ----------
(in thousands)
Total income from reportable segments .............. $ 174,699 $ 164,700
Unallocated expense:
Net interest expense ............................. (9,372) (8,535)
Equity in losses of Classwell Learning Group Inc. (779) --
Loss on surrender of INSO Corporation common stock -- (5,586)
Write-down of investment ......................... (4,553) --
--------- ---------
Income before taxes ................................ $ 159,995 $ 150,579
========= =========
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 30, 1999:
<TABLE>
<CAPTION>
K-12 COLLEGE
PUBLISHING PUBLISHING OTHER CONSOLIDATED
--------------- --------------- -------------- --------------
(in thousands)
<S> <C> <C> <C> <C>
2000
Net sales from external customers $619,776 $126,238 $79,745 $825,759
Segment operating income (loss) 135,273 16,547 (1,504) 150,316
1999
Net sales from external customers 572,114 123,810 67,030 762,954
Segment operating income (loss) 125,490 12,817 (5,857) 132,450
</TABLE>
14
<PAGE> 15
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(6) SEGMENT AND RELATED INFORMATION - continued
RECONCILIATION OF SEGMENT INCOME TO THE CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS:
September 30,
---------------------
2000 1999
--------- ---------
(in thousands)
Total income from reportable segments $150,316 $132,450
Unallocated expense:
Net interest expense (24,313) (23,754)
Equity in losses of Classwell Learning Group Inc. (779) --
Loss on surrender of INSO Corporation common stock -- (5,586)
Write-down of investment (4,553) --
-------- --------
Income before taxes $120,671 $103,110
======== ========
(7) EXECUTIVE STOCK PURCHASE PLAN
On February 29, 2000, Houghton Mifflin provided financing for the purchase
of an aggregate of 281,430 shares of Houghton Mifflin common stock pursuant to
the 2000 Senior Management and Director Stock Purchase Plan. The purchases were
made at fair market value of $39.813 per share. The loans, which totaled
approximately $11.2 million, have an interest rate of 8.0% and are due on
February 28, 2005. The loans are collateralized by the shares of common stock
purchased and Houghton Mifflin has full recourse against the borrower.
(8) SPECIAL CHARGES
In the third quarter of 2000, Houghton Mifflin recorded a special
charge of $2.5 million ($1.5 million after tax), or $0.05 per diluted share,
related to the write-down of a portion of the goodwill and other long-lived
assets attributable to the Little Planet Literacy Series, a Sunburst Technology
product, to their estimated fair values as determined from estimated future cash
flows. In January 1999, Houghton Mifflin purchased the assets of the Little
Planet Literacy Series, a pre-kindergarten to grade three literacy program.
During 1999, sales for the Little Planet Literacy Series fell short of goals
established at the time of the acquisition, and plans were put into place to
improve sales of this product by the third quarter of 2000, when a number of
sales are made in the education marketplace. A significant improvement failed to
materialize by the third quarter, and as a result, sales are now expected to be
lower than originally expected. Based on these indicators, the goodwill and
other long-lived assets recorded at the time of acquisition were re-evaluated
and compared to the estimated undiscounted cash flows from the Little Planet
products. The undiscounted cash flows indicated there was an impairment, and the
assets were written down to their estimated fair values, as determined from the
estimated anticipated discounted future cash flows. This amount is reported as
an "Asset impairment charge" in a separate line item of Costs and Expenses in
the accompanying consolidated financial statements.
15
<PAGE> 16
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
(9) SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Houghton Mifflin derives revenue primarily from the sale of textbooks
and instructional materials, trade books, test materials, multimedia
instructional programs, license fees for book rights and content, and services
which include test scoring, test development, and training.
Revenues from textbooks and instructional materials, trade books, test
materials, and multimedia instructional programs are recognized in the period
when a purchase order is received from the customer and the products are shipped
from our warehouse, all significant obligations have been delivered, and
collection is considered probable. A provision for estimated returns on these
sales is made at the time of sale, in accordance with FASB Statement No. 48,
"Revenue Recognition when Right of Return Exists," based on historical
experience. Also, the cost of any obligation deemed insignificant by management
related to the sale is accrued at that time. Textbooks shipped from a depository
location are recorded one month in arrears.
Revenues for test scoring are recognized in the period when the scoring
has been completed, the scoring fee is fixed and determinable, and collection is
probable.
Houghton Mifflin also enters into license agreements to sell certain
book publishing rights. Our current policy is to recognize revenue only when the
contract is signed, all obligations have been delivered to the customer, and
collection is probable.
Revenues for fixed-priced contracts that require significant test
development are recognized on a percentage-of-completion method. Revenues from
these contracts are recognized upon attainment of scheduled performance
milestones.
Pending Accounting Pronouncements
In 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin (SAB) 101, "Revenue Recognition in Financial Statements," which must be
adopted no later than the fourth quarter of a registrant's fiscal year beginning
after December 15, 1999. SAB 101 requires that the following four basic criteria
must be met before revenue can be recorded: 1) persuasive evidence that an
arrangement exists, 2) delivery has occurred or services have been rendered, 3)
the seller's price to the buyer is fixed or determinable, and 4) collectibility
is reasonably assured. Houghton Mifflin is currently reviewing the provisions of
SAB 101 to determine the impact on our revenue recognition policy. In connection
with such review, Houghton Mifflin has identified certain situations which may
affect our present revenue recognition policy. Houghton Mifflin has historically
recorded revenue upon shipment of products to customers via common carrier,
regardless of when legal title transfers to the customer while SAB 101 generally
requires that revenue be recorded only upon transfer of title to the customer.
Second, Houghton Mifflin is also evaluating those obligations historically
assessed to be insignificant in the light of the SEC's interpretations. In
addition to these situations, we are still evaluating all the effects of SAB 101
and the SEC's related interpretations. The impact of the adoption is not known
or estimable at this time.
In September 2000, the Emerging Issues Task Force (EITF) reached consensus
on Issue 00-10, "Accounting for Shipping and Handling Fees and Costs," which
must be adopted no later than the fourth quarter of a registrant's fiscal year
beginning after December 15, 1999. Houghton Mifflin is currently classifying
shipping and handling fees, net of shipping and handling costs, as selling and
administrative expenses. Beginning in the fourth quarter of 2000, Houghton
Mifflin will implement the provisions of EITF 00-10 and classify shipping and
handling fees as a component of net sales and shipping and handling costs as a
component of cost of sales. This reclassification will impact line items on the
Statements of Income but will have no effect on consolidated net income.
16
<PAGE> 17
HOUGHTON MIFFLIN COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--Continued--
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities." As amended in June 2000 by Statement of
Financial Standards Accounting Standards No. 138 ("SFAS 138"), "Accounting for
Certain Derivative Instruments and Certain Hedging Activities," it requires
companies to recognize all derivatives as either assets or liabilities in the
balance sheet and measure such instruments at fair value. Derivatives that are
not determined to be hedges must be adjusted to fair value through net income.
As amended by Statement of Financial Accounting Standards No. 137 ("SFAS 137"),
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133," the provisions of SFAS 133 will
require adoption no later than the beginning of our fiscal year ending December
31, 2001. Houghton Mifflin has two interest rate swaps which will expire on
December 1, 2000. We do not anticipate holding any derivative instruments in the
near future. Accordingly, adoption of SFAS 133, as amended by SFAS 138, is not
expected to have an impact on our consolidated financial statements.
(10) DEBT AND BORROWING AGREEMENTS
Houghton Mifflin had a five-year, $300 million unsecured revolving credit
facility which expired on October 31, 2000. On October 31, 2000, Houghton
Mifflin entered into a $200 million unsecured revolving credit facility which
expires on December 31, 2000. The revolving credit facility requires Houghton
Mifflin to comply with certain covenants, the most restrictive of which include
maintenance of a specific level of leverage and fixed-charge coverage ratio. We
expect a new credit facility to be in place by year-end 2000. No amounts were
outstanding under this new revolving credit facility at November 14, 2000. At
December 31, 1999, the outstanding balance on the expired revolving credit
facility was $20 million, at a weighted average interest rate of 6.75%.
At September 30, 2000 and September 30, 1999, Houghton Mifflin had two
interest rate swaps in place, each with a notional amount of $25 million and
terminating on December 1, 2000. Interest income from the interest rate swaps
was $78,112 in the third quarter of 2000 and $92,938 for the nine months ended
September 30, 2000. Interest expense from the interest rate swap was
$107,539 for the third quarter of 1999 and $365,813 for the nine months ended
September 30, 1999.
(11) SUBSEQUENT EVENTS
At its October 25, 2000 meeting, the Board of Directors declared a
quarterly dividend of $0.13 per share, payable on November 22, 2000, to
shareholders of record on November 8, 2000.
On October 25, 2000, the Board of Directors voted to increase the
authorization to buy back stock by an additional 2.25 million shares. This
raises the current share repurchase authorization to approximately three million
shares. Houghton Mifflin expects to buy back shares in the open market or
through negotiated transactions from time to time. From October 26, 2000 to
November 13, 2000, the Company bought back 1,572,600 shares at a total cost of
$57.7 million.
17
<PAGE> 18
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
"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 other similar expressions that
predict or indicate future events or trends, or that do not relate to historical
matters, identify forward-looking statements. Investors should not rely on
forward-looking statements because they are subject to a variety of risks,
uncertainties, and other factors that could cause actual results to differ
materially from our expectations, and we expressly do not undertake any duty to
update forward-looking statements. These factors include, but are not limited
to: (i) cost of development and market acceptance of educational and testing
products and services; (ii) the seasonal and cyclical nature of educational
sales; (iii) possible changes in funding in school systems throughout the
nation, which may result in both cancellation of planned purchases of
educational and testing products and services and shifts in timing of purchases;
(iv) changes in purchasing patterns in elementary and secondary school and
college markets; (v) changes in the competitive environment, including those
which could adversely affect selling expenses; (vi) regulatory changes which
could affect the purchase of educational and testing products and services;
(vii) strength of the retail market for general-interest publications and market
acceptance of newly-published titles and new electronic products; (viii) delays
or unanticipated expenses in connection with development of new CAT products or
establishment of CAT testing facilities; (ix) delays, unanticipated expenses,
and lack of market acceptance of Internet technology products; (x) risks related
to the operating and capital needs of companies in which we have invested, that
could impair the value of such investments; and (xi) other factors detailed from
time to time in Houghton Mifflin's filings with the Securities and Exchange
Commission.
Houghton Mifflin's principal business is publishing, and our 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, multimedia instructional programs, and career guidance
products and services. The principal markets for these products are elementary
and secondary schools.
K-12 Publishing consists of five Houghton Mifflin divisions:
- The School Division, which publishes for the elementary school
market;
- McDougal Littell Inc., which publishes for the secondary school
market;
- Great Source Education Group, Inc., which publishes supplementary
materials for both the elementary and secondary school markets;
- Sunburst Technology Corporation (Sunburst), 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
18
<PAGE> 19
elementary and secondary schools select and purchase new instructional
materials is referred to as the "adoption" process. Twenty-one states,
representing approximately one-half of the United States elementary and
secondary school-age population, select new instructional materials on a
statewide basis for a particular subject approximately every five to eight
years. These twenty-one states are referred to as "adoption states." Generally,
a school or school district within an adoption state may use state monies to
purchase instructional materials only from the list of publishers' programs that
have been approved, or "adopted," by the particular state's governing body. In
the other states, referred to as "open territories," individual schools or
school districts make the purchasing decisions from the unrestricted offerings
of all publishers. The industry terms "adopted" or "adoption" may be used both
to describe a state governing body's approval process and 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 or private career
schools, which 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, the selection of college product is made through the adoption process.
19
<PAGE> 20
Other
Houghton Mifflin's Other operating segment consists of unallocated
corporate-related items and two divisions:
- The Trade & Reference, or Trade, Division; and
- Computer Adaptive Technologies, Inc., or CAT.
The Trade Division publishes fiction and nonfiction for adults and
children, dictionaries, and other reference works. Its principal markets are
retail stores, including Internet bookstore sites, and wholesalers. The division
also sells reference materials to schools, colleges, office supply distributors,
and businesses. The sales volume for trade books and reference works may vary
significantly from year to year based on the success of one or more titles. The
division also licenses book rights and content to paperback publishers, book
clubs, Web sites, and other publishers and electronic businesses in the United
States and abroad. CAT specializes in the development and delivery of
computer-based testing solutions to corporations and associations worldwide.
Company Business as a Whole
We derive approximately 90% of our annual revenues from educational
publishing in the K-12 and College Publishing segments, which are markedly
seasonal businesses. Schools and colleges make most of their purchases in the
second and third quarters of the calendar year, in preparation for the beginning
of the school year in September. Thus, we realize approximately 50% of net sales
and a substantial portion of annual net income during the third quarter, making
third-quarter results material to full-year performance. We also
characteristically post a net loss in the first and fourth quarters of the year,
when fewer educational institutions are making purchases.
Sales of K-12 instructional materials are also cyclical, with some years
offering more sales opportunities than others. The amount of funding available
at the state level for educational materials also has a significant effect on
Houghton Mifflin's year-to-year revenues. Although the loss of a single customer
or a few customers would not have a material adverse effect on our business,
schedules of school adoptions and market acceptance of our products can affect
year-to-year revenue performance.
20
<PAGE> 21
RESULTS OF OPERATIONS:
THIRD QUARTER 2000 COMPARED TO THIRD QUARTER 1999
IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS
NET INCOME:
<TABLE>
<CAPTION>
Three months ended September 30,
-------------------------------------------------
Diluted
earnings (loss)
per share
2000 1999 2000 1999
------- ------- ----- -----
<S> <C> <C> <C> <C>
Income after tax, but excluding extraordinary and
nonrecurring expenses $98,139 $93,556 $3.32 $3.18
Extraordinary and nonrecurring expenses, net of taxes,
where applicable:
Extraordinary gain on extinguishment of debt -- 30,323 -- 1.03
Loss on surrender of INSO Corporation
common stock to satisfy indebtedness -- (3,240) -- (0.11)
Write-down of investment (2,857) -- (0.10) --
------- -------- ----- -----
Net income $95,282 $120,639 $3.22 $4.10
======= ======== ===== =====
</TABLE>
For the quarter ended September 30, 2000, consolidated net income was
$95.3 million, or $3.22 per diluted share, compared to net income of $120.6
million, or $4.10 per diluted share, for the same period in 1999.
Income after tax, but excluding extraordinary and nonrecurring expenses,
for the third quarter of 2000 was $98.1 million, or $3.32 per diluted share,
compared to $93.6 million, or $3.18 per diluted share, in the third quarter of
1999. The primary reasons for the increase were higher net sales and lower
editorial costs, partially offset by higher selling and implementation costs,
higher losses at CAT, an asset impairment charge, increased intangible asset
amortization, and equity in losses of Classwell Learning Group.
In the third quarter of 2000, Houghton Mifflin recorded a special charge
for the write-down of an investment in a distance learning start-up company,
which resulted in a loss of $4.6 million ($2.9 million after tax), or $0.10 per
diluted share. On August 2, 1999, the remaining one-half, or $63.3 million,
Stock Appreciation Linked Securities ("SAILS") matured. Houghton Mifflin
delivered approximately 1.9 million shares of INSO Corporation (INSO) common
stock upon maturity of the SAILS. The transaction represented a surrender of
INSO common stock and resulted in a non-cash loss of $5.6 million ($3.2 million
after tax), or $0.11 per diluted share. Houghton Mifflin also recognized an
extraordinary gain of $52.3 million ($30.3 million after tax), or $1.03 per
diluted share, on the extinguishment of the remaining SAILS indebtedness.
21
<PAGE> 22
NET SALES:
Three months ended September 30,
---------------------------------------------------
Increase (decrease)
2000 1999 $ %
-------- -------- ------- ------
K-12 Publishing $353,722 $342,038 $11,684 3.4%
College Publishing 87,853 87,084 769 0.9
Other 34,904 28,668 6,236 21.8
--------- -------- ------- ----
Total net sales $476,479 $457,790 $18,689 4.1%
========= ======== ======= =====
Net sales of $476.5 million for the quarter ended September 30, 2000 were
up $18.7 million, or 4.1%, from $457.8 million reported in the third quarter of
1999. The K-12 Publishing segment's net sales of $353.7 million in the third
quarter of 2000 increased $11.7 million, or 3.4%, from net sales of $342.0
million in the third quarter of 1999. The School Division and McDougal Littell
had higher net sales, reflecting opportunities in adoption states, particularly
California, in which both divisions had substantial sales. Great Source reported
a significant increase in net sales, also benefiting from the California market
as well as strong sales of language arts products and product introductions.
Riverside Publishing had higher net sales due to the May 2000 acquisition of VLT
and higher group assessment sales, partially offset by lower clinical sales. The
College Publishing segment's net sales increased slightly in the third quarter
of 2000, to $87.9 million from $87.1 million in the third quarter of 1999.
Although sales of frontlist titles rose, sales to the high school advanced
placement market declined due to fewer adoption opportunities. The Other
segment's net sales in the third quarter of 2000 increased $6.2 million, or
21.8%, to $34.9 million from last year's third-quarter net sales of $28.7
million. This was primarily due to the Trade Division's strong list of adult and
children's titles as well as the successful launch of The American Heritage (R)
Dictionary 4th Edition.
22
<PAGE> 23
COSTS AND EXPENSES:
Three months ended September 30,
-----------------------------------------
Increase (decrease)
2000 1999 $ %
-------- -------- ------ -----
Cost of sales $171,284 $169,398 $1,886 1.1%
Selling and administrative, excluding
intangible asset amortization 119,316 115,682 3,634 3.1
Intangible asset amortization 8,692 8,010 682 8.5
Asset impairment charges 2,488 -- 2,488 --
-------- -------- ------ ---
Total costs and expenses $301,780 $293,090 $8,690 3.0%
======== ======== ====== ====
Cost of sales:
Cost of sales in the third quarter of 2000 increased $1.9 million, or
1.1%, to $171.3 million from $169.4 million in the third quarter of 1999. Higher
manufacturing costs resulting from higher net sales were offset by lower
editorial costs, reflecting the winding down of the current product development
schedule in preparation for sales opportunities in 2000 and beyond. As a result,
cost of sales as a percentage of sales decreased to 35.9% in the third quarter
of 2000 from 37.0% in the third quarter of 1999.
Selling and administrative:
In the third quarter of 2000, selling and administrative expenses,
excluding intangible asset amortization, were $119.3 million, an increase of
$3.6 million, or 3.1%, from $115.7 million in the third quarter of 1999. Higher
selling expenses were partially offset by lower administrative expenses. Selling
expense increased primarily due to higher implementation costs. Administrative
expenses decreased primarily due to lower employee-related costs. Due to higher
net sales and lower administrative expenses, selling and administrative
expenses, excluding intangible asset amortization, decreased as a percentage of
sales, to 25.0% in the third quarter of 2000 from 25.3% in the third quarter of
1999.
Intangible asset amortization:
Due to the May 2000 acquisition of VLT, intangible asset amortization
increased to $8.7 million in the third quarter of 2000 from $8.0 million in the
same period last year.
23
<PAGE> 24
Asset Impairment Charge:
In the third quarter of 2000, Houghton Mifflin recorded a special charge
of $2.5 million ($1.5 million after tax), or $0.05 per diluted share, related to
the write-down of a portion of the goodwill and other long-lived assets
attributable to the Little Planet Literacy Series, a Sunburst Technology
product, to their estimated fair values as determined from estimated future cash
flows. In January 1999, Houghton Mifflin purchased the assets of the Little
Planet Literacy Series, a pre-kindergarten to grade three literacy program.
During 1999, sales for the Little Planet Literacy Series fell short of goals
established at the time of the acquisition, and plans were put into place to
improve sales of this product by the third quarter of 2000, when a number of
sales are made in the education marketplace. A significant improvement failed to
materialize by the third quarter, and as a result, future sales are now expected
to be lower than originally expected. Based on these indicators, the goodwill
and other long-lived assets recorded at the time of acquisition were
re-evaluated and compared to the estimated undiscounted cash flows from the
Little Planet products. The undiscounted cash flows indicated there was an
impairment, and the assets were written down to their estimated fair values, as
determined from the estimated anticipated discounted future cash flows. This
amount is reported as an "Asset impairment charge" in a separate line item of
Costs and Expenses in the accompanying consolidated financial statements.
NET INTEREST EXPENSE:
Net interest expense for the third quarter of 2000 was $9.4 million, an
increase of $0.9 million from $8.5 million in the third quarter of 1999. This
increase reflects higher borrowings and higher interest rates. Houghton Mifflin
also had two interest rate swaps in place in 2000 and 1999, the effect of which
was to decrease interest expense in the third quarter of 2000 by $0.1 million
and to increase interest expense in the third quarter of 1999 by $0.1 million.
EQUITY IN LOSSES OF CLASSWELL LEARNING GROUP:
In the third quarter of 2000, Houghton Mifflin recorded an $0.8 million
loss, or $0.03 per diluted share, reflecting its share of the losses in
Classwell Learning Group, recorded on the equity method.
INCOME TAXES:
The income tax provision increased $4.5 million, or 7.4%, over the same
period last year. This increase was due to higher operating income and an
increase in the effective tax rate to 40.4% in the third quarter of 2000 from
40.0% in the third quarter of 1999. The increase in the effective tax rate was
due to a higher amount of non-deductible intangible asset amortization.
24
<PAGE> 25
K-12 PUBLISHING:
Operating income for the K-12 Publishing segment increased $3.0 million,
or 2.2%, to $137.0 million in the third quarter of 2000 compared to $134.0
million in the third quarter of 1999. The resulting operating margin for the
third quarter of 2000 was 38.7% compared to 39.2% in the third quarter of 1999.
The decrease in the operating margin was primarily due to higher selling costs
and the asset impairment charge for the Little Planet Literacy Series, partially
offset by higher net sales and lower editorial, distribution, and administrative
costs. The increase in selling costs was due to higher implementation expenses.
Lower editorial costs were due to the winding down of a heavy product
development cycle in preparation for sales opportunities in 2000 and beyond.
Distribution costs were lower due to benefits from the new warehouse systems
implemented over the last two years. Administrative costs were lower due to
lower employee-related costs.
COLLEGE PUBLISHING:
The College Publishing segment's operating income increased $5.0 million,
or 17.9%, to $32.8 million in the third quarter of 2000 compared to $27.8
million for the same period in 1999. The resulting operating margin for the
third quarter of 2000 was 37.3% compared to 31.9% in the third quarter of 1999.
The increase in the operating margin was primarily due to lower royalty and
selling costs. Lower royalty costs were due to a change in the mix of products
sold, which resulted in a higher percentage of revenues from products with a
lower royalty rate. Lower selling costs were primarily due to lower selling
commissions.
OTHER:
The Other segment's operating income was $4.9 million in the third quarter
of 2000 compared to $2.9 million in the same period in 1999. The increased
operating income was primarily due to higher net sales and lower manufacturing
and royalty costs as a percentage of net sales, partially offset by higher
losses at CAT.
25
<PAGE> 26
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS
NET INCOME
<TABLE>
<CAPTION>
Nine months ended September 30,
------------------------------------------
Diluted income
(loss) per share
2000 1999 2000 1999
-------- -------- ------ ------
<S> <C> <C> <C> <C>
Income after tax, but excluding extraordinary and
nonrecurring expenses ........................... $ 74,039 $ 64,977 $ 2.53 $ 2.21
Extraordinary and nonrecurring expenses, net of
taxes, where applicable:
Extraordinary gain on extinguishment of debt -- 30,323 -- 1.03
Loss on surrender of INSO Corporation common
stock to satisfy indebtedness .............. -- (3,240) -- (0.11)
Write-down of investment ................... (2,857) -- (0.10) --
-------- -------- ------ ------
Net income ...................................... $ 71,182 $ 92,060 $ 2.43 $ 3.14
======== ======== ====== ======
</TABLE>
The consolidated net income for the nine months ended September 30, 2000
was $71.2 million, or $2.43 per diluted share, compared to net income of $92.1
million, or $3.14 per diluted share, for the same period in 1999.
Income after tax, excluding extraordinary and nonrecurring expenses, for
the nine months ended September 30, 2000 was $74.0 million, or $2.53 per diluted
share, compared to $65.0 million, or $2.21 per diluted share, for the same
period in 1999. The primary reasons for the increase were higher sales and
operating efficiencies, partially offset by higher selling costs, higher losses
at CAT, an asset impairment charge, increased intangible asset amortization, and
equity in losses of Classwell Learning Group.
During the first nine months of 2000, the Company recorded a special
charge for the write-down of an investment in a distance learning start-up
company, which resulted in a loss of $4.6 million ($2.9 million after-tax), or
$0.10 per diluted share. The 1999 results included a non-cash loss of $5.6
million ($3.2 million after tax), or $0.11 per diluted share, on the surrender
of INSO common stock upon maturity of the remaining outstanding SAILS, and an
extraordinary gain of $52.3 million ($30.3 million after tax), or $1.03 per
diluted share, on the extinguishment of the SAILS indebtedness.
26
<PAGE> 27
NET SALES:
Nine months ended September 30,
---------------------------------------------
Increase (decrease)
2000 1999 $ %
-------- -------- ------- -----
K-12 Publishing $619,776 $572,114 $47,662 8.3%
College Publishing 126,238 123,810 2,428 2.0
Other 79,745 67,030 12,715 19.0
-------- -------- ------- -----
Total net sales $825,759 $762,954 $62,805 8.2%
======== ======== ======= =====
Net sales for the nine months ended September 30, 2000 were $825.8
million, an increase of 8.2% from the $763.0 million reported in the same period
in 1999. The K-12 Publishing segment's net sales increased $47.7 million, or
8.3%, to $619.8 million in the nine months ended September 30, 2000 from $572.1
million in the same period in 1999. Each division in the segment reported higher
net sales, benefiting from adoption opportunities and product introductions. The
College Publishing segment's net sales for the nine months ended September 30,
2000 increased 2.0%, to $126.2 million from $123.8 million in the same period in
1999. The Other segment's net sales for the nine months ended September 30, 2000
increased $12.7 million, or 19.0%, to $79.7 million from $67.0 million for the
same period in 1999. This increase was primarily due to increased sales from the
Trade Division's adult and children's titles, publishing rights, and higher
dictionary sales.
27
<PAGE> 28
COSTS AND EXPENSES:
<TABLE>
<CAPTION>
Nine months ended September 30,
--------------------------------------------------
Increase (decrease)
2000 1999 $ %
-------- -------- ------- ------
<S> <C> <C> <C> <C>
Cost of sales $346,654 $328,247 $18,407 5.6%
Selling and administrative, excluding
intangible asset amortization 299,664 278,854 20,810 7.5
Intangible asset amortization 25,337 23,403 1,934 8.3
Asset impairment charges 2,488 -- 2,488 --
Acquired in-process research and development 1,300 -- 1,300 --
-------- -------- ------- ----
Total costs and expenses $675,443 $630,504 $44,939 7.1%
======== ======== ======= ====
</TABLE>
Cost of sales:
During the nine months ended September 30, 2000, cost of sales increased
$18.4 million, or 5.6%, to $346.7 million from $328.2 million during the same
period in 1999. The increased cost of sales was due to higher manufacturing and
royalty costs, which were the result of higher net sales, and increased
editorial and plate amortization incurred for new program development and
product revisions in preparation for sales opportunities in 2000 and beyond.
As a percentage of sales, cost of sales decreased to 42.0% for the nine months
ended September 30, 2000 from 43.0% during the same period in 1999. Although
editorial expenses and plate amortization were higher in absolute dollars, the
net sales gains offset the percentage increase in these items.
Selling and administrative:
For the nine months ended September 30, 2000, selling and administrative
expenses, excluding intangible asset amortization, were $299.7 million, an
increase of $20.8 million, or 7.5%, from $278.9 million for the same period in
1999. The primary reasons for this increase were higher selling costs related to
sales opportunities in 2000 and beyond, the additional selling and
administrative costs for the operations of Sunburst, the additional distribution
and administrative costs for the operations of CAT, and increased spending on
technology initiatives. The increases were partially offset by lower
distribution costs. Implementation of a new warehouse automation system in 1999
and in-sourcing of the Trade Division's distribution function contributed to the
lower distribution costs. Overall, as a percentage of sales, selling and
administrative expenses decreased to 36.3% for the nine months ended September
30, 2000, from 36.5% during the same period in 1999.
28
<PAGE> 29
Intangible Asset Amortization:
Due to the May 2000 acquisition of VLT and the May 1999 acquisition of
Sunburst Communications, intangible asset amortization increased to $25.3
million in the nine months ended September 30, 2000 from $23.4 million in the
same period last year.
Asset Impairment Charge:
In the third quarter of 2000, Houghton Mifflin recorded a special charge
of $2.5 million ($1.5 million after tax), or $0.05 per diluted share, related to
the write-down of a portion of the goodwill and other long-lived assets
attributable to the Little Planet Literacy Series, a Sunburst Technology
product, to their estimated fair values as determined from estimated future cash
flows.
Acquired in Process Research and Development:
The acquisition of VLT included the purchase of certain technology and
research development which resulted in a one-time charge of $1.3 million ($0.8
million after tax), or $0.03 per diluted share.
NET INTEREST EXPENSE:
Net interest expense for the nine months ended September 30, 2000
increased $0.5 million, to $24.3 million from $23.8 million for the same period
in 1999. The increase reflects higher borrowings and higher interest rates. This
increase was partially offset by the maturity on August 2, 1999, of $63.3
million of SAILS. The effect of the interest rate swaps was to decrease interest
expense for the nine months ended September 30, 2000 by $0.1 million and to
increase interest expense for the nine months ended September 30, 1999 by $0.4
million.
29
<PAGE> 30
EQUITY IN LOSSES OF CLASSWELL LEARNING GROUP:
In the third quarter of 2000, Houghton Mifflin recorded an $0.8 million
equity loss, or $0.03 per diluted share, reflecting its share of the losses in
Classwell Learning Group, recorded on the equity method.
INCOME TAXES:
The income tax provision increased $8.1 million, or 19.6%, over the same
period last year. The increase was due to the higher operating income in 2000
and an increase in the effective tax rate to 41.0% for the nine months ended
September 30, 2000 from 40.1% for the same period in 1999. The increase in the
effective tax rate was due to a higher amount of non-deductible intangible asset
amortization.
K-12 PUBLISHING:
Operating income for the K-12 Publishing segment increased $9.8 million, or
7.8%, to $135.3 million for the nine months ended September 30, 2000 from $125.5
million for the same period of 1999. The increase in operating income was
primarily due to higher net sales in all divisions and decreased distribution
costs, partially offset by higher cost of sales and selling expenses, higher
intangible asset amortization due to the acquisition of Sunburst and VLT, the
acquired in-process research and development charge related to the VLT
acquisition, and an adjustment associated with the impaired assets of the Little
Planet Literacy Series. Lower distribution expenses were primarily due to the
implementation of a new warehouse automation system. Cost of sales rose due to
higher manufacturing and royalty costs, which were the result of higher net
sales, partially offset by lower editorial expense due to the winding down of a
heavy product development cycle in preparation for sales opportunities in the
year 2000 and beyond. The increase in selling expense was due to higher sampling
and implementation expense related to the increase in sales opportunities in
2000.
COLLEGE PUBLISHING:
The College Publishing segment's operating income was $16.5 million for the
first nine months of 2000, compared to $12.8 million for the same period in
1999. The increase in operating income was primarily due to higher net sales and
lower royalty and selling expenses.
OTHER:
The Other segment's operating loss was $1.5 million in the nine months
ended September 30, 2000, compared to $5.9 million in the same period of 1999.
The decrease in operating loss was primarily due to higher net sales and lower
distribution expenses in the Trade Division, partially offset by higher losses
at CAT and higher spending on technology initiatives.
30
<PAGE> 31
LIQUIDITY AND CAPITAL RESOURCES
Houghton Mifflin's principal businesses are seasonal, with almost 90% of
annual revenues derived from educational publishing in the K-12 and College
Publishing segments, which are markedly seasonal businesses. We realize
approximately 50% of net sales and a substantial portion of net income during
the third quarter and characteristically post a net loss in the first and fourth
quarters of the year.
This sales seasonality affects our operating cash flow. Houghton Mifflin
normally incurs a net cash deficit from all of our activities through the middle
of the third quarter of the year. We fund the deficit through the draw-down of
cash and marketable securities, supplemented by short-term borrowings,
principally commercial paper.
During the nine months ended September 30, 2000, Houghton Mifflin used
$128.2 million of net borrowings to cover seasonal working capital needs and to
fund publishing and capital investments. During the nine months ended September
30, 1999, Houghton Mifflin used $107.4 million of net borrowings to cover
seasonal working capital needs and to fund publishing and capital investments.
Net cash provided by operating activities was $3.6 million during the nine
months ended September 30, 2000, a $14.3 million decrease from the $17.9 million
of cash provided by operating activities during the same period in 1999. Net
income excluding non-cash items increased by $20.3 million during the nine
months ended September 30, 2000 as compared to the same period in 1999. Changes
in operating assets and liabilities used $34.8 million more cash during the nine
months ended September 30, 2000 than in the same period in 1999 due to higher
accounts receivable and inventories. Higher accounts receivable was primarily
due to the timing of sales, as third-quarter sales in 2000 increased over the
third quarter of 1999. Inventory levels increased in anticipation of sales
opportunities in the fourth quarter of 2000 and 2001.
Cash used for investing activities was $107.9 million during the nine
months ended September 30, 2000, an increase of $4.4 million from the $103.5
million required in the same period in 1999. The increase was principally due to
higher plate expenditures resulting from increased investments in new products
for sales opportunities in 2000 and beyond and the May 2000 acquisition of VLT,
mostly offset by the May 1999 acquisition of Sunburst Communications.
Net proceeds from financing activities increased by $30.5 million during
the nine months ended September 30, 2000 from the same period in 1999. Houghton
Mifflin's net borrowings increased by $20.8 million during the nine months as
compared to the same period in 1999. For the nine months ended September 30,
2000, Houghton Mifflin made common stock repurchases totaling approximately $4.7
million, $2.8 million less than in the same period last year.
Houghton Mifflin had a five-year, $300 million unsecured revolving credit
facility which expired on October 31, 2000. On October 31, 2000, Houghton
Mifflin entered into a $200 million unsecured revolving credit facility which
expires on December 31, 2000. The revolving credit facility requires Houghton
Mifflin to comply with certain covenants, the most restrictive of which include
maintenance of a specific level of leverage and fixed-charge coverage ratio. We
expect a new credit facility to be in place by year-end 2000. No amounts were
outstanding under this new revolving credit facility at November 14, 2000. At
December 31, 1999, the outstanding balance on the expired revolving credit
facility was $20 million, at a weighted average interest rate of 6.75%.
Houghton Mifflin believes its existing cash, expected positive cash flow
from operations, and its existing credit facilities will be sufficient to
finance the VLT acquisition, fund capital expenditures and dividend payments,
and buy back common stock from time to time.
31
<PAGE> 32
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisition of VLT in May 2000, Houghton Mifflin
wrote off in-process research and development totaling $1.3 million ($0.8
million after tax) in the second quarter of 2000. The charge was necessary
because the acquired technology had not yet reached technological feasibility
and had no future alternative use. This amount represents an allocation of the
purchase price related to new versions of CyberSTAR and ActNow!
CyberSTAR is a Web-based assessment product specifically targeted at the
K-12 market that provides student testing, scoring, and reporting of test
questions. The CyberSTAR in-process project will replace the existing CyberSTAR
product and will include the following features and functions: (1) test
formatting/printing which will allow for production of a test booklet from
CyberSTAR; (2) database storage, which involves storing test results to a new
area of the database and production of reports from that new area; (3) grouping
student-specific records written in Java, which will replace the existing Visual
Basic Code that exists around student and course management; and (4) a portal,
which provides on-line delivery of the test and view of the grade report.
ActNow! is a complete Web-based training program that offers educational
professionals anytime, anywhere, precision training in a wide variety of
industry-standard desktop software applications. The ActNow! in-process project
involves the creation of fully Web-enabled delivery software; the current
ActNow! product delivers assessments from the local PC drive.
Houghton Mifflin anticipates that the products using the acquired
in-process research and development will be released during 2001. We expect that
the acquired in-process research and development will be successfully developed,
but we cannot be sure that the products will be commercially successful.
The nature of the efforts required to develop the acquired in-process
research and development into commercially viable products principally relate to
the completion of all planning, designing, prototyping, verification, and
testing activities necessary to establish that the products can meet design
specifications, including functions, features and technical performance
requirements.
We determined the value of the acquired in-process research and development
by estimating the projected net cash flows related to the products and the stage
of completion of the products and discounting these cash flows to the net
present value. We based the resulting projected net cash flows on management's
estimates of revenues and operating profits related to the products. The revenue
estimates we used to value the in-process research and development were based on
estimates of relevant market sizes and growth factors, expected trends in the
related technology, and the nature and expected timing of new product
introductions by Houghton Mifflin and our competitors. The rates utilized to
discount the net cash flows to the net present value were based on a discount
rate of 30% for CyberSTAR and 25% for ActNow! These discount rates took into
account the time value of money and investment risk factors described above.
The stage of completion at the time of the acquisition was 29% for
CyberSTAR and 41% for ActNow! The expected cost to complete is $0.3 million for
CyberSTAR and $0.2 million for ActNow!, and both projects are expected to be
completed by the first quarter of 2001.
The estimates used by Houghton Mifflin in valuing the in-process research
and development were based upon assumptions we believe to be reasonable but
which are inherently uncertain and unpredictable. Our assumptions may be
incomplete or inaccurate, and unanticipated events and circumstances may occur.
Accordingly, actual results may vary from the projected results. Any such
variances may adversely affect the sales and profitability of future periods.
Additionally, the value of other intangible assets may become impaired.
32
<PAGE> 33
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, 1999.
Due to the seasonal nature of our business, Houghton Mifflin's borrowings
under our commercial paper program typically increase through the third quarter
of each year. The outstanding commercial paper balance was $169.6 million at
September 30, 2000, $21.4 million at December 31, 1999, and $89.4 million at
September 30, 1999. The average interest rate on the commercial paper for the
nine months ended September 30, 2000 was 6.61%. The carrying value of the
commercial paper equals fair value due to the short-term maturity of the
instrument.
Houghton Mifflin had a five-year, $300 million unsecured revolving
credit facility which expired on October 31, 2000. On October 31, 2000,
Houghton Mifflin entered into a $200 million unsecured revolving credit
facility which expires on December 31, 2000. The revolving credit facility
requires Houghton Mifflin to comply with certain covenants, the most
restrictive of which include maintenance of a specific level of leverage and
fixed-charge coverage ratio. We expect a new credit facility to be in place by
year-end 2000. No amounts were outstanding under this new revolving credit
facility at November 14, 2000. At December 31, 1999, the outstanding balance on
the expired revolving credit facility was $20 million, at a weighted average
interest rate of 6.75%.
33
<PAGE> 34
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) None
ITEM 5. Other Events
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit No. (27) Financial Data Schedule
(b) Reports on Form 8-K
Form 8-K dated September 8, 2000
Item 5. Other Events
34
<PAGE> 35
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: November 14, 2000 /s/ Gail Deegan
----------------------------------
Gail Deegan
Executive Vice President, Chief
Financial Officer
Dated: November 14, 2000 /s/ David R. Caron
----------------------------------
David R. Caron
Vice President, Corporate
Controller
35
<PAGE> 36
Houghton Mifflin Company
Index To Exhibits
Item 6(a)
Exhibit No Description of Document Page Number in This Report
---------- ----------------------- --------------------------
(27) Financial Data Schedule
36
