-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VeqO58HGcLRufAVftF11gq0TG/Zayr0vTSAMb5qTRDIMt2pHmTMjppaxF9U5H3BE 1y40FVyI7+xf3GuinMU+0A== 0000950135-99-001591.txt : 19990330 0000950135-99-001591.hdr.sgml : 19990330 ACCESSION NUMBER: 0000950135-99-001591 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOUGHTON MIFFLIN CO CENTRAL INDEX KEY: 0000048638 STANDARD INDUSTRIAL CLASSIFICATION: BOOKS: PUBLISHING OR PUBLISHING AND PRINTING [2731] IRS NUMBER: 041456030 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-05406 FILM NUMBER: 99576014 BUSINESS ADDRESS: STREET 1: 222 BERKELEY ST STREET 2: 5TH FL CITY: BOSTON STATE: MA ZIP: 02116-3764 BUSINESS PHONE: 6173515000 MAIL ADDRESS: STREET 1: 222 BERKELEY ST STREET 2: 5TH FL CITY: BOSTON STATE: MA ZIP: 02116-3764 FORMER COMPANY: FORMER CONFORMED NAME: HOUGHTON MIFFLIN & CO DATE OF NAME CHANGE: 19670402 10-K 1 HOUGHTON MIFFLIN 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 (State or other jurisdiction of incorporation or organization) 222 BERKELEY ST., BOSTON (Address of principal executive offices) 04-1456030 (I.R.S. Employer Identification No.) 02116-3764 (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (617) 351-5000 ------------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- --------------------- Common Stock, $1 par value New York Stock Exchange Preferred Stock Purchase Rights
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock of the registrant held by nonaffiliates of the registrant was approximately $1,143,583,000 as of February 28, 1999. The registrant had outstanding 30,080,264 shares of common stock (exclusive of Treasury shares) and 30,080,264 Preferred Stock Purchase Rights as of February 28, 1999. ------------------------ DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement (the "Definitive Proxy Statement") to be filed with the Securities and Exchange Commission relative to the Company's 1999 Annual Meeting of Stockholders are incorporated into Part III. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 HOUGHTON MIFFLIN COMPANY TABLE OF CONTENTS FORM 10-K
PAGE ---- PART I Item 1. Business.................................................... 1 Item 2. Properties.................................................. 6 Item 3. Legal Proceedings........................................... 7 Item 4. Submission of Matters to a Vote of Securities Holders....... 7 PART II Item 5. Market for Houghton Mifflin's Common Stock and Related Stockholder Matters......................................... 9 Item 6. Selected Financial Data..................................... 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 12 Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 24 Item 8. Consolidated Financial Statements and Supplementary Data.... 27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 61 PART III Item 10. Directors and Executive Officers of Houghton Mifflin........ 61 Item 11. Executive Compensation...................................... 61 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 61 Item 13. Certain Relationships and Related Transactions.............. 61 PART IV Item 14. Exhibits, Financial Statements and Schedule, and Reports on Form 8-K.................................................... 61 Index to Consolidated Financial Statements and Financial Schedules................................................... 61 Financial Statement Schedule................................ 61 Signatures.................................................. 63 Index to Exhibits........................................... 64
This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Houghton Mifflin's actual results could differ materially from the expectations described in the forward-looking statements. Some of the factors that might cause such a difference are discussed in the section entitled " 'Safe Harbor' Statement under Private Securities Litigation Reform Act of 1995" on page 25 of this Form 10-K. 3 PART I ITEM 1. BUSINESS (a) DESCRIPTION OF BUSINESS Houghton Mifflin Company was incorporated in 1908 in Massachusetts as the successor to a partnership formed in 1880. Antecedents of the partnership date back to 1832. Houghton Mifflin has five operating subsidiaries: McDougal Littell Inc., Evanston, Illinois, publishes educational materials for the secondary school market; The Riverside Publishing Company, Itasca, Illinois, publishes assessment materials for the educational and clinical testing markets; Great Source Education Group, Inc., Wilmington, Massachusetts, publishes supplementary instructional materials for the elementary and secondary school markets; Houghton Mifflin Interactive Corporation, Somerville, Massachusetts, develops and sells multimedia products, chiefly CD-ROM titles, in the children's, reference, and adult-hobby markets; and Computer Adaptive Technologies, Inc., Evanston, Illinois, specializes in the development and delivery of computer-based testing solutions to corporations and associations worldwide. Houghton Mifflin's principal business is publishing, and its operations are classified into three operating segments: - K-12 Publishing, which includes textbooks and other educational materials and services for the kindergarten through grade twelve, or K-12, school markets; - College Publishing, which includes textbooks and other educational materials and services for the college markets; and - Other, which includes fiction, nonfiction, children's books, dictionary and reference materials in a variety of formats and media and computer-based testing solutions. In this description of its business, all subsidiaries are treated as part of Houghton Mifflin. In December 1998, Houghton Mifflin purchased DiscoveryWorks, a science program for the elementary school market from Silver Burdett Ginn Inc., a subsidiary of Pearson Plc, for approximately $10.5 million in cash. The financial statements show the effect of DiscoveryWorks on Houghton Mifflin's operating results from the date of the acquisition in the K-12 Publishing segment. In July 1998, Houghton Mifflin purchased all of the outstanding stock of Computer Adaptive Technologies, Inc., or CAT, for approximately $10.7 million in cash plus an additional $6 million if agreed-upon performance and technical goals are met. The financial statements include CAT's operating results from the date of acquisition in the Other segment. In March 1994, Houghton Mifflin's former Software Division successfully completed an initial public offering. Houghton Mifflin retained an equity interest in the successor company, INSO Corporation, of approximately 40%. As of January 1, 1998, Houghton Mifflin owned approximately 27% of INSO's common stock. On August 1, 1998, Houghton Mifflin used approximately 1.9 million shares of INSO common stock to redeem one-half of its outstanding 6% Exchangeable Notes due 1999 -- Stock Appreciation Income Linked Securities, or SAILS, reducing Houghton Mifflin's ownership to approximately 13%. (b) FINANCIAL INFORMATION ABOUT THE OPERATING SEGMENTS Financial information about Houghton Mifflin's operating segments is in Part II, Item 8, the Notes to Consolidated Financial Statements in Note 12 under the heading "Segment and Related Information" on page 55 and the schedule titled "Five-Year Financial Summary" on page 10. 1 4 (c) NARRATIVE DESCRIPTION OF BUSINESS As a publisher, Houghton Mifflin shapes ideas, information, and instructional methods into various media that satisfy the lifelong need of people to learn, gain proficiency, and be entertained. Houghton Mifflin seeks out, selects, and generates worthwhile concepts and then enhances their value and accessibility through creative development, design, production (performed by outside suppliers), marketing, sales, and distribution. While Houghton Mifflin's works have been published principally in printed form, it publishes many programs or works in other formats including computer software, laser discs, CD-ROM, and other electronic media. K-12 PUBLISHING This operating segment includes textbooks and instructional materials, tests for measuring achievement and aptitude, clinical/special needs testing products, computer-assisted as well as computer-managed instructional programs for the K-12 market, and a computer-based career and college guidance information system in versions for both junior and senior high school students. The principal markets for these products are elementary and secondary schools. K-12 Publishing consists of four of Houghton Mifflin's 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; and - The Riverside Publishing Company, which serves the educational and clinical testing markets. Houghton Mifflin's major regional sales offices for this segment are in California, Georgia, Illinois, Massachusetts, New Jersey, and Texas. Each of these divisions has its own dedicated sales forces. Houghton Mifflin distributes products of the School Division, McDougal, and Great Source from two facilities located in Indianapolis, Indiana and Geneva, Illinois. In addition, some states require Houghton Mifflin to use in-state textbook depositories for educational materials sold in that state. Riverside's products are shipped directly from vendor site locations. In the school market, which consists of kindergarten through grade twelve, the process by which elementary and secondary schools select and purchase new instructional materials is referred to as the "adoption" process. Twenty-one states, representing approximately one-half of the United States elementary and secondary school-age population, select new instructional materials on a statewide basis for a particular subject approximately every five to eight years. These twenty-one states are referred to as "adoption states." Generally, a school or school district within an adoption state may use state monies to purchase instructional materials only from the list of publishers' programs that have been approved, or "adopted," by the particular state's governing body. In the other states, referred to as "open territories," individual schools or school districts make the purchasing decisions from the unrestricted offerings of all publishers. The industry terms "adopted" or "adoption" may be used both to describe a state governing body's approval process, or to describe a school or school district's selection and purchase of instructional materials. After adopting, or selecting, instructional materials, schools later decide the quantity and timing of their purchases. In general, Houghton Mifflin presents products to schools and teachers by sending samples to teachers in a school market which is considering a purchase. Sending sample copies is an essential part of marketing instructional materials. Since any educational program may have many individual components, and samples are widely distributed, the cost of sampling a new program can be substantial. In addition, once a program is purchased, Houghton Mifflin provides a variety of ancillary materials (such as teachers' editions, charts, classroom displays, classroom handouts, and tests) to purchasers at no cost. 2 5 Houghton Mifflin also conducts training sessions within a school district that has purchased its materials to help teachers learn to use its products effectively. These free materials, usually called "implementation" and "in-service" training, are a cost of doing business. The elementary school market, which consists of kindergarten through grade eight, has four major disciplines: - reading and language arts (which includes handwriting and spelling), - mathematics, - science and health, and - social studies. With the December 1998 acquisition of DiscoveryWorks, a science program for elementary schools, the School Division now develops and markets its products for all four of these disciplines. The secondary school market, which consists of sixth grade through twelfth grade, has six major disciplines: - literature and language arts, - mathematics, - social studies, - world languages, - science and health, and - vocational studies. McDougal develops and markets its products for four of these disciplines: literature and language arts, social studies, mathematics, and world languages. Riverside publishes tests for educational and psychological assessment, and provides career guidance products and service. Educational tests include norm-referenced tests that compare students to national performance levels. Riverside also contracts with states to custom develop criterion-referenced, standards-based educational assessments. Psychological tests are administered to one person at a time by a trained clinician or specialist. In September 1997, Houghton Mifflin acquired the assets of Wintergreen/Orchard House, Inc., a publisher of guidance products for the elementary and secondary school markets, to strengthen Riverside's guidance system product line. COLLEGE PUBLISHING This operating segment, which consists of the College Division, includes textbooks, ancillary products such as workbooks and study guides, and instructional materials for introductory and upper level courses in the post-secondary higher education market. Products may be in print or electronic form. The principal markets for these products are two- and four-year colleges and universities, served by the national sales office in Boston, Massachusetts, or by the regional sales office in St. Charles, Illinois. Houghton Mifflin also sells these products for high school advanced placement courses (through the McDougal sales force) and to for-profit, certificate-granting institutions, or private career schools, which offer skill-based training and job placement. Products for this segment are distributed from the Indianapolis, Indiana facility. In the college and private career school markets, the faculty generally selects the texts and other materials to be used in class, acting either as a committee or individually. The College Division sales force promotes product to faculty through a combination of on-campus visits, shipment of sample 3 6 copies of products to instructors, and e-mail correspondence. In addition, targeted marketing and advertising to faculty, in both print and electronic form, are an important part of the selling process. For high school advanced placement courses, the selection of college product is made through the adoption process. For the college market, once the faculty selects the educational content for a course, students have the option of purchasing product from several different sources: - from bookstores; - through an Internet bookstore site; or - direct from the publisher. A bookstore or Internet site may purchase product for a course "new" from the publisher or, in the case of product with a copyright older than one year, "used" from other students. About 30% of all student purchases in the college market are used product. In the private career school market, the institution generally purchases product directly from the publisher and requires students to purchase the product from the institution as part of the tuition. The College Division publishes in approximately eighteen disciplines, including mathematics, chemistry, business, history, English, and modern languages. Most textbooks are on a three- or four-year revision cycle. Textbooks with a current-year copyright date are referred to in the industry as "frontlist" and textbooks with an older copyright date are referred to as "backlist." The success of each year's frontlist titles significantly influences sales of backlist titles in subsequent years. Consequently, most of the selling and marketing activities of college publishers focus on promoting frontlist titles. OTHER Houghton Mifflin's Other operating segment consists of unallocated corporate-related items and three divisions: - The Trade & Reference, or Trade, Division; - Houghton Mifflin Interactive, or HMI; 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 sales volume for trade books and reference works may vary significantly from year to year based on the success of one or more titles. The division also sells book reprint rights to paperback publishers, book clubs, and other publishers in the United States and abroad, and reference materials to schools, colleges, office supply distributors, and businesses. The Trade Division's publications are sold by its own sales force, as well as some of Houghton Mifflin's other divisional sales forces and commission agents. The division's major corporate sales and support offices are in Massachusetts and New York. In May 1997, Houghton Mifflin acquired the assets of Chapters Publishing Ltd., predominantly a publisher of cookbooks, to supplement the Trade Division's reference product line. HMI develops and sells multimedia products, chiefly CD-ROM titles, in the children's, reference, and adult-hobby markets. Its principal markets have been retail stores, but Houghton Mifflin is now refocusing HMI's business on the growing educational marketplace. HMI's products are sold by its own sales force and outside sales representatives, as well as some of Houghton Mifflin's other divisional sales forces and commission agents. HMI's major corporate sales and support offices are in Massachusetts. 4 7 CAT specializes in developing and delivering computer-based testing solutions. Its principal markets are corporations and associations worldwide. CAT's products are sold by its own sales force, and its major corporate sales and support offices are in Illinois. COMPANY BUSINESS AS A WHOLE Book printing and binding capacity and the availability of raw materials remained at satisfactory levels throughout the year. Houghton Mifflin is not dependent on any one supplier. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 12. Houghton Mifflin derives almost 90% of its revenues from educational publishing in the K-12 and College Publishing segments, which are markedly seasonal businesses. Schools and colleges make most of their purchases in the second and third quarters of the calendar year, in preparation for the beginning of the school year in September. Thus, Houghton Mifflin realizes more than 50% of net sales and a substantial portion of annual net income during the third quarter, making third-quarter results material to full-year performance. Houghton Mifflin also characteristically posts a net loss in the first and fourth quarters of the year, when fewer educational institutions are making purchases. Sales of K-12 instructional materials are also cyclical, with some years offering more sales opportunities than others. The amount of funding available at the state level for educational materials also has a significant impact on Houghton Mifflin's year-to-year revenues. Although the loss of a single customer or a few customers would not have a materially adverse effect on Houghton Mifflin's business, schedules of school adoptions and market acceptance of its products can affect year-to-year revenue performance. In 1998, the increase in funding for K-12 educational materials in both adoption states and open territories more than offset fewer statewide adoption opportunities in that year as compared to 1997. See "Summary of Quarterly Results of Operations (unaudited)" for the two-year period ended December 31, 1998 on page 59. Houghton Mifflin expects that there will be an increase in statewide adoption opportunities, as well as additional funding opportunities, for instructional and assessment materials and services in both adoption and open territory states in 1999. The adoption opportunities will be primarily in the social studies and science disciplines for the elementary school market and in the mathematics and social studies disciplines for the secondary school market. Houghton Mifflin also expects growth opportunities in the other divisions to contribute to higher revenues year over year. During 1999, Houghton Mifflin plans to increase its investment in new products and services to take advantage of opportunities in all publishing segments. Houghton Mifflin will also continue to invest to improve operating and support systems and to comply with Year 2000 computer requirements. These investments will help Houghton Mifflin maintain a market-leading educational product line, as well as improve its efficiency, profitability, and service to customers. Houghton Mifflin sells its products in highly competitive markets and believes the major competitive factors are quality of product and customer service. There are approximately four significant publishers serving the elementary and secondary school markets, and approximately eight significant publishers serving the college market. At December 31, 1998, Houghton Mifflin employed approximately 2,830 people. Houghton Mifflin anticipates no substantial expenditures for compliance with environmental laws or regulations. (d) FINANCIAL INFORMATION ABOUT FOREIGN AND EXPORT SALES Export sales are not significant to Houghton Mifflin's three business segments. 5 8 ITEM 2. PROPERTIES Houghton Mifflin's principal executive office is located at 222 Berkeley Street, Boston, Massachusetts. The following table describes the approximate building areas and principal uses, and the years of expiration on leased premises of Houghton Mifflin's significant operating properties at December 31, 1998. Houghton Mifflin believes that these properties are suitable and adequate for its present and anticipated business needs, satisfactory for the uses to which each is put, and, in general, fully utilized.
EXPIRATION APPROXIMATE PRINCIPAL YEAR: LEASED AREA USE LOCATION PREMISES IN SQUARE FEET OF SPACE SEGMENT USED BY - ---------------------------------- ------------ -------------- ---------------- ------------------------------ OWNED PREMISES Geneva, Illinois.................. 486,000 Offices & K-12 Publishing; sales office Warehouse Indianapolis, Indiana............. 503,000 Offices & K-12 Publishing and College Warehouse Publishing LEASED PREMISES Boston, Massachusetts............. 2007 301,000 Executive & All segments and 222 Berkeley Street/ Business Offices Corporate headquarters 500 Boylston Street Indianapolis, Indiana............. 2004 185,000 Warehouse Other West Chicago, Illinois............ 2000 130,000 Warehouse K-12 Publishing Itasca, Illinois.................. 2006 75,000 Offices K-12 Publishing, sales office Evanston, Illinois................ 2004 71,000 Offices K-12 Publishing; sales office Dallas, Texas..................... 2005 70,000 Offices & K-12 Publishing; sales office Warehouse Wilmington, Massachusetts......... 2005 50,000 Offices K-12 Publishing; corporate support; sales office Atlanta, Georgia.................. 2004 44,000 Offices & K-12 Publishing; sales office Warehouse Evanston, Illinois................ 2004 18,000 Offices Other New York, New York................ 2004 15,000 Offices Other; sales office St. Charles, Illinois............. 2006 14,000 Offices College Publishing; sales office Somerville, Massachusetts......... 2001 12,000 Offices Other; sales office Princeton, New Jersey............. 1999 5,700 Offices K-12 Publishing; sales office
6 9 ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Houghton Mifflin did not submit any matters to a stockholder vote during the last quarter of the fiscal year ended December 31, 1998. EXECUTIVE OFFICERS OF HOUGHTON MIFFLIN
OTHER OFFICE POSITIONS AGE AT HELD WITH THE NAME 2/28/99 OFFICE SINCE COMPANY - ------------------------ ------- ------------------------------------------- ------ --------- Nader F. Darehshori..... 62 Chairman, President, and Chief Executive 1991 Director Officer Arthur S. Battle, Jr.... 48 Vice President, Human Resources 1998 -- Albert Bursma, Jr....... 61 Executive Vice President; President, Great 1995 -- Source Education Group, Inc. David R. Caron.......... 38 Vice President, Controller 1997 -- Gail Deegan............. 52 Executive Vice President and Chief 1996 -- Financial Officer Richard C. Gershon...... 39 Senior Vice President; President, Computer 1998 -- Adaptive Technologies, Inc. Elizabeth L. Hacking.... 57 Senior Vice President, Strategic 1993 -- Development George A. Logue......... 48 Executive Vice President, School Division 1997 -- Julie A. McGee.......... 56 Executive Vice President; President, 1995 -- McDougal Littell Inc. Mark E. Mooney.......... 46 Senior Vice President, Chief Technology 1997 -- Officer John H. Oswald.......... 49 Executive Vice President; President, 1992 -- The Riverside Publishing Company Conall E. Ryan.......... 41 Senior Vice President; President, Houghton 1997 -- Mifflin Interactive Corporation Gary L. Smith........... 54 Senior Vice President, Administration 1991 -- June Smith.............. 55 Executive Vice President, College Division 1994 -- Wendy J. Strothman...... 48 Executive Vice President, 1996 -- Trade & Reference Division Paul D. Weaver.......... 56 Senior Vice President, Clerk, 1989 -- Secretary, and General Counsel
The following information provides a brief description of the business experience of each executive officer during the past five years. Each executive officer, other than Mr. Battle, Mr. Bursma, Mr. Caron, Ms. Deegan, Mr. Gershon, Ms. McGee, Mr. Mooney, Mr. Ryan, and Ms. Strothman, has been employed by Houghton Mifflin for more than five years. Nader F. Darehshori 1991 -- Chairman, President, and Chief Executive Officer Arthur S. Battle, Jr. 1998 -- Vice President, Human Resources 1995 -- Divisional Vice President, Human Resources, Corning, Inc. 1993 -- Corporate Manager, Benefits, Haworth, Inc. Albert Bursma, Jr. 1995 -- Executive Vice President; President, Great Source Education Group, Inc.* 1993 -- Executive Vice President, D.C. Heath and Company; President, School Division (D.C. Heath and Company was a publisher not affiliated with Houghton Mifflin prior to its acquisition on October 31, 1995.) 7 10 David R. Caron 1997 -- Vice President, Controller 1996 -- Assistant Controller 1995 -- Director-Corporate Accounting, NYNEX 1993 -- Staff Director, NYNEX Gail Deegan 1998 -- Executive Vice President and Chief Financial Officer 1996 -- Executive Vice President, Chief Financial Officer, and Treasurer 1995 -- Senior Vice President, Regulatory and Government Affairs, NYNEX 1991 -- Vice President and Chief Financial Officer, New England Telephone, a wholly-owned subsidiary of NYNEX Richard C. Gershon 1998 -- Senior Vice President; President, Computer Adaptive Technologies, Inc.* 1984 -- President and Chief Executive Officer, Computer Adaptive Technologies, Inc. (Computer Adaptive Technologies, Inc. was not affiliated with Houghton Mifflin prior to its acquisition on July 21, 1998.) Elizabeth L. Hacking 1993 -- Senior Vice President, Strategic Development George A. Logue 1998 -- Executive Vice President, School Division 1997 -- Senior Vice President, School Division 1994 -- Vice President, Sales and Marketing, School Division Julie A. McGee 1995 -- Executive Vice President; President, McDougal Littell Inc.* 1994 -- Senior Vice President 1994 -- President, McDougal Littell Inc.*/Houghton Mifflin Mark E. Mooney 1997 -- Senior Vice President, Chief Technology Officer 1996 -- Vice President, Director of Information Technology, The Bureau of National Affairs 1991 -- Director of Information Services, The Bureau of National Affairs John H. Oswald 1993 -- Executive Vice President; President, The Riverside Publishing Company* Conall E. Ryan 1997 -- Senior Vice President; President, Houghton Mifflin Interactive Corporation* 1996 -- President, Houghton Mifflin Interactive Corporation* 1995 -- Corporate Vice President, Houghton Mifflin Interactive 1994 -- Director, New Media, Trade & Reference Division, and Chairman, On Technology Corporation; Vice President, Publishing for Knowledge Adventure (a publisher not affiliated with Houghton Mifflin) Gary L. Smith 1991 -- Senior Vice President, Administration June Smith 1994 -- Executive Vice President, College Division 1992 -- Vice President, Editorial Director, College Division Wendy J. Strothman 1996 -- Executive Vice President, Trade & Reference Division 1995 -- Vice President, Publisher, Adult Trade and Reference 1993 -- Director, Beacon Press (a publisher not affiliated with Houghton Mifflin) Paul D. Weaver 1989 -- Senior Vice President, Clerk, Secretary, and General Counsel * A subsidiary of Houghton Mifflin 8 11 PART II ITEM 5. MARKET FOR HOUGHTON MIFFLIN'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Houghton Mifflin's common stock trades on the New York Stock Exchange. As of February 28, 1999, Houghton Mifflin had approximately 5,500 stockholders of record. The following table shows information about stock prices and dividends paid per share. HOUGHTON MIFFLIN COMPANY STOCK PRICES AND DIVIDENDS PAID PER SHARE (UNAUDITED)
1998 1997 ---------------------------- ---------------------------- DIVIDEND DIVIDEND HIGH LOW PAID HIGH LOW PAID ------ ------ -------- ------ ------ -------- First Quarter....................... $39.00 $26.94 $0.125 $28.31 $26.75 $0.120 Second Quarter...................... 35.31 31.06 0.125 33.38 26.31 0.120 Third Quarter....................... 33.56 30.19 0.125 39.19 33.00 0.125 Fourth Quarter...................... 47.25 30.44 0.125 40.25 34.44 0.125 ------ ------ Year................................ $0.500 $0.490 ====== ======
ITEM 6. SELECTED FINANCIAL DATA Houghton Mifflin 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 the Five-Year Financial Summary on the next page and in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, are based on the diluted weighted average shares outstanding, unless the per-share amounts are specifically identified as basic. For further discussion of earnings per share and the effect of Statement No. 128, see Note 13 in the Notes to the Consolidated Financial Statements on page 58. On June 25, 1997, the Board of Directors declared a two-for-one split of Houghton Mifflin's common stock effected in the form of a 100% stock dividend to shareholders. All per-share amounts have been retroactively restated in this report to reflect the effect of the stock split. 9 12 HOUGHTON MIFFLIN COMPANY FIVE-YEAR FINANCIAL SUMMARY (UNAUDITED, IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, -------------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- ---------- ---------- -------- OPERATING RESULTS Net sales.......................................... $861,657 $797,320 $717,863 $529,022 $483,076 Operating income (loss)............................ 102,020 106,558 87,382 (13,095) 53,464 Net interest expense............................... 33,981 38,926 40,875 13,008 6,509 Gains on INSO Corporation common stock and equity in earnings (losses) of INSO Corporation......... 18,797 15,901 27,446 14,659 38,185 Loss on sale of long-term investment............... (3,017) -- -- -- -- Acquired in-process research and development....... (3,500) -- -- -- -- Income (loss) before taxes and extraordinary item............................................. 79,269 83,533 73,953 (11,444) 85,140 Extraordinary gain on extinguishment of debt, net of tax........................................... 18,010 -- -- -- -- Net income (loss).................................. 63,649 49,822 43,622 (7,243) 51,191 -------- -------- ---------- ---------- -------- PER COMMON SHARE Basic: Income before extraordinary item................. $1.59 $1.76 $1.57 ($0.26) $1.85 Extraordinary gain on extinguishment of debt........................................ 0.63 -- -- -- -- ----- ----- ----- ------ ----- Basic net income (loss) per share................ $2.22 $1.76 $1.57 ($0.26) $1.85 ===== ===== ===== ====== ===== Diluted: Income before extraordinary item................. $1.57 $1.73 $1.56 ($0.26) $1.84 Extraordinary gain on extinguishment of debt........................................ 0.62 -- -- -- -- ----- ----- ----- ------ ----- Basic net income (loss) per share................ $2.19 $1.73 $1.56 ($0.26) $1.84 ===== ===== ===== ====== ===== Dividends declared per share....................... $0.50 $0.49 $0.48 $0.465 $0.435 Book value......................................... 13.20 10.61 9.22 8.05 8.47 Stock price -- High................................ 47.25 40.25 28.32 27.38 26.50 Low.................................. 26.94 26.31 20.25 19.82 18.07 Close................................ 47.25 38.38 28.32 21.50 22.69 FINANCIAL DATA Total assets....................................... $975,567 $981,100 $1,006,442 $1,046,449 $497,266 Long-term debt less current portion................ 274,521 371,081 500,999 426,148 99,445 Additions to book plates and property, plant, and equipment........................................ 73,984 67,903 74,943 54,278 33,720 Dividends paid..................................... 14,388 13,959 13,371 12,845 12,026 Weighted average shares outstanding: Basic............................................ 28,689 28,237 27,801 27,609 27,674 Diluted.......................................... 29,111 28,826 27,919 27,609 27,771 NET SALES -- CLASSES OF SIMILAR PRODUCTS K-12 Publishing.................................... $611,770 $560,259 $ 497,709 $ 359,523 $303,370 College Publishing................................. 160,677 148,969 138,346 82,277 84,057 Other.............................................. 89,210 88,092 81,808 87,222 95,649 -------- -------- ---------- ---------- -------- $861,657 $797,320 $ 717,863 $ 529,022 $483,076 ======== ======== ========== ========== ========
On August 1, 1998, Houghton Mifflin redeemed 50%, or $63.3 million in aggregate principal amount, of the outstanding 6% Exchangeable Notes, or SAILS. The SAILS were redeemed with approximately 1.9 million shares of INSO common stock. The redemption represented a surrender of the shares and generated a non-cash gain on the INSO shares of $15.4 million ($8.9 million after tax), or $0.31 per share. In addition, Houghton Mifflin recorded a $31.1 million extraordinary gain ($18.0 million after tax), or $0.62 per share, as a result of the extinguishment of the SAILS indebtedness. In 1998, Houghton Mifflin recorded items related to INSO resulting from INSO's special charge of $2.8 10 13 million in connection with its acquisitions of Henderson Software, Inc. and ViewPort Development AB. Houghton Mifflin's portion of these charges amounted to approximately $0.8 million ($0.5 million after tax), or $0.01 per share. Houghton Mifflin also recorded a gain of $3.2 million ($1.9 million after tax), or $0.06 per share, resulting from INSO's sale of its linguistic software net assets. Houghton Mifflin recognized a loss of $3.0 million ($2.0 million after tax), or $0.07 per share, on the sale of its investment in Cassell Plc in 1998. Houghton Mifflin's acquisition of CAT in July 1998 included the purchase of certain technology under research and development, which resulted in a charge of $3.5 million, or $0.12 per share. In 1997, Houghton Mifflin recognized a gain of $14.9 million ($8.6 million after tax), or $0.30 per share, representing Houghton Mifflin's portion of the increase in INSO's net equity as a result of INSO's completion of a public offering of 1.2 million shares of common stock at a net offering price of approximately $47 per share in the fourth quarter of 1996 (see Note 1 and Note 9 in the Notes to the Consolidated Financial Statements for a summary of Houghton Mifflin's recognition policy). The 1997 results include special charges of $2.5 million ($1.5 million after tax), or $0.05 per share, related to INSO's acquisition of the Mastersoft line of products from Adobe Systems Incorporated, the acquisition of Level Five Research, Inc., and a restructuring charge affecting INSO's Information Products and certain of its Information Management Tools products. In 1996, Houghton Mifflin recorded a gain of $34.3 million ($19.9 million after tax), or $0.71 per share, on the sale of 770,000 shares of INSO common stock. Houghton Mifflin also recorded special charges in 1996 of $11.7 million ($7.1 million after tax), or $0.25 per share, relating to its investment in INSO, resulting from INSO's acquisitions of ImageMark Software Labs, Inc. and Electronic Book Technologies, Inc. In October 1995, Houghton Mifflin completed the acquisition of D.C. Heath and Company from Raytheon Company in a purchase transaction. As a result, Houghton Mifflin recorded in 1995 charges totaling $49.3 million ($30.0 million after tax), or $1.09 per share, associated with the integration of the Heath business. In 1995, there was a $2.2 million charge, or $0.08 per share, relating to Houghton Mifflin's investment in INSO resulting from INSO's acquisition of Systems Compatibility Corporation. Houghton Mifflin also recorded a gain in 1995 of $13.1 million ($7.8 million after tax), or $0.28 per share, in connection with an additional public offering of 1.2 million shares made by INSO. In 1994, Houghton Mifflin recognized a gain of $36.2 million ($22.8 million after tax), or $0.82 per share, in connection with the initial public offering of INSO, the successor company to its former Software Division. 11 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1998 RESULTS OF OPERATIONS Net income:
TWELVE MONTHS ENDED DECEMBER 31, --------------------------------------------------- DILUTED EARNINGS (LOSS) PER SHARE --------------------- 1998 1997 1996 1998 1997 1996 ------- ------- ------- ----- ----- ----- (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS) Income after tax, but excluding extraordinary and infrequent items:........................ $40,750 $42,650 $30,834 $1.40 $1.48 $1.10 Extraordinary and infrequent 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.... 8,913 -- -- 0.31 -- -- Gain on sale of INSO Corporation common stock................................... 24 -- 19,871 -- -- 0.71 Loss on sale of long-term investment...... (1,961) -- -- (0.07) -- -- Acquired in-process research and development............................. (3,500) -- -- (0.12) -- -- Gain on equity transaction of INSO Corporation............................. -- 8,645 -- -- 0.30 -- Other gains (losses)...................... 1,413 (1,473) (7,083) 0.05 (0.05) (0.25) ------- ------- ------- ----- ----- ----- Net income..................................... $63,649 $49,822 $43,622 $2.19 $1.73 $1.56 ======= ======= ======= ===== ===== =====
Consolidated net income in 1998 was $63.6 million, or $2.19 per share, compared to net income of $49.8 million, or $1.73 per share, in 1997 and net income of $43.6 million, or $1.56 per share, in 1996. Income after tax, but excluding extraordinary and infrequent items for 1998 would have been $40.8 million, or $1.40 per share, compared to income after tax, but excluding infrequent items of $42.7 million, or $1.48 per share, in 1997. The primary reasons for the decrease was the dilution arising from the operating expenses and goodwill amortization of CAT (acquired in July 1998) and costs related to Houghton Mifflin's unsuccessful bid for a portion of Simon & Schuster's publishing assets. Increases in product development spending, higher selling expenses, and additional costs related to information systems initiatives and the Year 2000 computer issue were offset by higher sales. Income after tax, but excluding infrequent items of $42.7 million, or $1.48 per share, in 1997, compared to $30.8 million, or $1.10 per share, in 1996. The primary reasons for the increase was higher net sales and the operating margin improvements described below. During 1998, Houghton Mifflin recognized a non-cash gain of $15.4 million ($8.9 million after tax), or $0.31 per share, resulting from the surrender of INSO common stock to redeem one-half of the outstanding SAILS. Houghton Mifflin also recognized an extraordinary gain of $31.1 million ($18.0 million after tax), or $0.62 per share, on the extinguishment of the SAILS indebtedness. In 1998, Houghton Mifflin recognized a loss of $3.0 million ($2.0 million after tax), or $0.07 per share, on the sale of its investment in Cassell Plc. The acquisition of CAT included the purchase of certain technology under research and development which resulted in a charge of $3.5 million, or $0.12 per share. During 1998, Houghton Mifflin also recorded a one-time gain (net of charges) of $2.4 million ($1.4 million after tax), or $0.05 per share, related to the equity investment in INSO. In 1997, Houghton Mifflin recognized a gain of $14.9 million ($8.6 million after tax), or $0.30 per share, representing its portion of the increase in INSO's net equity as a result of INSO's completion of a public offering in 1996, and a special charge of $2.5 million ($1.5 million after tax), or $0.05 per share, related to the equity investment in INSO. 12 15 In 1996, Houghton Mifflin recorded a gain of approximately $34.3 million ($19.9 million after tax), or $0.71 per share, from the sale of 770,000 shares of INSO common stock. The 1996 results also include acquisition charges of $11.7 million ($7.1 million after tax), or $0.25 per share, related to the equity investment in INSO. Net sales:
INCREASE (DECREASE) ------------------------------ TWELVE MONTHS ENDED DECEMBER 31, 1998 VS. 1997 1997 VS. 1996 --------------------------------- ------------- -------------- 1998 1997 1996 $ % $ % --------- --------- --------- ------- --- ------- ---- (IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS) K-12 Publishing............... $611,770 $560,259 $497,709 $51,511 9.2% $62,550 12.6% College Publishing............ 160,677 148,969 138,346 11,708 7.9 10,623 7.7 Other......................... 89,210 88,092 81,808 1,118 1.3 6,284 7.7 -------- -------- -------- ------- ------- Total net sales..... $861,657 $797,320 $717,863 $64,337 8.1% $79,457 11.1% ======== ======== ======== ======= =======
Houghton Mifflin's net sales in 1998 increased $64.3 million, or 8.1%, to $861.7 million from $797.3 million in 1997. The K-12 Publishing segment's net sales of $611.8 million in 1998 were $51.5 million, or 9.2%, above 1997 net sales of $560.3 million. All divisions in the K-12 Publishing segment reported increased revenues in 1998 due to strong sales performance in statewide adoption and open territory opportunities, as well as increased funding for instructional and assessment materials. The College Publishing segment's net sales of $160.7 million in 1998 increased $11.7 million, or 7.9%, from $149.0 million in 1997. Sales of both new editions and backlist titles in the college market rose, and sales to the high school advanced placement market increased significantly. The Other segment's net sales in 1998 increased by $1.1 million, or 1.3%, to $89.2 million from $88.1 million in 1997. The Trade Division's net sales were higher in 1998 compared to 1997 due to increased sales of adult, children's, and reference products, partially offset by lower guidebook sales, reflecting the expiration of the Insight Travel Guide distribution arrangement on December 31, 1997. The Other net sales increase also reflects the inclusion of sales from CAT, a new division acquired in 1998. Partially offsetting these net sales increases was lower net sales at HMI. HMI's sales declined year over year due to increased competition in the retail channel. Houghton Mifflin is refocusing HMI's business on the growing educational marketplace rather than in the retail market. Houghton Mifflin's net sales in 1997 increased $79.5 million, or 11.1%, to $797.3 million from $717.9 million in 1996. The K-12 Publishing segment's net sales of $560.3 million in 1997 were $62.6 million, or 12.6%, above 1996 net sales of $497.7 million. All divisions in the K-12 Publishing segment reported increased revenues over the previous year, with the School Division and McDougal reporting the largest dollar increases. These two divisions benefited from greater sales opportunities in 1997 in both adoption states and open territories. The College Publishing segment's net sales increased $10.6 million, or 7.7%, to $149.0 million in 1997 from $138.3 million in 1996. The College Publishing segment's frontlist and backlist performed extremely well and book returns declined. The Other segment's net sales in 1997 increased by $6.3 million, or 7.7%, to $88.1 million from $81.8 million in 1996. This gain was due to strong market response to Mariner Books (the Trade Division's new paperback imprint), higher net sales of adult, children's, and reference titles, and increased sales from HMI. 13 16 Costs and expenses:
INCREASE (DECREASE) ---------------------------------- TWELVE MONTHS ENDED DECEMBER 31, 1998 VS. 1997 1997 VS. 1996 -------------------------------- --------------- --------------- 1998 1997 1996 $ % $ % -------- -------- -------- ------- ---- ------- ---- (IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS) Cost of sales.................... $390,922 $362,501 $329,686 $28,421 7.8% $32,815 10.0% Selling and administrative, excluding intangible asset amortization................... 340,207 300,347 274,062 39,860 13.3 26,285 9.6 Intangible asset amortization.... 28,508 27,914 26,733 594 2.1 1,181 4.4 -------- -------- -------- ------- ------- Total costs and expenses.............. $759,637 $690,762 $630,481 $68,875 10.0% $60,281 9.6% ======== ======== ======== ======= =======
Cost of sales: In 1998, cost of sales increased $28.4 million, or 7.8%, to $390.9 million from $362.5 million during 1997. The increased cost of sales was due to higher net sales and increased editorial expenses and plate amortization. As a percent of sales, cost of sales decreased slightly to 45.4% in 1998 from 45.5% in 1997. Although editorial expenses and plate amortization were considerably higher in absolute dollars, the net sales gains offset the percentage increase in these items. Primarily as a result of higher sales, cost of sales in 1997 rose $32.8 million, or 10%, to $362.5 million from $329.7 million in 1996. Cost of sales as a percent of sales decreased to 45.5% in 1997 from 45.9% in 1996. This improvement was primarily due to lower editorial expense and plate amortization as a percent of sales. Selling and administrative: In 1998, selling and administrative expenses, excluding intangible asset amortization, were $340.2 million, an increase of $39.9 million, or 13.3%, from $300.3 million in 1997. As a percent of sales, selling and administrative expenses increased to 39.5% in 1998 from 37.7% in 1997. The primary reasons for this increase were higher costs related to information systems initiatives and the Year 2000 computer issue, the additional selling and administrative costs for the operations of CAT, and increased selling expenses related to sales opportunities in 1999. Selling and administrative expenses, excluding intangible asset amortization, in 1997 were $300.3 million, an increase of $26.3 million, or 9.6%, over the $274.1 million recorded in 1996. Selling and administrative expense declined as a percent of sales to 37.7% in 1997 from 38.2% in 1996. The primary reason for this improvement was a decrease in distribution costs as a result of a new warehouse management system and other operating improvements. An increase in selling costs as a percent of sales partially offset this decrease, reflecting, in part, additional personnel to expand the sales force and increased sampling and implementation expenses. These increases were made to take advantage of increased sales opportunities in both adoption states and open territories in 1997. Administrative costs also increased marginally as Houghton Mifflin began efforts to improve its customer support system and to address the Year 2000 computer issue. Equity in earnings (losses) of INSO Corporation: During 1998, Houghton Mifflin recognized $3.4 million in equity earnings of INSO, representing $3.2 million of a one-time gain and $1.0 million of INSO's earnings, partially offset by $0.8 million of one-time charges recognized by INSO. During 1997, Houghton Mifflin recognized $1.0 million in equity earnings of INSO, of which $3.5 million related to INSO's earnings, offset by $2.5 million related to one-time charges recognized by INSO. During 1996, Houghton Mifflin recognized $6.8 million in equity losses of INSO, of which $11.7 million was one-time charges recognized by INSO, offset by $4.9 million of INSO's earnings. 14 17 Net interest expense: Net interest expense of $34.0 million in 1998 decreased $4.9 million from $38.9 million in 1997. The reduction was primarily due to repayment of $68.7 million of debt in the fourth quarter of 1997 and the extinguishment of $63.3 million of SAILS debt in August 1998. Net interest expense of $38.9 million in 1997 decreased $2.0 million from $40.9 million in 1996. The reduction was primarily a result of the paydown of $29.8 million of debt in the fourth quarter of 1996 and lower working capital borrowings in 1997, partially offset by higher interest rates in 1997. Other expense: In 1998, Houghton Mifflin recognized a $1.1 million pre-tax charge related to its unsuccessful bid for a portion of Simon & Schuster's publishing assets. Income taxes: The provision for taxes in 1998 decreased $0.1 million from 1997. This decrease was primarily due to the decrease in operating income in 1998 compared to 1997, offset by an increase in the effective tax rate to 42.4% in 1998 from 40.4% in 1997. The increase in the effective tax rate was primarily due to the acquired in-process research and development charge. The provision for taxes in 1997 increased $3.4 million, or 11%, over 1996. This increase was the result of the higher operating income in 1997 compared to 1996, partially offset by a decrease in the effective tax rate to 40.4% in 1997 from 41.0% in 1996. K-12 PUBLISHING The K-12 Publishing segment's net sales of $611.8 million in 1998 were $51.5 million, or 9.2%, above 1997 net sales of $560.3 million. This increase was due to strong sales performance in statewide adoption and open territory opportunities, as well as increased funding for instructional and assessment materials. McDougal's sales increased 13% due to its strong performance in mathematics and social studies adoptions. Riverside reported a 17% increase in sales due to higher sales of group assessment and clinical tests. Riverside is benefiting both from increased funding for assessment programs and from its strategy to invest in the development of criterion-referenced tests. Great Source had a sales increase of 25%, principally in its Write Source and mathematics product lines. The School Division's English, spelling, and new reading intervention programs performed extremely well in both adoption states and open territories. The School Division's reading program did not generate increased sales year over year, but sales from this product line were higher than originally projected. The School Division's math program had higher sales year over year, but less than originally expected. Overall, the School Division had a year-over-year net sales gain rather than the decline initially expected. Operating income for the K-12 Publishing segment increased $1.1 million, or 1.2%, to $97.9 million in 1998 from $96.8 million in 1997. The resulting operating margin for 1998 was 16.0% compared to 17.3% in 1997. The decrease in operating margin was primarily due to the increase in editorial costs incurred for product revisions and new product development and a change in the mix of products sold, which included a higher percent of revenues from products with lower margins. Increased selling expense also contributed to this decrease. Higher selling expense was related to the cost of preparing for anticipated sales opportunities in 1999. The year-over-year increase in administrative expense as a percent of sales was primarily due to additional costs related to information systems initiatives and the Year 2000 computer issue and the inclusion of gains recorded on the sales of property in 1997, which, in turn, lowered administrative expense in 1997. The K-12 Publishing segment's net sales of $560.3 million in 1997 represented a $62.6 million, or 12.6%, increase over 1996 net sales of $497.7 million. In elementary and secondary school publishing, 15 18 the School Division and McDougal contributed an increase of $49.1 million, benefiting from the increased sales opportunities in adoption states and open territories. The School Division's reading program had higher sales in state adoptions and open territories, as did its social studies program. McDougal gained significant market share in adoption states and open territories with its language arts and Spanish language programs. Great Source reported a 12% increase in net sales primarily due to the Write Source product line. Riverside's sales increased 17%, primarily as a result of increased sales of education and clinical assessment materials. Operating income for the K-12 Publishing segment increased $14.1 million, or 17.0%, to $96.8 million in 1997 from $82.7 million in 1996. The resulting operating margin for 1997 was 17.3% compared to 16.6% in 1996. The operating margin improvement was primarily due to the increase in net sales and lower expenses as a percent of sales in 1997. Distribution, editorial, and plate expenses decreased as a percent of sales in 1997 compared to 1996. Investments in a warehouse management system and other operating improvements reduced distribution costs. Although editorial and plate expenses were higher in absolute dollars, as a percentage of sales they were lower in 1997 primarily due to higher net sales. Increased selling and administrative costs partially offset these decreases. The increase in selling costs was the result of the large number of sales opportunities in adoption states and open territories in 1997. Houghton Mifflin expanded its sales force in preparation for these opportunities, and sampling and implementation expenses were higher. Administrative costs increased due to the investments in information system initiatives and costs related to the Year 2000 computer issue. COLLEGE PUBLISHING The College Publishing segment reported net sales of $160.7 million in 1998, a 7.9% increase over 1997 net sales of $149.0 million. Sales of both frontlist and backlist titles as well as sales to the high school advanced placement market increased significantly. Operating income for the College Publishing segment increased $3.9 million, or 24.5%, to $19.7 million in 1998 from $15.9 million in 1997. The resulting operating margin for 1998 was 12.3% compared to 10.6% in 1997. The operating margin improvement was primarily due to the increase in net sales and lower manufacturing and editorial expense as a percent of sales. These decreases were partially offset by higher administrative expense. The higher administrative expense was due to additional costs related to information system initiatives and the Year 2000 computer issue. The College Publishing segment reported 1997 net sales of $149.0 million, a 7.7% increase over 1996 net sales of $138.3 million. Its sales of frontlist and backlist titles increased and book returns declined. In 1997, operating income for the College Publishing segment increased $3.4 million, or 27.4%, to $15.9 million from $12.4 million in 1996. The resulting operating margin for 1997 was 10.6% compared to 9.0% in 1996. The operating margin improvement was primarily due to the increase in net sales and lower distribution, manufacturing, and plate expenses as a percent of sales in 1997 compared to 1996. Investments in a new warehouse management system and other operating improvements helped reduced distribution costs. Manufacturing costs were lower as a percent of sales primarily due to a change in the sales mix, which included a higher percent of revenues from products with higher margins. Higher administrative costs were due to the investments in information system initiatives and the Year 2000 computer issue, partially offset these decreases. OTHER The Other segment's net sales in 1998 increased by $1.1 million to $89.2 million from $88.1 million in 1997. This increase was primarily attributable to the Trade Division, where sales increased by 4.0% due to higher sales of adult, children's, and reference titles. Excluding the 1997 revenues from Insight Travel Guides, which were no longer being distributed by this division after December 1997, sales would 16 19 have increased by more than 10%. The sales increase in this segment was also due to the inclusion of sales from CAT, a new division acquired in 1998. Partially offsetting these increases were lower net sales from HMI. Houghton Mifflin is refocusing HMI's business on the growing educational marketplace rather than in the retail market. The Other segment's operating loss was $15.7 million in 1998 compared to $6.1 million in 1997. The increased operating loss was primarily due to the operating loss attributable to Houghton Mifflin's acquisition of CAT, the higher loss at HMI due to lower sales, and costs incurred in moving the Trade Division's distribution facility in 1998. In 1997, the Other segment's net sales increased by $6.3 million, or 7.7%, to $88.1 million from $81.8 million in 1996. Higher sales in 1997 were due to the Trade Division, which had increased sales of adult and juvenile books and dictionary products, as well as revenues from the acquisition of Chapters, a cookbook imprint purchased in the second quarter of 1997. Lower distribution income partially offset these increases. The gain in adult and juvenile books was due to increased sales of new titles and promotion of the backlist, led by Mariner Books. HMI's net sales in 1997 increased 39% due to an increase in the number of product offerings and the number of retail outlets through which its titles are sold. The Other segment's operating loss was $6.1 million in 1997 compared to $7.8 million in 1996. The improvement was primarily due to increased net sales and improved margin in the Trade Division. LIQUIDITY AND CAPITAL RESOURCES Houghton Mifflin's principal businesses are seasonal, with almost 90% of its revenues derived from educational publishing in the K-12 and College Publishing segments, markedly seasonal businesses. Houghton Mifflin realizes more than 50% of net sales and a substantial portion of net income during the third quarter and characteristically posts a net loss in the first and fourth quarters of the year. This sales seasonality affects Houghton Mifflin's operating cash flow. Houghton Mifflin normally incurs a net cash deficit from all of its activities through the middle of the third quarter of the year. Houghton Mifflin funds the deficit through the draw-down of cash and marketable securities, supplemented by short-term borrowings, principally commercial paper. In 1998, net cash provided by operating activities was $146.8 million, an increase of $5.0 million from $141.8 million in 1997. Net income excluding non-cash items increased by $11.5 million in 1998 from 1997. Changes in operating assets and liabilities used $6.5 million more cash during 1998 than in 1997. This increase was primarily due to the increase in income tax payments relating to the surrender of INSO common stock and the redemption of the SAILS, offset by lower working capital requirements. Net cash provided by operating activities was $141.8 million in 1997, an increase of $39.8 million from $102.0 million in 1996. Net income excluding non-cash items increased $21.5 million in 1997 from 1996. Changes in operating assets and liabilities provided $18.3 million more cash in 1997 than 1996 due to lower working capital requirements and lower income tax payments. Houghton Mifflin anticipates that cash provided by operating activities in 1999 will be lower than in 1998 due to higher working capital needs, partially offset by higher earnings. Houghton Mifflin used $97.8 million in cash for investing activities in 1998, an increase of $26.0 million over the $71.8 million used during 1997. The increase reflects a $15.8 million increase for acquisitions of publishing and technology assets, an increase in property, plant, and equipment expenditures of $7.0 million incurred primarily for information systems initiatives in 1998, and the $5.2 million in proceeds from the sales of property and plant in 1997. Houghton Mifflin received $0.8 million in proceeds from the sale of 400,000 ordinary shares of Cassell Plc in 1998. 17 20 Houghton Mifflin used $71.8 million in cash for investing activities in 1997, an increase of $5.5 million over the $66.3 million used during 1996. Excluding the $24.2 million Houghton Mifflin received from the sale of shares of INSO common stock in 1996, cash required for investing activities decreased by $18.7 million, principally due to a $7.9 million decrease in book plate expenditures, a $6.5 million decrease in acquisition of publishing assets, and from $5.2 million in proceeds from the sales of property in 1997 compared to 1996. Houghton Mifflin used $50.7 million for financing activities in 1998, primarily to make net repayments of $39.5 million of debt in the fourth quarter of 1998 and pay dividends. Total borrowings decreased $102.7 million to $369.7 million as of December 31, 1998 from $472.4 million at the end of 1997. Houghton Mifflin's percentage of debt (commercial paper borrowings, current portion of long-term debt, and long-term debt) to total capitalization (debt plus stockholders' equity) decreased to 48.1% at the end of 1998 from the 59.8% at the end of 1997. The decrease in debt was due to the non-cash redemption of 50%, or $63.3 million in principal amount of outstanding SAILS using INSO common stock, repayment of $40 million of medium-term notes, and repayment of $49.5 million of commercial paper borrowings, offset by $50 million of borrowings under Houghton Mifflin's five-year revolving commitment. Houghton Mifflin used $76.0 million for financing activities in 1997, primarily to repay $68.7 million of debt in the fourth quarter of 1997 and pay dividends. Total debt decreased to $472.4 million as of December 31, 1997 from $541.0 million at the end of 1996. Houghton Mifflin's percentage of debt (commercial paper borrowings, current portion of long-term debt, and long-term debt) to total capitalization (debt plus stockholders' equity) decreased to 59.8% at the end of 1997 from 66.7% at the end of 1996 primarily as a result of paying down $90 million outstanding under the five-year credit facility and $40 million of medium-term notes, offset by commercial paper borrowings of $61.3 million. In 1998, Houghton Mifflin's average short-term borrowing was $72.3 million, an increase of $5.4 million from 1997. Seasonal borrowing needs increased as a result of higher operating expenditures and increased working capital requirements. In 1997, Houghton Mifflin's average short-term borrowing was $66.9 million, a decrease of $10.7 million from 1996. The decrease was primarily due to higher earnings, lower operating expenses, and a decrease in book plate expenditures from 1996. In August 1995, Houghton Mifflin completed a $126.6 million public offering of 6% Exchangeable Notes due in 1999 at a public offering price of $34 per SAILS. In August 1998, Houghton Mifflin redeemed 50%, or $63.3 million in aggregate principal amount, of its outstanding SAILS. 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 accrued and unpaid interest at the date of the redemption. The remaining 50%, or $63.3 million in aggregate principal amount, of the outstanding SAILS is due on August 1, 1999 and therefore has been classified as current debt outstanding. The principal amount of each outstanding SAILS will be mandatorily exchanged for a number of shares of INSO common stock or, at Houghton Mifflin's option, cash with an equal value. If Houghton Mifflin chooses to redeem the SAILS with shares of INSO common stock, it would record a gain or loss representing the difference between the redemption amount and the book value of Houghton Mifflin's investment in INSO. Under the terms of the SAILS agreement, the number of shares that would be exchanged for the SAILS depends on the fair market value of INSO common stock on the redemption date. If the price of one share of INSO common stock is equal to or less than $34, then approximately 1.9 million shares would be exchanged. Between $34 and $39.44 per share, the number of shares that would be exchanged decreases from 1.9 million to 1.65 million. At $39.44 or more per share for INSO common stock, Houghton Mifflin would exchange 1.65 million shares. Houghton Mifflin would record as non-cash 18 21 interest expense over the remaining term of the SAILS the excess of the market value of the current INSO common stock price over the maximum redemption price of $39.44 per INSO share. Based upon INSO's December 31, 1998 stock price, there is no additional non-cash interest expense to be recorded through August 1999. The INSO shares may be sold by Houghton Mifflin, subject to certain restrictions, as market conditions and events warrant. At December 31, 1998, Houghton Mifflin has a $300 million unsecured revolving credit facility, the Revolving Credit Facility, for which Houghton Mifflin pays annual commitment fees. Borrowings under the Revolving Credit Facility are outstanding under a five-year revolving commitment which expires on October 31, 2000. This credit facility requires Houghton Mifflin to comply with certain covenants, the most restrictive of which include maintenance of a specific level of net worth, fixed-charge coverage ratio, and debt-to-equity ratio. At December 31, 1998, the outstanding balance on this credit facility was $50 million, at a weighted average interest rate of 5.5875%. No amounts were outstanding under this credit facility at December 31, 1997. Management routinely evaluates interest rates available to Houghton Mifflin under the Revolving Credit Facility as compared to those available through the issuance of commercial paper. The amount outstanding under the Revolving Credit Facility of $50 million has been excluded from current liabilities at December 31, 1998 because Houghton Mifflin intends that at least that amount would remain outstanding under the Revolving Credit Facility, or would be issued as additional commercial paper, for an uninterrupted period extending beyond one year from the balance sheet date. Houghton Mifflin currently expects that cash flow from operations for the full year 1999 will be sufficient to cover investment activities and dividend payments as well as to repay by year end a portion of the debt outstanding at the beginning of 1999. Houghton Mifflin intends to continue using the short- term debt market, primarily commercial paper, for seasonal liquidity needs. PENDING ACCOUNTING PRONOUNCEMENTS: In 1998, the Accounting Standards Executive Committee issued Statement of Position 98-5, "Reporting on the Costs of Start-up Activities," which must be adopted for fiscal years beginning after December 15, 1998, and the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Investments and Hedging Activities," which must be adopted for fiscal years beginning after June 15, 1999. Houghton Mifflin is currently evaluating the effects of implementing these statements. IMPACT OF INFLATION AND CHANGING PRICES Although inflation is currently well below levels in prior years and has, therefore, benefited recent Houghton Mifflin results, particularly in the area of manufacturing costs, there are offsetting costs. Houghton Mifflin's ability to adjust selling prices has always been limited by competitive factors and long-term contractual arrangements which either prohibit price increases or limit the amount by which prices may be increased. Further, a weak domestic economy at a time of low inflation could cause lower tax receipts at the state and local level, and the funding and buying patterns for textbooks and other educational materials could be adversely affected. Prices for paper have moderated in 1997 and 1998. Houghton Mifflin expects this trend to continue in 1999. The most significant investments affected by inflation include book plates; other property, plant, and equipment; and inventories. Houghton Mifflin uses the last-in, first-out (LIFO) method to value substantially all inventory and, therefore, the cost of inventory charged against income approximates replacement value. The incremental replacement cost expense amounted to $15.8 million in 1998 compared with $12.9 million in 1997. 19 22 Houghton Mifflin's publishing business requires a high level of investment in book plates for its educational and reference works, which represented approximately 8.3% of total assets at December 31, 1998, and, increasingly in other property, plant, and equipment, which represented 5.1% of consolidated assets at December 31, 1998. Houghton Mifflin continues to commit funds to the publishing areas through both internal growth and acquisitions. Houghton Mifflin believes that by valuing its inventory using the LIFO method, continuing to emphasize technological improvements, and quality control, it can continue to moderate the impact of inflation on its operating results and financial position. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT In connection with the acquisition of CAT in July 1998, Houghton Mifflin wrote off in-process research and development totaling $3.5 million in the third quarter of 1998. The charge was necessary because the acquired technology had not yet reached technological feasibility and had no future alternative use. This amount represents an allocation of the purchase price related to an application module called CAT Software System Version 7. This project 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. Houghton Mifflin anticipates that the product using the acquired in-process research and development will be released during 1999. Houghton Mifflin 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 acquired in-process research and development into a commercially viable product principally relate to the completion of all planning, designing, prototyping, verification, and testing activities that are necessary to establish that the product can be produced to meet its design specifications, including functions, features and technical performance requirements. The value of the acquired in-process research and development was determined by estimating the projected net cash flows related to the product and the stage of completion of the product. These cash flows were discounted to the net present value. The resulting projected net cash flows from the project were based on management's estimates of revenues and operating profits related to the product. The revenue estimates 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 its competitors. The rates utilized to discount the net cash flows to the net present value were based on a discount rate of 30%. This discount rate takes into account the time value of money and investment risks factors described above. The estimates used by Houghton Mifflin in valuing the in-process research and development were based upon assumptions Houghton Mifflin believes to be reasonable but which are inherently uncertain and unpredictable. Houghton Mifflin'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. OUTLOOK Houghton Mifflin's revenue opportunities in the K-12 market in 1999 are expected to be greater than in 1998 due to an increase in statewide adoption opportunities, as well as additional funding available at the state level for educational and assessment materials. Included in the sales growth will be sales generated from the science discipline in the elementary school market due to the DiscoveryWorks acquisition in December 1998. All other divisions are also expected to have growth opportunities, and Houghton Mifflin expects sales to increase in 1999 by approximately 10%. 20 23 Houghton Mifflin anticipates that the sales growth will generate increased gross margin, which will be partially offset by increased investment in products and support systems and higher selling expense in 1999. Houghton Mifflin expects editorial expense and plate amortization to increase by approximately 12-15%. These increases are related to investment in product revisions and new products and services to take advantage of statewide adoption opportunities in the K-12 Publishing segment in 2000 through 2002, including a significant investment to revise the science program. Houghton Mifflin also expects selling expense in the second half of 1999 to increase due to the increase in statewide adoption opportunities in 2000. Houghton Mifflin will also continue to invest to improve operating and support systems and to comply with Year 2000 computer requirements. These investments will help maintain market-leading product lines, as well as improve efficiency, profitability, and service to customers. Houghton Mifflin expects the cost of investments in new computer systems and Year 2000 compliance in 1999 to be approximately $3.0 million higher than in 1998. EFFECT OF THE YEAR 2000 COMPUTER ISSUE The statements in this section are "Year 2000 Readiness Disclosure" within the meaning of the Year 2000 Information and Readiness Disclosure Act. The Year 2000 computer issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. Any of Houghton Mifflin's computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations including, among other things, a temporary inability to process transactions, send invoices, ship products, or engage in similar normal business activities. In addition to hardware and software, the Year 2000 computer issue may also affect printers, facsimile machines, security systems, elevators, and other systems that are controlled by microprocessors. The Year 2000 computer issue will affect Houghton Mifflin, its vendors and suppliers, customers, and other third parties with whom Houghton Mifflin does business. To address this issue, Houghton Mifflin has created a plan under the direction of a Program Management Office, which consists of a team of Houghton Mifflin personnel and third-party consultants. The phases of the plan include assessment, remediation or replacement, testing and certification, and implementation. As part of this effort, the Program Management Office provides regular updates to management and the Board of Directors, as well as information bulletins to the entire company. Houghton Mifflin is focusing on the following four areas of exposure: information technology; non-information technology, or non-IT systems (for example, climate control systems, copy machines, security systems, etc.); technology products sold by Houghton Mifflin; and third-party relationships. Houghton Mifflin is using the status-of-completion method to evaluate its progress on the Year 2000 computer issue. This method compares the level of effort necessary to complete the task with the level of effort expended to date. Houghton Mifflin has completed its evaluation of the Year 2000 readiness of CAT, which was acquired in July 1998. Some expected completion dates have been extended to reflect CAT's state of readiness, and the following disclosure includes the effect of CAT upon Houghton Mifflin's Year 2000 readiness. Information technology includes mainframe applications, client server applications, end-user applications, infrastructure hardware and software, and networks and voice systems. Houghton Mifflin has completed the assessment of all information technology systems that it believes could be significantly affected by the Year 2000 computer issue, and has determined that it will have to modify or replace significant portions of its software and certain hardware so that those systems will properly utilize dates beyond December 31, 1999. The assessment also showed that for certain older systems, such as 21 24 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 Houghton Mifflin's future growth. The following chart (excluding the customer order management system) presents the estimated average status of completion for this area, and the expected completion date for each phase.
ESTIMATED EXPECTED AVERAGE % COMPLETION RESOLUTION PHASE COMPLETION DATE - ---------------- ---------- --------------- Assessment.................................................. 100% Completed Remediation or Replacement.................................. 80 July 31, 1999 Testing and Certification................................... 45 August 31, 1999 Implementation.............................................. 45 August 31, 1999
The expected completion date of the customer order management system has been extended due to an increase in the scope of work to complete the project. Houghton Mifflin has completed the assessment phase of this system and is approximately 35% complete with the replacement phase. The replacement, testing, and implementation phases are expected to be completed by October 31, 1999. Houghton Mifflin is also developing a contingency plan for this system, which includes remediation of the existing system. The following chart presents the estimated average status of completion for critical non-IT systems and the expected completion date of each phase.
ESTIMATED EXPECTED AVERAGE % COMPLETION RESOLUTION PHASE COMPLETION DATE - ---------------- ---------- ------------------ Assessment.................................................. 100% Completed Remediation or Replacement.................................. 100 Completed Testing and Certification................................... 75 June 30, 1999 Implementation.............................................. 0 June 30, 1999
Houghton Mifflin is also in the process of assessing the compliance of its technology product lines by testing the products in a Year-2000-compliant environment. The test results will determine any required action, including remediation, replacement, or retirement. In most cases, Houghton Mifflin believes there will be no need for remediation or replacement of the product. Houghton Mifflin 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, Houghton Mifflin does not expect that the effect of Year 2000 issues on Houghton Mifflin's technology products presents a material exposure. Houghton Mifflin has identified its most important customers, suppliers, and business partners (for example, printers, paper suppliers, distributors, and financial institutions), and has contacted them to determine the extent to which Houghton Mifflin may be vulnerable in the event that those parties fail to properly correct their own Year 2000 computer issues. Houghton Mifflin is monitoring the responses and progress of these parties. In addition, Houghton Mifflin intends to test critical systems interfaces, such as order and inventory transactions. Houghton Mifflin is in the process of working with the parties with whom it has these interfaces to reduce the risk of business interruptions. To date, Houghton Mifflin is not aware of any third party whose Year 2000 issues would have a material effect on Houghton Mifflin, but has no independent means of ensuring that third parties will be Year 2000 ready or whether their remediation efforts will be compatible with those of Houghton Mifflin. Houghton Mifflin is using both internal and external resources to reprogram or replace and test software for Year 2000 modifications. Management currently expects the total cost of the Year 2000 22 25 computer project, including costs to enhance the functionality of certain systems as well as to address the Year 2000 computer issue, to be approximately $30-35 million, which is being funded through operating cash flows. Of this total, approximately $10-14 million is for the purchase of new software and hardware that will be capitalized. The remaining $17-21 million will be expensed as incurred. As of December 31, 1998, Houghton Mifflin has spent approximately $16 million ($8 million expensed and $8 million capitalized for new systems) on its Year 2000 computer project and the development of new systems and systems modifications. Houghton Mifflin believes that it has an effective program in place to resolve any Year 2000 computer issues in a timely manner. Although Houghton Mifflin has not yet completed all the necessary phases of its Year 2000 program, it believes that with modifications to existing software and conversions to new software, the Year 2000 computer issue will not pose significant operational problems for its computer systems. However, if such modifications and conversions are not made or are not completed in time, or if a material third party fails to properly remediate its computer problems, or if the costs are higher than expected, the Year 2000 computer issue could have a material effect on Houghton Mifflin's operations. While Houghton Mifflin is not 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 Houghton Mifflin and its significant customers, suppliers, and business partners. In the event that Houghton Mifflin or any of its material suppliers or other third parties do not complete the necessary remediation, Houghton Mifflin could be subject to interruption of its normal business activities, including its ability to take customer orders, manufacture and ship products, invoice customers, collect payments, or engage in similar routine operations, and there could be a material adverse effect on Houghton Mifflin's revenues. Houghton Mifflin could also be subject to litigation for computer systems failures or problems with its technology products. In addition, disruptions in the economy generally resulting from the Year 2000 computer issue could materially adversely affect Houghton Mifflin. The amount of potential liability and lost revenues cannot reasonably be estimated at this time. To prepare for the possibility that it or a third party may be unable to remediate or replace and properly test critical systems on a timely basis, Houghton Mifflin will develop appropriate contingency plans after its assessment of risk is complete. Houghton Mifflin has prepared preliminary contingency plans for many of its information technology systems and will develop final plans during 1999 for those areas Houghton Mifflin determines are at risk. The projected costs and the dates on which Houghton Mifflin believes it will complete the Year 2000 computer modifications are based on its best estimates which, in turn, were based on numerous assumptions of future events, including the continued availability of certain resources, third-party modification plans, and other factors, many of which are not subject to Houghton Mifflin's control. Houghton Mifflin cannot be sure that these estimates will be achieved and actual results could differ materially from those anticipated. There are many factors that could affect the accuracy of these estimates, including the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer code, the ability of third parties to resolve their own Year 2000 computer issues, and other uncertainties referred to from time to time in Houghton Mifflin's filings with the Securities and Exchange Commission. 23 26 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Houghton Mifflin's exposure to market risk for changes in interest rates relates primarily to borrowings under Houghton Mifflin's commercial paper program and its unsecured credit facility. Houghton Mifflin does not enter into speculative or leveraged derivative transactions. Houghton Mifflin enters into transactions involving financial instruments for purposes of managing its exposure to interest rate risks and funding costs. Through the use of interest rate products such as interest rate swap agreements and interest rate locks, Houghton Mifflin can achieve a predetermined mix of fixed- and floating-rate debt. At December 31, 1998, Houghton Mifflin had two interest-rate swaps in place, each with a notional amount of $25 million and terminating on December 1, 2000. Houghton Mifflin pays the fixed rate on both swaps (5.90% and 5.95%) and receives a variable rate based upon a commercial paper index. Each interest rate swap agreement is designated with all or a portion of the principal balance and term of a specific debt obligation. These agreements involve the exchange of amounts based on a variable interest rate for amounts based on a fixed interest rate over the life of the agreement without an exchange of the notional amount upon which the payments are based. The differential to be paid or received as interest rates change is recognized as an adjustment to interest expense in the current period. The fair market value of the swap agreements and changes in the fair market value as a result of changes in market interest rates are not recognized in the financial statements. Gains and losses on terminations of interest rate swap agreements are deferred as an adjustment to the carrying amount of the outstanding designated debt and amortized as an adjustment to interest expense related to the debt over the remaining term of the original contract life of the terminated swap agreement. In the event of the early extinguishment of a designated debt obligation, any realized or unrealized gain or loss from the swap would be recognized in income coincident with the extinguishment gain or loss. Any swap agreements that are not designated with outstanding debt, or notional amounts (or durations) of interest rate swap agreements in excess of the principal amounts (or maturities) of the underlying debt obligations, are recorded as an asset or liability at fair market value, with changes in fair market value recorded in "Other income or expense" (the fair market value method). There were no such agreements at December 31, 1998. Houghton Mifflin currently holds an investment in INSO common stock, which is accounted for in accordance with Statement of Financial Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." These equity securities are classified as available-for-sale and are carried at fair market value based on the quoted market price. As such, Houghton Mifflin has exposure to market risk related to the fluctuation of INSO's stock price. At February 28, 1999, the value of Houghton Mifflin's investment in INSO has declined to $13.5 million. Houghton Mifflin expects to mitigate its exposure to changes in INSO stock price by using the INSO common stock to redeem the SAILS debt. If Houghton Mifflin redeems the SAILS with the shares of INSO common stock, it would record a gain representing the excess of the redemption amount over the book value of Houghton Mifflin's investment in INSO (see Note 4 in the Notes to the Consolidated Financial Statements). 24 27 The following table provides information about Houghton Mifflin's financial instruments that are sensitive to changes in interest rates. For investment securities and debt obligations, the table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Weighted- average variable rates are based on implied forward rates as derived from appropriate annual spot rate observation as of the reporting date. For interest rate swaps, the table presents notional amounts and weighted-average interest rates by contractual maturity dates. Notional amounts are used to calculate the contractual cash flows to be exchanged under the contract. INTEREST RATE SENSITIVITY PRINCIPAL (NOTIONAL) AMOUNTS AND AVERAGE INTEREST RATES
FAIR VALUE 1999 2000 2001 2002 2003 THEREAFTER TOTAL 12/31/98 ------- ------- ------- ------- ------- ---------- -------- ---------- ( IN THOUSANDS) ASSETS Available for sale securities.................. $48,565 -- -- -- -- -- $48,565 $48,565 Average interest rate......... -- -- -- -- -- -- LIABILITIES Commercial paper.............. $11,894 -- -- -- -- -- $11,894 $11,894 Average interest rate......... 5.95% -- -- -- -- -- Long-term debt, including current portion Fixed rate.................... $83,322 -- -- -- -- $224,521 $307,843 $297,179 Average interest rate......... 6.07% -- -- -- -- 7.06% Variable rate................. -- $50,000 -- -- -- -- $50,000 $50,000 Average interest rate......... -- 5.59% -- -- -- -- INTEREST RATE DERIVATIVE FINANCIAL INSTRUMENTS RELATED TO DEBT Interest rate swaps Notional amount of swap (Pay fixed/receive variable)... $50,000 $50,000 -- -- -- -- Average pay rate............ 5.93% 5.93% -- -- -- -- Average receivable rate..... 4.83% 4.90% -- -- -- --
"SAFE HARBOR" STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: This report includes forward-looking statements which reflect Houghton Mifflin's current views about future events and financial performance. Words such as "believe," "expect," "anticipate," and similar expressions identify forward-looking statements. Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from Houghton Mifflin's expectations, and Houghton Mifflin expressly does not undertake any duty to update forward-looking statements. These factors include, but are not limited to: (i) cost of development and market acceptance of Houghton Mifflin's educational and testing products and services; (ii) the seasonal and cyclical nature of Houghton Mifflin's educational sales; (iii) possible changes in funding in school systems throughout the nation, which may result in both cancellation of planned purchases of educational and testing products and services and shifts in timing of purchases; (iv) changes in purchasing patterns 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 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) unanticipated expenses or delays in resolving Year 2000 computer issues by either Houghton Mifflin or those with whom Houghton Mifflin does business; and (ix) other factors detailed from time to time in Houghton Mifflin's filings with the Securities and Exchange Commission. 25 28 (This page intentionally left blank) 26 29 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Management's Responsibility for Financial Statements........ 28 Report of Independent Auditors.............................. 29 Consolidated Balance Sheets at December 31, 1998 and 1997... 30 Consolidated Statements of Operations for the three years ended December 31, 1998................................... 32 Consolidated Statements of Cash Flows for the three years ended December 31, 1998................................... 33 Consolidated Statements of Stockholders' Equity for the three years ended December 31, 1998....................... 34 Notes to Consolidated Financial Statements.................. 36
SUPPLEMENTARY DATA Summary of Quarterly Results of Operations (unaudited) is presented on page 59. 27 30 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS The management of Houghton Mifflin Company is responsible for all information and representations contained in the financial statements and other sections of this annual report. Management is also responsible for the internal consistency of such information and representations. In preparing the financial statements it is necessary for management to make informed judgments and estimates and to select accounting principles which it believes are in accordance with generally accepted accounting principles appropriate in the circumstances. In meeting its responsibility for the reliability of the financial statements, management relies on Houghton Mifflin's internal control systems and procedures. In designing such control procedures, management recognizes that errors or irregularities may nevertheless occur and that estimates and judgments are needed to assess and balance the relative costs and expected benefits of controls. However, management believes that Houghton Mifflin's accounting controls do provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with corporate policy and management's authorization. As a further safeguard, Houghton Mifflin has a program of internal audits and appropriate follow-up by management. The financial statements have been audited by Houghton Mifflin's independent auditors, Ernst & Young LLP, in accordance with generally accepted auditing standards. In connection with its audit, Ernst & Young LLP develops and maintains an understanding of Houghton Mifflin's accounting and financial controls, and conducts such tests and related procedures as it deems necessary to render its opinion on the financial statements. The adequacy of Houghton Mifflin's internal financial controls and the accounting principles employed in financial reporting are under the general surveillance of the Audit Committee of the Board of Directors, consisting of five outside directors. The independent auditors and internal auditors have free and direct access to the Audit Committee and meet with the committee periodically to discuss accounting, auditing, and financial reporting matters. Houghton Mifflin has distributed to its employees a statement regarding, among other things, potentially conflicting outside business interests of employees, and proper conduct of domestic and international business activities. It has developed and instituted additional internal controls and audit procedures designed to prevent or detect violations of these policies. Management believes this provides reasonable assurance that its operations meet a high standard of business conduct. Nader F. Darehshori Gail Deegan Chairman, President, Executive Vice President and and Chief Executive Officer Chief Financial Officer
28 31 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Houghton Mifflin Company We have audited the accompanying consolidated balance sheets of Houghton Mifflin Company as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of Houghton Mifflin's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Houghton Mifflin Company at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Boston, Massachusetts January 26, 1999, except for the third paragraph of Note 14, as to which the date is February 28, 1999. 29 32 HOUGHTON MIFFLIN COMPANY CONSOLIDATED BALANCE SHEETS
DECEMBER 31, -------------------- 1998 1997 -------- -------- (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER-SHARE AMOUNTS) ASSETS CURRENT ASSETS Cash and cash equivalents.............................. $ 3,953 $ 5,621 Marketable securities and time deposits available for sale, at fair value................................... 49,203 614 Accounts receivable.................................... 170,706 184,597 Less: allowance for bad debts and book returns.... 27,969 25,090 -------- -------- 142,737 159,507 Inventories............................................ 151,669 145,043 Deferred income taxes.................................. -- 12,049 Prepaid expenses....................................... 2,279 1,882 -------- -------- Total current assets.............................. 349,841 324,716 Property, plant, and equipment, net......................... 49,412 39,108 Book plates, less accumulated amortization of $127,156 in 1998 and $117,213 in 1997................................................... 80,853 81,280 OTHER ASSETS Royalty advances to authors, less allowance of $23,589 in 1998 and $24,290 in 1997........................... 24,482 23,961 Goodwill and other intangible assets, net.............. 445,223 462,884 Deferred income taxes.................................. 7,885 3,807 Other investments and long-term receivables............ 17,871 45,344 -------- -------- Total other assets................................ 495,461 535,996 -------- -------- $975,567 $981,100 ======== ========
See accompanying Notes to Consolidated Financial Statements. 30 33 HOUGHTON MIFFLIN COMPANY CONSOLIDATED BALANCE SHEETS
DECEMBER 31, -------------------- 1998 1997 -------- -------- (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER-SHARE AMOUNTS) LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable....................................... $ 39,029 $ 47,612 Commercial paper....................................... 11,894 61,346 Royalties.............................................. 48,371 41,463 Salaries, wages, and commissions....................... 27,177 21,625 Deferred income taxes.................................. 7,500 -- Other.................................................. 27,019 26,680 Current portion of long-term debt...................... 83,322 40,000 -------- -------- TOTAL CURRENT LIABILITIES......................... 244,312 238,726 Long-term debt.............................................. 274,521 371,081 Accrued royalties payable................................... 1,148 1,430 Other liabilities........................................... 28,459 24,017 Accrued postretirement benefits............................. 28,839 28,089 Commitments and contingencies (Note 4 and 8) STOCKHOLDERS' EQUITY Preferred stock, $1 par value; 500,000 shares authorized, none issued............................... -- -- Common stock, $1 par value; 70,000,000 shares authorized; 30,549,706 shares issued in 1998 and 30,219,411 shares issued in 1997...................... 30,550 30,219 Capital in excess of par value......................... 95,740 75,307 Retained earnings...................................... 330,672 281,411 -------- -------- 456,962 385,039 Notes receivable from stock purchase agreements........ (4,621) (4,628) Unearned compensation related to restricted stock...... (2,318) (7,178) Common shares held in treasury, at cost, 374,052 shares in 1998 and 282,329 shares in 1997.................... (8,681) (5,553) Benefits Trust assets, at market....................... (61,432) (49,923) Accumulated other comprehensive income (loss).......... 18,378 (1,898) -------- -------- TOTAL STOCKHOLDERS' EQUITY........................ 398,288 317,757 -------- -------- $975,567 $981,100 ======== ========
See accompanying Notes to Consolidated Financial Statements. 31 34 HOUGHTON MIFFLIN COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, -------------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) NET SALES.................................................. $861,657 $797,320 $717,863 COSTS AND EXPENSES Cost of sales......................................... 390,922 362,501 329,686 Selling and administrative............................ 368,715 328,261 300,795 -------- -------- -------- 759,637 690,762 630,481 -------- -------- -------- OPERATING INCOME........................................... 102,020 106,558 87,382 OTHER INCOME (EXPENSE) Net interest expense.................................. (33,981) (38,926) (40,875) Gains on INSO Corporation common stock and equity in earnings (losses) of INSO Corporation............... 18,797 15,901 27,446 Loss on sale of investment............................ (3,017) -- -- Acquired in-process research and development.......... (3,500) -- -- Other expense......................................... (1,050) -- -- -------- -------- -------- (22,751) (23,025) (13,429) -------- -------- -------- Income before taxes and extraordinary item................. 79,269 83,533 73,953 Income tax provision....................................... 33,630 33,711 30,331 -------- -------- -------- Income before extraordinary item........................... 45,639 49,822 43,622 Extraordinary gain on extinguishment of debt, net of tax of $13,042.................................................. 18,010 -- -- -------- -------- -------- Net income................................................. $ 63,649 $ 49,822 $ 43,622 ======== ======== ======== EARNINGS PER SHARE: Basic Income before extraordinary item...................... $ 1.59 $ 1.76 $ 1.57 Extraordinary gain on extinguishment of debt.......... 0.63 -- -- -------- -------- -------- Net income............................................ $ 2.22 $ 1.76 $ 1.57 ======== ======== ======== Diluted Income before extraordinary item...................... $ 1.57 $ 1.73 $ 1.56 Extraordinary gain on extinguishment of debt.......... 0.62 -- -- -------- -------- -------- Net income............................................ $ 2.19 $ 1.73 $ 1.56 ======== ======== ========
See accompanying Notes to Consolidated Financial Statements. 32 35 HOUGHTON MIFFLIN COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ---------- ----------- ----------- (IN THOUSANDS OF DOLLARS) CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES Net income.......................................... $ 63,649 $ 49,822 $ 43,622 Adjustments to reconcile net income to net cash used in operating activities: Extraordinary gain on extinguishment of debt, net of tax................................... (18,010) -- -- Depreciation and amortization expense.......... 95,681 89,739 84,335 Amortization of unearned compensation on restricted stock............................. 5,177 2,095 695 Gains on INSO Corporation common stock and equity in earnings (losses) of INSO Corporation.................................. (18,797) (15,901) (27,446) Loss on sale of long-term investment........... 3,017 -- -- Acquired in-process research and development... 3,500 -- -- Gain on sale of property....................... -- (3,011) -- Changes in operating assets and liabilities: Accounts receivable, net....................... 16,805 6,267 18,031 Inventories.................................... (1,626) (5,079) 1,380 Accounts payable............................... (9,006) (10,262) (36,969) Royalties, net................................. 6,356 4,072 (3,307) Deferred and income taxes payable.............. (10,877) 17,209 25,485 Other, net..................................... 10,928 6,898 (3,798) -------- --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES.............................. 146,797 141,849 102,028 CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES Book plate expenditures............................. (53,255) (54,163) (62,080) Acquisition of publishing and technology assets, net of cash acquired.................................. (24,845) (9,049) (15,501) Property, plant, and equipment expenditures......... (20,729) (13,740) (12,863) Proceeds from sale of property...................... -- 5,204 -- Proceeds from the sale of INSO Corporation stock.... 210 -- 24,186 Proceeds from the sale of long-term investment...... 835 -- -- Purchase of marketable securities................... (24) (2) (8) -------- --------- --------- NET CASH USED IN INVESTING ACTIVITIES..... (97,808) (71,750) (66,266) CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES Dividends paid on common stock...................... (14,388) (13,959) (13,371) Issuance (repayment) of commercial paper............ (49,452) 61,346 (144,612) Proceeds from the issuance of long-term financing... 50,000 -- 224,785 Repayment of long-term financing.................... (40,000) (130,000) (109,955) Exercise of stock options........................... 2,875 4,782 1,897 Other............................................... 308 1,819 327 -------- --------- --------- NET CASH USED IN FINANCING ACTIVITIES..... (50,657) (76,012) (40,929) Decrease in cash and cash equivalents.................... (1,668) (5,913) (5,167) Cash and cash equivalents at beginning of year........... 5,621 11,534 16,701 -------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR................. $ 3,953 $ 5,621 $ 11,534 ======== ========= ========= SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION: Income taxes paid................................... $ 40,693 $ 12,890 $ 17,409 Interest paid....................................... $ 33,875 $ 39,366 $ 38,931
See accompanying Notes to Consolidated Financial Statements. 33 36 HOUGHTON MIFFLIN COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON CAPITAL STOCK IN EXCESS RETAINED $1 PAR VALUE OF PAR VALUE EARNINGS ------------ ------------ -------- FOR THE THREE YEARS ENDED DECEMBER 31, 1998 (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS) BALANCE AT JANUARY 1, 1996................................ $29,518 $29,973 $215,540 Net income................................................ -- -- 43,622 Common stock dividends, $0.48 per share................... -- -- (13,371) Stock options exercised................................... 44 1,249 (22) Issuance of restricted stock.............................. -- 1,009 -- Executive stock repurchases............................... -- -- -- Other equity transactions, net............................ -- 278 -- Issuance of stock for contribution to the retirement savings plan............................................ -- 1,884 -- Benefits Trust asset remeasurement........................ -- 8,856 -- Amortization of unearned compensation on restricted stock................................................... -- -- -- Tax benefit related to stock plan activities.............. -- 227 -- ------- ------- -------- BALANCE AT DECEMBER 31, 1996.............................. 29,562 43,476 245,769 ======= ======= ======== Comprehensive income: Net income................................................ -- -- 49,822 Other comprehensive income, net of tax: Unrealized loss on available for sale securities..... -- -- -- Total comprehensive income........................... -- -- -- Common stock dividends, $0.49 per share................... -- -- (13,959) Stock options exercised................................... 332 7,136 (66) Issuance of restricted stock.............................. 298 8,201 (142) Restricted stock forfeited................................ -- 228 -- Executive stock repurchases............................... -- -- -- Other equity transactions, net............................ 27 968 (13) Issuance of stock for contribution to the retirement savings plan............................................ -- 731 -- Benefits Trust asset remeasurement........................ -- 13,081 -- Amortization of unearned compensation on restricted stock................................................... -- -- -- Tax benefit related to stock plan activities.............. -- 1,486 -- ------- ------- -------- BALANCE AT DECEMBER 31, 1997.............................. 30,219 75,307 281,411 ======= ======= ======== Comprehensive income: Net income................................................ -- -- 63,649 Other comprehensive income, net of tax: Unrealized gain on available for sale securities..... -- -- -- Reclassification adjustment on realized loss on sale of security........................................ -- -- -- Total comprehensive income........................... -- -- -- Common stock dividends, $0.50 per share................... -- -- (14,388) Stock options exercised................................... 259 5,642 -- Issuance of executive performance shares.................. 31 852 -- Issuance of restricted stock.............................. 11 306 -- Executive stock repurchases............................... -- -- -- Other equity transactions, net............................ 30 838 -- Benefits Trust asset remeasurement........................ -- 11,538 -- Amortization of unearned compensation on restricted stock................................................... -- -- -- Tax benefit related to stock plan activities.............. -- 1,257 -- ------- ------- -------- BALANCE AT DECEMBER 31, 1998.............................. $30,550 $95,740 $330,672 ======= ======= ========
See accompanying Notes to Consolidated Financial Statements. 34 37
UNEARNED ACCUMULATED NOTES RECEIVABLE COMPENSATION TREASURY STOCK OTHER FROM STOCK RELATED TO -------------------- BENEFITS COMPREHENSIVE PURCHASE AGREEMENTS RESTRICTED STOCK SHARES AMOUNT TRUST INCOME (LOSS) TOTAL ------------------- ---------------- --------- ------- -------- ------------- -------- $(5,821) $ (349) (547,362) $(5,795) $(27,950) $(1,771) $233,345 -- -- -- -- -- -- 43,622 -- -- -- -- -- -- (13,371) -- -- 59,088 626 -- -- 1,897 -- (1,909) 84,828 900 -- -- -- 209 -- -- -- -- -- 209 (304) -- 24,352 248 (10) -- 212 -- -- 148,314 1,573 -- -- 3,457 -- -- -- -- (8,856) -- -- -- 695 -- -- -- -- 695 -- -- -- -- -- -- 227 ------- ------- --------- ------- -------- ------- -------- (5,916) (1,563) (230,780) (2,448) (36,816) (1,771) 270,293 ======= ======= ========= ======= ======== ======= ======== -- -- -- -- -- -- -- -- -- -- -- (127) -- -- -- -- -- -- 49,695 -- -- -- -- -- -- (13,959) -- -- (74,604) (2,620) -- -- 4,782 -- (8,357) -- -- -- -- -- -- 647 (24,000) (875) -- -- -- 1,547 -- (8,446) (282) -- -- 1,265 (259) -- -- -- (26) -- 697 -- -- 55,501 672 -- -- 1,403 -- -- -- -- (13,081) -- -- -- 2,095 -- -- -- -- 2,095 -- -- -- -- -- -- 1,486 ------- ------- --------- ------- -------- ------- -------- (4,628) (7,178) (282,329) (5,553) (49,923) (1,898) 317,757 ======= ======= ========= ======= ======== ======= ======== -- -- -- -- -- -- -- -- -- -- -- 18,560 -- -- -- -- -- 1,716 -- -- -- -- -- 83,925 -- -- -- -- -- -- (14,388) -- -- (88,182) (3,026) -- -- 2,875 -- -- -- -- -- -- 883 -- (317) -- -- -- -- -- 220 -- -- -- -- -- 220 (213) -- (3,541) (102) 29 -- 582 -- -- -- -- (11,538) -- -- -- 5,177 -- -- -- -- 5,177 -- -- -- -- -- -- 1,257 ------- ------- --------- ------- -------- ------- -------- $(4,621) $(2,318) (374,052) $(8,681) $(61,432) $18,378 $398,288 ======= ======= ========= ======= ======== ======= ========
See accompanying Notes to Consolidated Financial Statements. 35 38 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Houghton Mifflin Company and its wholly-owned subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation. Investments in 20% to 50% owned entities are accounted for on the equity method, while investments in entities less than 20% owned and for which Houghton Mifflin does not have control are accounted for under the cost method. Houghton Mifflin uses the income statement method to account for the issuance of common stock by a subsidiary or equity investee. Under this method gains and losses on issuance of stock by a subsidiary or equity investee are recognized in the income statement. Certain amounts in the prior years' financial statements have been reclassified to conform to the current- year presentation. CASH AND CASH EQUIVALENTS: Cash and cash equivalents consist primarily of cash in banks and highly liquid investment securities that have maturities of three months or less when purchased. The carrying amount approximates fair market value due to the short-term maturity of these instruments. MARKETABLE SECURITIES AND TIME DEPOSITS AVAILABLE-FOR-SALE: Marketable securities included in current assets consist principally of equity securities which have a readily available fair market value. The December 31, 1998 balance consists primarily of equity securities, which are accounted for in accordance with Statement of Financial Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," or SFAS 115. These securities are classified as current assets due to Houghton Mifflin's option and expectation to use them to redeem the remaining $63.3 million of aggregate principal amount of its outstanding 6% Exchangeable Notes due 1999 -- Stock Appreciation Income Linked Securities, or SAILS, due on August 1, 1999 (see Note 4). These securities are classified as available for sale and are carried at fair market value based on the quoted market price. The fair market value of these securities, $48.6 million, are included as a component of marketable securities as of December 31, 1998. Houghton Mifflin also held tax-exempt municipal certificates, government agency obligations, and time deposits, which are stated at fair market value, which approximates cost due to the short maturity of the instruments. The fair market values are estimated based on quoted market prices. In 1997, marketable securities included in other assets are classified as "Other investments and long-term receivables" for consolidated financial statement purposes. These investments, which consist of equity securities, are carried at market value. Unrealized holding gains and losses are recognized as a reduction in stockholders' equity. Investments in companies in which Houghton Mifflin has a 20% to 50% interest are carried at cost and adjusted for Houghton Mifflin's proportionate share of their undistributed earnings and losses, and for gains and losses associated with the issuance of additional stock, as discussed above. BOOK RETURNS: A provision for estimated future book returns is made at time of sale, and consists of the sales value less related inventory value and royalty costs. 36 39 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) INVENTORIES: Inventory balances at December 31, 1998 and 1997 are as follows:
1998 1997 -------- -------- (IN THOUSANDS) Finished goods......................................... $141,457 $130,825 Work in process........................................ 4,294 9,010 Raw materials.......................................... 5,918 5,208 -------- -------- $151,669 $145,043 ======== ========
Inventories are stated at the lower of cost or market (replacement cost for raw materials and net realizable value for other inventories). The last-in, first-out (LIFO) method is used to determine the cost of inventory. If the cost of all inventories had been determined by the first-in, first-out method (FIFO), which approximates replacement cost, inventory values would have been higher by $19.8 million at both December 31, 1998 and December 31, 1997. PROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment are carried on the basis of cost. Depreciation is provided on a straight-line basis over the estimated useful lives as follows:
ESTIMATED USEFUL LIFE ----------------------------------- Building and building equipment............. 10 to 35 years Machinery and equipment..................... 3 to 15 years Leasehold improvements...................... lesser of useful life or lease term
Balances of major classes of assets and allowances for depreciation and amortization at December 31, 1998 and 1997, are as follows:
1998 1997 -------- -------- (IN THOUSANDS) Land and land improvements............................. $ 1,179 $ 1,179 Building and building equipment........................ 17,410 19,905 Machinery and equipment................................ 85,226 66,243 Leasehold improvements................................. 11,718 10,608 -------- -------- Total............................................. 115,533 97,935 Less: allowances for depreciation and amortization..... (66,121) (58,827) -------- -------- Property, plant, and equipment, net.................... $ 49,412 $ 39,108 ======== ========
Maintenance and repair costs are charged to expense as incurred, and renewals and improvements that extend the useful life of the assets are capitalized. Depreciation expense was approximately $10.4 million in 1998; $8.2 million in 1997; and $7.3 million in 1996. BOOK PLATES: Houghton Mifflin's investment in book plates is capitalized and amortized over three to five years using the sum-of-the-years digits method. Amortization begins based upon when the book plate expenditures are made using a class of assets method. This policy is used by all divisions uniformly, except for the Trade & Reference Division, which expenses its book plates for all products except 37 40 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) reference and dictionary materials. Amortization expense was approximately $56.8 million in 1998; $53.6 million in 1997; and $50.3 million in 1996. INCOME TAXES: Income taxes are provided based on the liability method of accounting pursuant to Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Deferred income taxes are recorded to reflect the tax benefit and consequences of future years differences between the tax bases of assets and liabilities and their financial reporting amounts. GOODWILL AND OTHER INTANGIBLE ASSETS: Goodwill and other intangible assets at December 31, 1998 and 1997, consist of the following:
1998 1997 -------- -------- (IN THOUSANDS) Goodwill............................................... $525,279 $515,532 Publishing rights...................................... 17,724 16,623 Other.................................................. 4,000 4,000 -------- -------- Total............................................. 547,003 536,155 Less: accumulated amortization......................... (101,780) (73,271) -------- -------- Goodwill and other intangibles, net.................... $445,223 $462,884 ======== ========
Purchased editorial publishing rights are amortized on a straight-line basis over the estimated economic life of the titles or contracts, which does not exceed 15 years. The excess of cost over net assets acquired, or goodwill, is amortized on a straight-line basis over periods ranging from 3 to 25 years. Amortization expense on intangible assets, principally goodwill, was approximately $28.5 million in 1998; $27.9 million in 1997; and $26.7 million in 1996. IMPAIRMENT EVALUATION: Houghton Mifflin examines the carrying value of its long lived assets, certain identifiable intangibles, and goodwill to determine whether there are any impairment losses. If indicators of impairment were present in those assets, and future cash flows were not expected to be sufficient to recover the assets carrying amount, an impairment loss would be charged to expense in the period identified. No event has been identified that would indicate an impairment of the value of long-lived assets, identifiable intangibles, and goodwill recorded in the accompanying consolidated financial statements. CAPITAL STRUCTURE: The Financial Accounting Standards Board issued Statement No. 129, "Disclosure of Information about Capital Structures," in 1997. This statement does not change Houghton Mifflin's disclosure requirements. BENEFITS TRUST: The Trust assets consist primarily of 1.3 million shares of Houghton Mifflin's common stock purchased from Houghton Mifflin's treasury shares at quoted market price in 1992. The Trust is available to fund certain compensation and benefit plan obligations. The common stock is carried at market value 38 41 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) with changes in share price from prior reporting periods reflected as an adjustment to capital in excess of par value. COMMON STOCK SPLIT: On June 25, 1997, the Board of Directors declared a two-for-one split of Houghton Mifflin'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 periods presented by adjusting the par value for the additional shares due to the stock split from retained earnings. All share and per-share amounts in the accompanying financial statements have been restated to reflect the effect of this stock split. STOCK-BASED COMPENSATION: Houghton Mifflin grants stock options for a fixed number of shares to employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. Houghton Mifflin accounts for stock option grants in accordance with Accounting Principle Board Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense for the stock option grants. Houghton Mifflin also grants restricted stock and performance restricted stock awards to key employees, including officers. For such restricted stock awards, Houghton Mifflin measures compensation equal to the fair market value of the shares at the date of grant. Compensation expense for these awards is then recognized ratably over the period the restriction lapses. For performance restricted stock awards, adjustments are also made to recognize expense for achievement based upon financial goals. Houghton Mifflin has adopted the disclosure-only provision of Statement of Financial Accounting Standards No. 123, or SFAS 123, "Accounting for Stock-Based Compensation" (see Note 6). EARNINGS PER SHARE: In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings Per Share," or SFAS 128, which was required to be adopted for fiscal years ending after December 15, 1997. All earnings per share amounts for all periods presented have been restated to conform to the SFAS 128 requirements. See Note 13 for the computation of basic and diluted earnings per share. COMPREHENSIVE INCOME: In 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income," or SFAS 130, which was required to be adopted for fiscal years beginning after December 15, 1997. This statement established new rules for reporting and display of comprehensive income and its components. SFAS 130 requires that unrealized gains or losses on Houghton Mifflin's marketable equity securities be included in other comprehensive income, as well as certain other components of stockholders' equity. The adoption of this Statement had no impact on Houghton Mifflin's net income or stockholders' equity. Total comprehensive income amounted to $83.9 million for the twelve-months ended December 31, 1998, $49.7 million for the twelve months ended 1997, and $43.6 million for the twelve months ended 1996. 39 42 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION: In 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures About Segments of an Enterprise and Related Information," or SFAS 131, which was required to be adopted for fiscal years beginning after December 15, 1997. SFAS 131 superseded SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise." This statement changes the way public companies report segment information in annual financial statements. SFAS 131 requires public companies to report financial and descriptive information about their operating segments in interim financial reports to shareholders as well. The adoption of this Statement had no impact on Houghton Mifflin's net income or stockholders' equity. See Note 12 for the detailed presentation of business segments report. RISKS AND UNCERTAINTIES: Organization: Houghton Mifflin's business is publishing, primarily operating in three segments in the domestic market. Based on sales, Houghton Mifflin's largest segment is K-12 Publishing, which provides textbooks and other educational and testing products and services for the elementary and secondary school markets. College Publishing provides textbooks and other educational products and services to the two-year and four-year college markets and advanced placement programs in the secondary school market. The Other segment provides products in a wide variety of topics, formats, and media to the general public. Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The significant estimates that affect the financial statements include, but are not limited to, book returns, recoverability of advances to authors, inventory valuation, amortization periods, and recoverability of long-term assets such as book plates, intangibles, and goodwill. REVENUE RECOGNITION: Houghton Mifflin recognizes revenues upon shipment of products, net of a provision for returns based on sales. PENDING ACCOUNTING PRONOUNCEMENTS: In 1998, the Accounting Standards Executive Committee, issued Statement of Position 98-5, "Reporting on the Costs of Start-up Activities," which must be adopted for fiscal years beginning after December 15, 1998, and the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Investments and Hedging Activities," which must be adopted for fiscal years beginning after June 15, 1999. Houghton Mifflin is currently evaluating the effects of implementing these statements. NOTE 2. ACQUISITIONS On December 16, 1998, Houghton Mifflin acquired the assets of DiscoveryWorks, a science program for the elementary school market from Silver Burdett Ginn Inc., a subsidiary of Pearson Plc. The acquisition was accounted for as a purchase, and the net assets and results of operations are included in 40 43 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Houghton Mifflin's consolidated financial statements from the date of the acquisition. Net cash consideration for the acquisition amounted to approximately $10.5 million. The cost of the acquisition was allocated on a preliminary basis, based on the estimated fair market value of the assets acquired. The excess of the net assets acquired, or goodwill, is being amortized on a straight-line basis over a period of 12 years. On July 21, 1998, Houghton Mifflin acquired all of the outstanding stock of Computer Adaptive Technologies, Inc., or CAT, which specializes in developing and delivering computer-based testing solutions to organizations worldwide. The acquisition was accounted for as a purchase, and the assets acquired, liabilities assumed, and results of operations are included in Houghton Mifflin's consolidated financial statements from the date of the acquisition. Net cash consideration paid for the acquisition amounted to approximately $10.7 million, of which $8.0 million was paid to the former shareholders of CAT and $2.7 million was expended to repay debt, cash out certain warrants, and pay other acquisition related fees. 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. As of the acquisition date, CAT had only one product that qualified as in-process research and development, CAT Software System Version 7. This project represents an integrated application suite of products whose functionality includes test development, automated assembly and test production, test administration, scoring, automated test reporting, and test security. The amount of the charge represents the calculated value based on residual cash flows related to this in-process research and development project. At the date of acquisition, the development of this project had not yet reached technological feasibility, and the research and development in progress had no alternative uses. Accordingly, these costs were expensed as of the acquisition date. The cost of the acquisition was allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed, including the acquired in-process research and development. Goodwill and other intangible assets of $7.3 million were recorded as part of the acquisition and are being amortized on a straight-line basis over periods ranging from approximately 3 to 10 years. Additional goodwill will be recorded if the contingent considerations is earned. On September 10, 1997, Houghton Mifflin, through its subsidiary The Riverside Publishing Company, acquired the assets of Wintergreen/Orchard House, Inc., a publisher of guidance products for the elementary and secondary school markets. The acquisition was accounted for as a purchase and the net assets and results of operations are included in Houghton Mifflin's consolidated financial statements from the date of the acquisition. Net cash consideration for the acquisition amounted to approximately $3.6 million. The cost of the acquisition was allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed. The excess of the net assets acquired, or goodwill, is being amortized on a straight-line basis over a period of 15 years. On May 12, 1997, Houghton Mifflin acquired the assets of Chapters Publishing Ltd., predominantly a publisher of cookbooks. The acquisition was accounted for as a purchase, and the net assets and results of operations are included in Houghton Mifflin's consolidated financial statements from the date of the acquisition. Net cash consideration for the acquisition amounted to approximately $3.3 million. The cost of the acquisition was allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed. The excess of the net assets acquired, or goodwill, is being amortized on a straight-line basis over a period of 10 years. None of the above acquisitions materially affect consolidated results; therefore, no pro forma information is provided. 41 44 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) During the second quarter of 1996, Houghton Mifflin acquired all of the outstanding shares of D.C. Heath, Canada, Limited, or Heath Canada, from Raytheon following receipt of Canadian regulatory approval. ITP Nelson, a division of Thomson Canada Limited, subsequently acquired the assets of Heath Canada from Houghton Mifflin and entered into a series of agreements which expanded an existing exclusive distribution agreement for the school and college markets. Cash and licensing fees for these arrangements were approximately $5.0 million. NOTE 3. TAXES ON INCOME Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of the net deferred tax assets are shown in the following table:
1998 1997 -------- -------- (IN THOUSANDS) Tax asset-related: Pension and postretirement benefits............... $ 20,620 $ 19,394 Publishing expense................................ 16,842 19,072 Allowance for book returns........................ 4,004 4,377 Deferred compensation............................. 5,155 4,145 Other, net........................................ 604 3,397 -------- -------- 47,225 50,385 ======== ======== Tax liability-related: Depreciation expense.............................. (27,050) (24,715) INSO Corporation basis and related differences.... (6,061) (9,572) INSO Corporation shares unrealized gain........... (13,309) -- Deferred income................................... (420) (242) -------- -------- (46,840) (34,529) -------- -------- Net deferred tax asset................................. $ 385 $ 15,856 ======== ========
The net deferred tax asset balance is stated at prevailing statutory income tax rates. Houghton Mifflin currently does not anticipate any change in valuation methodology applied to the determination of net deferred tax assets. In 1998, the net deferred tax asset balance included a $13.3 million deferred tax liability on the unrealized gain related to Houghton Mifflin's investment in INSO Corporation, or INSO, which is accounted for in accordance with SFAS 115. 42 45 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Significant components of the provision (benefit) for income taxes attributable to income before taxes consist of the following:
1998 1997 1996 ------- ------- ------- (IN THOUSANDS) Current: Federal.................................... $29,034 $14,539 $20,573 State and other............................ 2,434 1,963 3,407 ------- ------- ------- Total current......................... 31,468 16,502 23,980 Deferred: Federal.................................... 1,520 14,315 5,154 State and other............................ 642 2,894 1,197 ------- ------- ------- Total deferred........................ 2,162 17,209 6,351 ------- ------- ------- $33,630 $33,711 $30,331 ======= ======= =======
The reconciliation of the income tax rate computed at the U.S. federal statutory tax rate to reported income tax expense (benefit) attributable to income before taxes is as follows:
1998 1997 1996 ---- ---- ---- Federal statutory rate................................. 35.0% 35.0% 35.0% State income taxes, net of federal benefit............. 3.1 3.8 4.6 Non-deductible goodwill amortization................... 2.7 2.5 3.0 Acquired in-process research and development........... 1.5 -- -- Other.................................................. 0.1 (0.9) (1.6) ---- ---- ---- Effective tax rate..................................... 42.4% 40.4% 41.0% ==== ==== ====
In 1998 and 1997, Houghton Mifflin recorded a provision for deferred taxes on the undistributed earnings of INSO. Accumulated undistributed earnings of INSO on which taxes have not been provided were approximately $1.0 million at December 31, 1998 and $2.0 million at December 31, 1997. Additionally, Houghton Mifflin has recorded a provision for deferred income taxes on the gains recognized as a result of any additional equity issuances of INSO. NOTE 4. DEBT AND BORROWING AGREEMENTS At December 31, 1998, Houghton Mifflin has a $300 million unsecured revolving credit facility, the Revolving Credit Facility, for which Houghton Mifflin pays annual commitment fees. Borrowings under the Revolving Credit Facility are outstanding under a five-year revolving commitment which expires on October 31, 2000. This credit facility requires Houghton Mifflin to comply with certain covenants, the most restrictive of which include maintenance of a specific level of net worth, fixed-charge coverage ratio, and debt-to-equity ratio. At December 31, 1998, the outstanding balance on this credit facility was $50 million, at a weighted average interest rate of 5.5875%. No amounts were outstanding under this credit facility at December 31, 1997. Management routinely evaluates interest rates available to Houghton Mifflin under the Revolving Credit Facility as compared to those available through the issuance of commercial paper. The amount outstanding under the Revolving Credit Facility of $50 million has been excluded from current liabilities at December 31, 1998 because Houghton Mifflin intends that at least that amount would remain outstanding under the Revolving Credit Facility, or 43 46 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) would be issued as additional commercial paper, for an uninterrupted period extending beyond one year from the balance sheet date.
1998 1997 -------- -------- (IN THOUSANDS) 7.00% Notes due March 1, 2006, interest payable semi-annually............................................. $124,836 $124,813 7.125% Notes due April 1, 2004, interest payable semi-annually............................................. 99,685 99,625 6% Exchangeable Notes, due August 1, 1999, Stock Appreciation Income-Linked Securities (SAILS)............. 63,322 126,643 Borrowings from financial institutions, unsecured, under committed five-year credit facility, expiring October 31, 2000...................................................... 50,000 -- 6.07% Notes due December 1, 1998, interest payable semi-annually............................................. -- 40,000 6.29% Notes due December 1, 1999, interest payable semi-annually............................................. 20,000 20,000 -------- -------- 357,843 411,081 Less: portion included in current liabilities............... 83,322 40,000 -------- -------- Total long-term debt........................................ $274,521 $371,081 ======== ========
Long-term debt due in each of the next five years is as follows:
YEARS IN THOUSANDS ----- ------------ 1999........................................................ $83,322 2000........................................................ 50,000 2001........................................................ -- 2002........................................................ -- 2003........................................................ --
Houghton Mifflin had approximately $11.9 million of commercial paper outstanding at December 31, 1998 at an interest rate of 5.95%. At the end of 1997, the amount of Houghton Mifflin's outstanding commercial paper was approximately $61.3 million with a weighted average interest rate of 6.76%. Houghton Mifflin has a shelf registration statement with the Securities and Exchange Commission for the offering of $300 million in debt securities, of which $125 million of non-callable unsecured notes have been issued. The notes mature on March 1, 2006 and were priced at 99.8% to yield an effective rate of 7.02%. In addition, Houghton Mifflin issued a total of $100 million of non-callable, unsecured medium-term notes under this registration statement; $40 million with a coupon of 5.83% which matured on December 1, 1997; $40 million with a coupon of 6.07% which matured on December 1, 1998; and $20 million with a coupon of 6.29% maturing on December 1, 1999. The proceeds from these issuances were used to pay down part of the borrowings used as short-term bridge financing for the acquisition of D.C. Heath and Company. Houghton Mifflin issued in a public offering 6% Exchangeable Notes due in 1999, Stock Appreciation Income Linked Securities, or SAILS, at a public offering price of $34 per SAILS at issue. Net proceeds of approximately $126.6 million were used for general corporate purposes, including the repayment of seasonal borrowings and the partial funding of the acquisition of Heath. In August 1998, Houghton Mifflin redeemed 50%, or $63.3 million in aggregate principal amount, of its outstanding SAILS. Redemption of the SAILS was made at the option of Houghton Mifflin pursuant to Section 1301 (b) of the Indenture dated as of March 15, 1994, between Houghton Mifflin and State 44 47 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 surrender of the INSO shares to redeem the SAILS generated a non-cash gain of $15.4 million ($8.9 million after tax), or $0.31 per share. Houghton Mifflin also recognized an $18.0 million extraordinary after-tax gain, or $0.62 per share, on the extinguishment of the debt resulting from the redemption. The remaining 50%, or $63.3 million in aggregate principal amount, of the outstanding SAILS is due on August 1, 1999 and, therefore, has been classified as current debt outstanding. The principal amount of each SAILS will be mandatorily exchanged for a number of shares of INSO common stock or, at Houghton Mifflin's option, cash with an equal value. If Houghton Mifflin chooses to redeem the SAILS with shares of INSO common stock, it would record a gain representing the excess of the redemption amount over the book value of Houghton Mifflin's investment in INSO. Under the terms of the SAILS, the number of shares that would be exchanged for the SAILS depends on the fair market value of INSO common stock on the redemption date. If the price of one share of INSO common stock is equal to or less than $34, then approximately 1.9 million shares would be exchanged. Between $34 and $39.44 per share, the number of shares that would be exchanged decreases from 1.9 million to 1.65 million. At $39.44 or more per share for INSO common stock, Houghton Mifflin would exchange 1.65 million shares. Houghton Mifflin would record as non-cash interest expense over the remaining term of the SAILS the excess, if any, of the market value of the current INSO common stock price over the maximum redemption price of $39.44 per INSO share. Based upon INSO's December 31, 1998 stock price, there is no additional non-cash interest expense to be recorded through August 1999. The INSO shares may be sold by Houghton Mifflin, subject to certain restrictions, as market conditions and events warrant. Houghton Mifflin has issued $100 million of 7.125% 10-year notes in a public debt offering. The notes, which mature on April 1, 2004, were priced at 99.4% of principal amount to yield an effective interest rate of 7.21%. The proceeds from the issuance were applied to repay the $100 million short-term credit facilities used as bridge financing in the March 1994 acquisition of McDougal Littell. Houghton Mifflin enters into transactions involving financial instruments for purposes of managing its exposure to interest rate risks and funding costs. Through the use of interest rate products such as interest rate swap agreements and interest rate locks, Houghton Mifflin can achieve a predetermined mix of fixed- and floating-rate debt. At December 31, 1998 and 1997, Houghton Mifflin had two interest-rate swaps in place, each with a notional amount of $25 million and terminating on December 1, 2000. Houghton Mifflin pays the fixed rate on both swaps (5.90% and 5.95%) and receives a variable rate based upon a commercial paper index. In connection with Houghton Mifflin's issuance of debt securities through the draw-down of the $300 million shelf registration in 1995, a forward interest rate-lock agreement was entered into with a counterparty for the notional principal amount of $100 million at 5.995%. This rate-lock agreement was settled in 1996, resulting in a net gain of approximately $0.6 million, which is being amortized over the approximate term of the related borrowings. Each interest rate swap agreement is designated with all or a portion of the principal balance and term of a specific debt obligation. These agreements involve the exchange of amounts based on a variable interest rate for amounts based on a fixed interest rate over the life of the agreement without an 45 48 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) exchange of the notional amount upon which the payments are based. The differential to be paid or received as interest rates change is recognized as an adjustment to interest expense in the current period. The fair market value of the swap agreements and changes in the fair market value as a result of changes in market interest rates are not recognized in the financial statements. Gains and losses on terminations of interest rate swap agreements are deferred as an adjustment to the carrying amount of the outstanding designated debt and amortized as an adjustment to interest expense related to the debt over the remaining term of the original contract life of the terminated swap agreement. In the event of the early extinguishment of a designated debt obligation, any realized or unrealized gain or loss from the swap would be recognized in income coincident with the extinguishment gain or loss. Any swap agreements that are not designated with outstanding debt, or notional amounts (or durations) of interest rate swap agreements in excess of the principal amounts (or maturities) of the underlying debt obligations, are recorded as an asset or liability at fair market value, with changes in fair market value recorded in other income or expense (the fair market value method). There were no such agreements at December 31, 1998 or December 31, 1997. NOTE 5. RETIREMENT AND POSTRETIREMENT BENEFITS PLANS Houghton Mifflin has a noncontributory, qualified defined-benefit pension plan, the Houghton Mifflin Retirement Plan, or Retirement Plan, that covers substantially all employees. The Retirement Plan is a cash balance plan which accrues benefits based on pay, service, and interest. The funding policy is to contribute amounts subject to minimum funding standards set forth by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. The plan's assets consist principally of common stocks, fixed income securities, investments in registered investment companies, and cash and cash equivalents. Houghton Mifflin also has a nonqualified defined-benefit plan, or nonqualified plan, that covers employees who earn over the qualified pay limit. The nonqualified plan accrues benefits for the executive officers based on service and pay, and benefits for all other employees accrue based on the cash balance plan calculation. The nonqualified plan is not funded. Houghton Mifflin provides postretirement medical benefits to retired full-time, non-union employees hired before April 1, 1992, who have provided a minimum of five years of service and attained age 55. Additionally, employees of Heath as of October 31, 1995 who became Houghton Mifflin employees with the acquisition of Heath are covered subject to the same age and service requirements. Under the terms of the Benefits Trust agreement formed in 1992, proceeds from the periodic sale of assets by the trustee, cash dividends received, and other trust earnings may be used to pay designated compensation and benefit plan obligations, including retiree health care benefit costs. The assets in the Benefits Trust consist principally of Houghton Mifflin's common stock. The fair market value of the Benefits Trust net assets was $61.4 million at December 31, 1998 and $49.9 million at December 31, 1997. In 1998, the Financial Accounting Standards Board issued Statement No. 132, "Employers' Disclosure about Pensions and Other Postretirement Benefits," or SFAS 132, which was required to be adopted for fiscal years beginning after December 15, 1997. SFAS 132 superseded Financial Accounting Standards Board Statements No. 87, "Employers' Accounting for Pensions," and No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The new statement did not change the measurement or recognition of costs for pension or other postretirement plans. It standardized disclosures and eliminated certain disclosures. For the Retirement Plan, Houghton Mifflin uses a September 30 46 49 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) measurement date and adjusts for any contributions made after the measurement date to disclose the accrued pension liability at December 31. For postretirement benefits, a December 31 measurement date is used to disclose accrued postretirement benefit liability. The following tables, prepared in accordance with SFAS 132, sets forth the pension and postretirement benefit liability recognized in the consolidated balance sheet at December 31:
PENSION BENEFITS POSTRETIREMENT BENEFITS ------------------- ----------------------- 1998 1997 1998 1997 -------- -------- ---------- ---------- (IN THOUSANDS) CHANGE IN BENEFIT OBLIGATION Benefit obligation at January 1....................... $115,727 $106,003 $ 25,533 $ 24,901 Service cost (benefits earned during the year)........ 4,639 4,335 498 526 Interest cost on projected benefit obligation......... 8,182 8,020 1,757 1,844 Plan amendment........................................ 554 -- -- -- Actuarial (gain) loss................................. 7,412 4,232 3,457 162 Benefits paid......................................... (8,993) (6,863) (1,504) (1,900) -------- -------- -------- -------- Benefit obligation at December 31..................... $127,521 $115,727 $ 29,741 $ 25,533 ======== ======== ======== ======== CHANGE IN PLAN ASSETS Fair market value at beginning of year................ $120,417 $102,883 $ -- $ -- Actual return......................................... 3,247 24,331 -- -- Company contribution.................................. 65 66 1,504 1,900 Benefits paid......................................... (8,993) (6,863) (1,504) (1,900) -------- -------- -------- -------- Fair market value at end of year...................... $114,736 $120,417 $ -- $ -- ======== ======== ======== ======== FUNDED STATUS......................................... $(12,785) $ 4,690 $(29,741) $(25,533) Unrecognized items: Net (gain) loss.................................. (11,046) (24,126) 915 (2,542) Prior service cost............................... 1,974 1,590 (13) (14) Transition asset................................. (692) (875) -- -- -------- -------- -------- -------- Net amount recognized................................. $(22,549) $(18,721) $(28,839) $(28,089) ======== ======== ======== ======== AMOUNTS RECOGNIZED IN THE BALANCE SHEET CONSIST OF: Accrued benefit liability............................. $(23,475) $(18,721) $(28,839) $(28,089) Intangible asset...................................... 926 -- -- -- -------- -------- -------- -------- Net amount recognized................................. $(22,549) $(18,721) $(28,839) $(28,089) ======== ======== ======== ========
47 50 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Net periodic pension cost for 1998, 1997, and 1996 includes the following components:
PENSION BENEFITS ----------------------------- 1998 1997 1996 ------- ------- ------- (IN THOUSANDS) Service cost.................................. $ 4,639 $ 4,335 $ 3,736 Interest cost on projected benefit obligation.................................. 8,182 8,020 6,809 Expected return on plan assets................ (8,967) (8,308) (7,618) Amortization of unrecognized: Net (gain) loss.......................... 89 45 (9) Prior service cost....................... 133 137 3 Transition (asset)....................... (183) (182) (169) ------- ------- ------- Net pension expense........................... $ 3,893 $ 4,047 $ 2,752 ======= ======= =======
Net periodic postretirement benefit cost includes the following components for the twelve months ended December 31:
POSTRETIREMENT BENEFITS -------------------------- 1998 1997 1996 ------ ------ ------ (IN THOUSANDS) Service cost..................................... $ 498 $ 526 $ 529 Interest cost on accumulated postretirement benefit obligation............................. 1,757 1,844 1,801 Amortization of unrecognized: Net (gain) loss.................................. -- (35) -- Prior service cost............................... (1) (1) (1) ------ ------ ------ Net periodic postretirement benefit expense...... $2,254 $2,334 $2,329 ====== ====== ======
Significant actuarial assumptions:
PENSION POSTRETIREMENT BENEFITS BENEFITS ------------ -------------- 1998 1997 1998 1997 ---- ---- ----- ----- Discount rate................................... 6.75% 7.25% 6.75% 7.00% Increase in future compensation................. 4.75 4.75 N/A N/A Expected long-term rate of return on assets..... 9.00 9.00 N/A N/A Ultimate medical inflation trend factor......... N/A N/A 3.50 3.50
Assumed healthcare trend rates have a significant effect on the amounts reported for the healthcare plans. A one-percentage-point change in assumed healthcare cost trend rates would have the following effects:
ONE PERCENTAGE ONE PERCENTAGE POINT INCREASE POINT DECREASE -------------- -------------- (IN THOUSANDS) Effect on total service and interest cost components.................................... $ 108 $ (121) Effect on postretirement benefit obligation..... 1,403 (1,559)
In addition, Houghton Mifflin maintains a defined contribution retirement plan, the Houghton Mifflin 401(k) Savings Plan, which conforms to Section 401(k) of the Internal Revenue Code and covers substantially all of Houghton Mifflin's employees. Participants may elect to contribute up to 15% 48 51 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) of their compensation subject to an annual limit ($10,000 in 1998) to eleven funds: seven equity funds, a balanced fund, a fixed income fund, a managed income fund, and a fund invested solely in Houghton Mifflin's common stock. Effective January 1, 1997, the Houghton Mifflin 401(k) Savings Plan provides a Company match in amounts up to 4 1/2% of employee compensation. The contribution expense, which is invested solely in shares of Houghton Mifflin's common stock, amounted to approximately $3.6 million in 1998; $3.2 million in 1997; and $2.1 million in 1996. NOTE 6. STOCK COMPENSATION PLANS At December 31, 1998, Houghton Mifflin had three stock-based compensation plans which are described below. Houghton Mifflin applies APB Opinion 25 and related Interpretations in accounting for its plans. Houghton Mifflin has adopted the disclosure-only provision of SFAS 123. Accordingly, no compensation cost has been recognized for its fixed stock compensation plans. Had compensation cost for Houghton Mifflin's three stock-based compensation plans been determined based on the fair market value at the grant dates for awards under those plans consistent with the method of SFAS 123, Houghton Mifflin's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
1998 1997 1996 ------- ---------- ------- (IN MILLIONS, EXCEPT PER-SHARE AMOUNTS) NET INCOME As reported.................................. $63.6 $49.8 $43.6 Pro forma.................................... 62.3 48.7 42.4 EARNINGS PER SHARE As reported -- basic......................... $2.22 $1.76 $1.57 Pro forma -- basic........................... 2.17 1.72 1.53 As reported -- diluted....................... 2.19 1.73 1.56 Pro forma -- diluted......................... 2.14 1.69 1.52
The effects on pro forma net income and earnings per share of expensing the estimated fair market value of stock options are not necessarily representative of the effects on reported net income for future years due to such factors as the vesting period of the stock options and the potential for issuance of additional stock options in future years. Additionally, because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1999 or 2000. FIXED STOCK COMPENSATION PLANS: Houghton Mifflin maintains three fixed stock compensation plans, the 1992 Stock Compensation Plan, the 1995 Stock Compensation Plan, and the 1998 Stock Compensation Plan, or 1998 Plan. Options outstanding include some granted under the 1992 Stock Compensation Plan and the 1995 Stock Compensation Plan, under which no further options may be granted. Houghton Mifflin had authorized 1.4 million common shares under the 1992 Stock Compensation Plan and 1.8 million common shares under the 1995 Stock Compensation Plan. A total of 1.8 million shares of common stock are authorized for issuance under the 1998 Plan, plus any shares authorized but unused under the prior plans. The plans may be used to grant incentive and non-qualified stock options, awards of restricted or bonus stock, or other performance awards to eligible employees. The plans may also be used to grant options to non- 49 52 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) employee members of the Board of Directors and to issue shares to Directors as part of their compensation. Recipients of restricted stock awards may not sell or transfer the shares until the restriction period lapses, provided that shares have not been forfeited due to termination of employment. During the restriction period, the recipient is entitled to vote and receive dividends. In 1998, grants of 11,060 shares of restricted stock were made; at December 31, 1998, a total of 84,861 restricted shares were not yet vested. In 1997, grants of 298,034 shares of restricted stock were made; at December 31, 1997, a total of 262,532 restricted shares were not yet vested. The plans provide that the exercise price for stock options shall not be less than the fair market value of the shares on the date of grant. Options granted under all plans become exercisable at such times as the Compensation & Nominating Committee has determined, but not later than ten years from the date of the grant. The fair market value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998, 1997, and 1996:
1998 1997 1996 ------------- ------------- ------ Dividend yield..................... 1.69% 1.75% 1.89% Range of expected lives (years).... 3.2 - 8.7 3.9 - 4.7 3 - 4.8 Expected volatility................ 26.59% 22.17% 24.90% Range of risk-free interest rates............................ 5.38% - 6.63% 5.70% - 5.72% 6.21%
A summary of the status of Houghton Mifflin's three fixed stock compensation plans as of December 31, 1998, 1997, and 1996 and changes during the years ending on those dates is presented below:
1998 1997 1996 ------------------ ------------------ ------------------ WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE (000) PRICE (000) PRICE (000) PRICE ------ --------- ------ --------- ------ --------- FIXED OPTIONS Outstanding at beginning of year.... 1,652 $25 1,718 $23 1,578 $22 Granted............................. 1,270 42 314 34 416 23 Exercised........................... (267) 23 (335) 22 (114) 19 Forfeited........................... (43) 28 (45) 22 (162) 22 ------ ----- ----- Outstanding at end of year.......... 2,612 33 1,652 25 1,718 23 ====== ===== ===== Options exercisable at year-end..... 1,008 951 922 Weighted-average fair market value of options granted during the year.............................. $13.27 $6.37 $4.89
50 53 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table summarizes information about fixed stock options at December 31, 1998:
OPTIONS OUTSTANDING ------------------------------------ OPTIONS EXERCISABLE WEIGHTED- ----------------------- AVERAGE WEIGHTED- WEIGHTED- RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE EXERCISE OUTSTANDING CONTRACTUAL EXERCISE OUTSTANDING EXERCISE PRICES AT 12/31/98 LIFE PRICE AT 12/31/98 PRICE - ---------- ----------- ----------- --------- ----------- --------- $19 to $21 401,066 1.9 years $21 308,238 $21 22 to 23 412,660 1.1 23 389,860 23 24 to 29 287,800 2.7 25 154,210 25 30 to 36 326,835 3.9 34 129,968 35 37 to 43 1,183,500 9.5 43 25,700 42 --------- --------- 2,611,861 5.5 33 1,007,976 25 ========= =========
EXECUTIVE STOCK PURCHASE PLAN: In August 1994, pursuant to the 1994 Executive Stock Purchase Plan, or Executive Stock Purchase Plan, whose purpose was to increase stock ownership of Houghton Mifflin's Executive Officers, Houghton Mifflin granted 248,544 options under the 1992 Stock Compensation Plan to certain corporate officers for exercise at the then market price of $21.313. These options were exercisable only on the date granted and stock was issued from treasury shares. A note was obtained from the officers and collateralized by the stock (see Note 11). NOTE 7. PREFERRED STOCK PURCHASE PLAN In December 1988, Houghton Mifflin adopted a Stockholders' Rights Plan, which was renewed in July 1997, and declared a dividend distribution of one Right (as defined in the renewed rights plan) for each outstanding share of common stock of Houghton Mifflin effective upon expiration of the original plan in December 1998. The Rights are attached to the common stock, do not have voting or dividend rights and, until they become exercisable, they can have no dilutive effect on Houghton Mifflin's earnings. Each Right, when exercisable, entitles the holder to purchase one ten-thousandth of a share of Series A Junior Participating Preferred Stock at an exercise price of $125. The Rights will become exercisable after (a) a person or group has acquired beneficial ownership of 20% or more of the outstanding common stock of Houghton Mifflin, (b) the commencement of a tender or exchange offer that would result in a person or group beneficially owning 30% or more of the outstanding common stock of Houghton Mifflin, or (c) the determination by the Board of Directors (with the concurrence of a majority of the Outside Directors (as defined in the renewed rights plan)) that a person or group which has acquired a substantial amount (at least 15%) of the outstanding common stock of Houghton Mifflin is an Adverse Person (as defined in the renewed rights plan). In the event that (i) the Board of Directors (with the concurrence of a majority of the Outside Directors) declares that a person is an Adverse Person, (ii) Houghton Mifflin is the surviving corporation in a merger or other business combination transaction with a person or group beneficially owning 20% or more of the outstanding common stock of Houghton Mifflin and Houghton Mifflin's common stock is not changed or exchanged as a result of such merger or business combination transaction, (iii) a person or group acquires beneficial ownership of 30% or more of the outstanding common stock of Houghton Mifflin (except pursuant to an offer the Outside Directors have determined is fair to, and in the best interest of, Houghton Mifflin and its stockholders, or a transaction described in the succeeding 51 54 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) paragraph), (iv) Houghton Mifflin engages in certain "self-dealing" transactions (as set forth in the renewed rights plan) with a person or group beneficially owning 20% or more of the outstanding common stock of Houghton Mifflin, or (v) during such time a person or group beneficially owns 20% or more of the outstanding common stock of Houghton Mifflin, an event (except pursuant to a transaction described in the succeeding paragraph) occurs which results in such person's or group's beneficial ownership interest increasing by more than 1% (e.g., a reverse stock split), then each Right holder, other than the potential acquirer, may be entitled to receive upon exercise of each Right an amount of common stock of Houghton Mifflin having a market value equal to twice the exercise price of the Right. In the event that Houghton Mifflin, after a person or group has acquired beneficial ownership of 20% or more of the outstanding common stock of Houghton Mifflin, (i) engages in a merger or other business combination transaction (with certain exceptions) and Houghton Mifflin is not the surviving entity, (ii) engages in a merger or other business combination transaction (with certain exceptions) in which all or part of Houghton Mifflin's outstanding common stock is changed or exchanged, or (iii) sells or transfers 50% or more of its assets or earning power, then each Right holder, other than the potential acquirer, may be entitled to receive upon exercise of each Right an amount of common stock of the acquirer having a market value equal to twice the exercise price of the Right. In general, the Board of Directors may redeem the Rights in whole at a price of $0.01 per Right at any time prior to the tenth business day after a person or group acquires beneficial ownership of 20% or more of the outstanding common stock of Houghton Mifflin. The Board of Directors may not redeem the Rights if it has declared (with the concurrence of a majority of the Outside Directors) someone to be an Adverse Person. The Rights will expire on July 30, 2007, subject to adjustment. NOTE 8. COMMITMENTS AND CONTINGENCIES OPERATING LEASE OBLIGATIONS: Houghton Mifflin has leases for various real property, office facilities, and warehouse equipment which expire at various dates. Certain leases contain renewal and escalation clauses for a proportionate share of operating expenses. The future minimum rental commitments under all noncancelable leases for real estate and equipment are payable as follows:
YEARS IN THOUSANDS - ----- ------------ 1999........................................................ $ 17,902 2000........................................................ 16,958 2001........................................................ 15,550 2002........................................................ 14,964 2003........................................................ 14,206 Thereafter.................................................. 35,019 -------- Total minimum lease payments...................... $114,599 ========
Rent expense, net of sublease income, was approximately $17.6 million in 1998; $17.5 million in 1997; and $17.3 million in 1996. 52 55 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) CONTINGENCIES: Houghton Mifflin is involved in ordinary and routine litigation incidental to its business. There are no such matters pending that Houghton Mifflin expects to be material in relation to its financial condition or results of operations. NOTE 9. INSO CORPORATION In March 1994, Houghton Mifflin spun off its former Software Division in an initial public offering. Houghton Mifflin's equity interest in INSO, the successor company, was approximately 40% after the offering. Houghton Mifflin recognized earnings from its investment in INSO based upon the equity method of accounting. In 1996, Houghton Mifflin received $38.6 million in proceeds from the sale of 770,000 shares of INSO common stock. As a result of the sale, Houghton Mifflin recorded a gain of approximately $34.3 million ($19.9 million after-tax), or $0.71 per share. Houghton Mifflin's equity ownership in INSO, after the sale of common stock, was approximately 30%. 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 total consideration of $56.4 million. As a result, in March 1997, Houghton Mifflin recorded a gain of $14.9 million ($8.6 million after tax), or $0.30 per share, representing Houghton Mifflin's portion of the increase in INSO's net assets. As a result of this offering, the equity ownership in INSO was reduced to approximately 27%. During 1998, Houghton Mifflin used 1.9 million shares of INSO common stock to redeem 50%, or $63.3 million in aggregate principal amount, of its SAILS. Houghton Mifflin's equity ownership in INSO after the surrender of INSO common stock was reduced to approximately 13%. Because Houghton Mifflin's ownership of INSO dropped below 20%, it no longer records its investment in INSO under the equity method. Instead, Houghton Mifflin accounts for the remaining shares held of INSO common stock in accordance with Statement of Financial Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." These securities are classified as available for sale and are carried at fair market value based on the quoted market price. When Houghton Mifflin recorded its pro-rata share of income and losses and the impact of INSO's equity activities, if any, on a quarterly basis, it did so one quarter in arrears. 53 56 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 10. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair market values of Houghton Mifflin's financial instruments as of December 31, 1998 and 1997 are as follows:
1998 1997 ---------------------- ---------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE --------- --------- --------- --------- (IN THOUSANDS) FINANCIAL ASSETS: Cash, cash equivalents, and marketable securities........... $4,591 $4,591 $6,235 $6,235 Investments: INSO................... 48,565 48,565 30,194 44,777 Cassell Plc............ -- -- 2,178 2,178 Other.................. 2,500 2,500 -- -- FINANCIAL LIABILITIES: SAILS.................. (63,322) (44,160) (126,643) (50,160) 7.00% notes............ (124,836) (128,525) (124,813) (127,688) 7.125% notes........... (99,685) (104,400) (99,625) (103,620) Credit facility........ (50,000) (50,000) -- -- 6.07% notes............ -- -- (40,000) (40,064) 6.29% notes............ (20,000) (20,094) (20,000) (20,106) Commercial paper....... (11,894) (11,894) (61,346) (61,346)
The fair market values of financial instruments are estimates based on market conditions and perceived risks at December 31, 1998 and 1997, and require varying degrees of management judgment. The fair market values of the financial instruments presented may not be indicative of their future values. The following methods and assumptions were used to estimate the fair market value of each class of financial instrument: CASH, CASH EQUIVALENTS, MARKETABLE SECURITIES, AND COMMERCIAL PAPER: The carrying amount approximates fair market value due to the short-term maturity of the instruments. INVESTMENTS: The fair market value of Houghton Mifflin's investments is estimated based on the quoted market prices, if available, for these securities at December 31, 1998 and 1997. Included in the book and fair market value of Cassell Plc in 1997 was approximately $1.8 million of deferred tax benefit. LONG-TERM DEBT: The fair market value of the SAILS and notes is estimated based on quoted market prices. The carrying amount of the credit facility approximates fair market value because of the renewing feature of the facility. OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS GAINS (LOSSES): Houghton Mifflin does not have any speculative or leveraged derivative transactions. At December 31, 1998, Houghton Mifflin had two interest rate swaps on commercial paper which were 54 57 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) entered into in 1997 (see Note 4). The fair market value represents the amount Houghton Mifflin would receive or pay to terminate the agreement taking into consideration current interest rates. The fair market value of these agreements, representing the estimated amount that Houghton Mifflin would pay a third party assuming Houghton Mifflin's obligations under the interest rate agreements ceased at December 31, 1998, is approximately $968,300. NOTE 11. RELATED PARTIES Houghton Mifflin presently holds notes receivable for a total of $4.6 million from certain corporate officers and members of the Board of Directors. Houghton Mifflin provided financing in 1994 to effect the purchase of an aggregate of 276,544 shares of Houghton Mifflin's common stock pursuant to the 1994 Executive Stock Purchase Plan and the 1994 Non-Employee Director Stock Purchase Plan at the fair market value on August 27, 1994 of $21.313 per share. The original loans made to Houghton Mifflin's current officers were amended in 1998. The amended loans have an interest rate of 6.25% and are due in the third quarter of 2003. Loans made to officers are collateralized by the shares of common stock purchased. Loans provided to members of the Board of Directors are unsecured. All loans have full recourse against the borrower. The notes receivable are shown as a reduction in stockholders' equity in the consolidated financial statements. In 1998, Houghton Mifflin recognized approximately $0.3 million in interest income in connection with the outstanding loans. NOTE 12. SEGMENT AND RELATED INFORMATION Houghton Mifflin adopted SFAS 131 in 1998, which changes the way Houghton Mifflin reports information about its operating segments. SFAS 131 superseded Financial Accounting Standards Board Statement No. 14, "Financial Reporting for Segments of a Business Enterprise." The information relating to 1997 and 1996 has been restated from the prior years' presentation in order to conform with SFAS 131. Houghton Mifflin has eight divisions with separate management teams and infrastructures that offer different products and services. These divisions have been aggregated into 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 four divisions: School Division, McDougal Littell Inc., Great Source Education Group, Inc., 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, computer-assisted as well as computer-managed instructional programs for the K-12 market, and a computer-based career and college guidance information system in versions for both junior and senior high school students. The principal markets for these products are elementary and secondary schools. College Publishing: The College Division is the sole business unit reported in this segment. This operating segment includes textbooks, ancillary products such as workbooks and study guides, and instructional materials for introductory and upper level courses for the post-secondary education market. The principal markets for these products are two- and four-year colleges and universities. Other markets in which these products are sold include high school advanced placement courses and to for-profit, certificate-granting institutions which offer skill-based training and job placement. Other: This segment consists of the Trade & Reference Division, Houghton Mifflin Interactive Corporation, or HMI, CAT and unallocated corporate-related items. The Trade & Reference Division publishes fiction and nonfiction for adults and children, dictionaries, and other reference works. The 55 58 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) division also gains revenue from sales of book reprint rights to paperback publishers, book clubs, and other publishers in the United States and abroad. Its principal markets are retail stores, including Internet bookstore sites, and wholesalers. Reference materials are also sold to schools, colleges, office supply distributors, and businesses. HMI develops and sells multimedia products, chiefly CD-ROM titles, in the children's, reference, and adult-hobby markets. Its principal markets are retail stores. CAT specializes in the development and delivery of computer-based testing solutions, and its principal markets are organizations worldwide. Houghton Mifflin's geographic area of operation is predominantly in the United States. Export sales and long-lived asset balances for locations outside the Unites States are not significant to Houghton Mifflin's three business segments. Houghton Mifflin does not have any customers which exceed 10% of net sales, and the loss of a single customer, in management's opinion, would not have a material adverse effect on net sales. Houghton Mifflin evaluates the performance of its operating segments based on the profit and loss from operations before interest income and expense, income taxes, and infrequent and extraordinary items. The accounting policies of the reportable segments are the same as those described in Note 1. Summarized financial information concerning Houghton Mifflin's reportable segments is shown in the following table. The "Other" column includes unallocated corporate-related items, operations which do not meet the quantitative thresholds of SFAS 131, nonrecurring items and, as it relates to segment profit (loss), income and expense not allocated to reportable segments.
K-12 COLLEGE PUBLISHING PUBLISHING OTHER CONSOLIDATED ---------- ---------- -------- ------------ (IN THOUSANDS) 1998 Net sales from external customers............. $611,770 $160,677 $ 89,210 $ 861,657 Depreciation and amortization................. 72,672 20,761 2,248 95,681 Segment operating income (loss)............... 97,944 19,734 (15,658) 102,020 Identifiable assets........................... 624,095 195,681 124,900 944,676 Acquired assets............................... 10,640 -- 14,205 24,845 Total assets.................................. 634,735 195,681 139,105 969,521 Purchase of property, plant, and equipment, including book plates....................... 54,518 16,931 2,535 73,984 1997 Net sales from external customers............. $560,259 $148,969 $ 88,092 $ 797,320 Depreciation and amortization................. 68,342 19,759 1,638 89,739 Segment operating income (loss)............... 96,807 15,854 (6,103) 106,558 Identifiable assets........................... 647,974 196,429 127,648 972,051 Acquired assets............................... 5,959 -- 3,090 9,049 Total assets.................................. 653,933 196,429 130,738 981,100 Purchase of property, plant, and equipment, including book plates....................... 50,609 15,380 1,914 67,903
56 59 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
K-12 COLLEGE PUBLISHING PUBLISHING OTHER CONSOLIDATED ---------- ---------- -------- ------------ (IN THOUSANDS) 1996 Net sales from external customers............. $497,709 $138,346 $ 81,808 $ 717,863 Depreciation and amortization................. 62,259 20,382 1,694 84,335 Segment operating income (loss)............... 82,746 12,442 (7,806) 87,382 Identifiable assets........................... 628,918 188,183 173,840 990,941 Acquired assets............................... 13,179 2,322 -- 15,501 Total assets.................................. 642,097 190,505 173,840 1,006,442 Purchase of property, plant, and equipment, including book plates....................... 58,405 14,702 1,836 74,943
RECONCILIATION OF SEGMENT INCOME (LOSS) TO CONSOLIDATED STATEMENT OF OPERATIONS:
1998 1997 1996 -------- -------- -------- (IN THOUSANDS) Total income from reportable segments........................... $102,020 $106,558 $ 87,382 Unallocated income (expense): Net interest expense....................................... (33,981) (38,926) (40,875) Gains on INSO Corporation common stock and equity in earnings (losses) of INSO Corporation.................... 18,797 15,901 27,446 Loss on sale of long-term investment....................... (3,017) -- -- Acquired in-process research and development............... (3,500) -- -- Other expense.............................................. (1,050) -- -- -------- -------- -------- Income before taxes and extraordinary item...................... $ 79,269 $ 83,533 $ 73,953 ======== ======== ========
57 60 HOUGHTON MIFFLIN COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 13. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
1998 1997 1996 -------- -------- -------- (IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS) Numerator: Net income............................................. $63,649 $49,822 $43,622 Denominator: Denominator for basic earnings per share: Weighted-average shares outstanding.................. 28,689 28,237 27,801 Effect of dilutive securities: Employee stock options................................. 389 407 90 Restricted stock....................................... 33 146 16 Performance shares..................................... -- 36 12 ------- ------- ------- 422 589 118 Dilutive potential common shares: Denominator for diluted earnings per share: Adjusted weighted-average shares outstanding and assumed conversions............................... 29,111 28,826 27,919 ======= ======= ======= Basic earnings per share.................................... $ 2.22 $ 1.76 $ 1.57 ======= ======= ======= Diluted earnings per share.................................. $ 2.19 $ 1.73 $ 1.56 ======= ======= =======
Options to purchase 1,429,534 shares of common stock at December 31, 1998 and 267,300 shares of common stock at December 31, 1997 were outstanding but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares and, therefore, the effect would be antidilutive. There were no shares of common stock excluded in the computation of diluted earnings per share in 1996. NOTE 14. SUBSEQUENT EVENTS In January 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 will be accounted for as a purchase, and the net assets and results of operations will be included in Houghton Mifflin's consolidated financial statements from the date of the acquisition. Net cash consideration for the acquisition amounted to approximately $4.0 million. The cost of the acquisition will be allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed. The excess of the net assets acquired, or goodwill, will be amortized on a straight-line basis over a period of approximately 8 years. At its January 27, 1999 meeting, the Board of Directors declared a quarterly dividend of $0.125 per share, payable on February 24, 1999, to shareholders of record on February 10, 1999. Subsequent to December 31, 1998, the quoted price of INSO shares dropped significantly; therefore, as of February 28, 1999, the investment in INSO is valued at approximately $13.5 million, or approximately $35.0 million less than the carrying value at December 31, 1998. As discussed in Note 9, Houghton Mifflin accounts for its investment in INSO in accordance with SFAS 115, and the resulting unrealized loss would be a component of stockholders' equity. 58 61 SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED, IN THOUSANDS OF DOLLARS EXCEPT PER-SHARE AMOUNTS)
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER YEAR -------- -------- -------- -------- -------- 1998 Net sales............................... $ 71,632 $202,740 $446,860 $140,425 $861,657 Gross profit (net sales less cost of sales)................................ 18,409 107,449 278,849 66,028 470,735 Income (loss) before extraordinary item.................................. $(36,715) $ 6,885 95,910 (20,441) 45,639 Extraordinary gain on extinguishment of debt, net of tax of $13,042........... -- -- 18,010 -- 18,010 -------- -------- -------- -------- -------- Net income (loss)....................... $(36,715) $ 6,885 $113,920 $(20,441) $ 63,649 ======== ======== ======== ======== ======== Per share: Basic Income (loss) before extraordinary item............ $ (1.29) $ 0.24 $ 3.35 $ (0.71) $ 1.59 Extraordinary gain on extinguishment of debt........ -- -- 0.63 -- 0.63 -------- -------- -------- -------- -------- Net income (loss)................ $ (1.29) $ 0.24 $ 3.98 $ (0.71) $ 2.22 ======== ======== ======== ======== ======== Diluted (except when anti-dilutive) Income (loss) before extraordinary item............ $ (1.29) $ 0.24 $ 3.31 $ (0.71) $ 1.57 Extraordinary gain on extinguishment of debt........ -- -- 0.62 -- 0.62 -------- -------- -------- -------- -------- Net income (loss)................ $ (1.29) $ 0.24 $ 3.93 $ (0.71) $ 2.19 ======== ======== ======== ======== ======== 1997 Net sales............................... $ 68,747 $202,321 $399,094 $127,158 $797,320 Gross profit (net sales less cost of sales)................................ 16,524 108,669 249,237 60,389 434,819 -------- -------- -------- -------- -------- Net income (loss)....................... $(26,876) $ 10,825 $ 83,057 $(17,184) $ 49,822 ======== ======== ======== ======== ======== Per share: Net income (loss) -- basic.............. $ (0.96) $ 0.38 $ 2.94 $ (0.61) $ 1.76 ======== ======== ======== ======== ======== Net income (loss) -- diluted (except when anti-dilutive)................... $ (0.96) $ 0.38 $ 2.87 $ (0.61) $ 1.73 ======== ======== ======== ======== ========
The above quarterly information indicates the seasonal fluctuations of Houghton Mifflin's educational publishing business. The increase in the net loss during the first quarter of 1998 and the decrease in net income for the second quarter of 1998 compared to the same periods in 1997 were primarily due to increases in editorial and plate costs related to product revisions and new product development and increased investments in Year 2000 compliance and new systems. The increase in net income for the third quarter of 1998 compared to the same period in 1997 was primarily due to 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. The increased 1998 fourth-quarter loss was attributable to a $0.05 per-share operating loss related to CAT, increased product development efforts, and higher selling costs associated with sales opportunities in 1999. The fourth quarter of 1997 also benefited from gains recorded on sales of property. 59 62 During the first quarter of 1998, Houghton Mifflin recognized a charge of $0.2 million ($0.1 million after tax) related to INSO's acquisition of Henderson Software, Incorporated. In the second quarter of 1998, Houghton Mifflin recognized a charge of $0.6 million ($0.3 million after tax), or $0.01 per share, related to INSO's acquisition of ViewPort Development AB. During the third quarter of 1998, Houghton Mifflin recognized a non-cash gain of $15.4 million ($8.9 million after tax), or $0.31 per share, which represented the gain on the surrender of INSO common stock to redeem one-half of the outstanding SAILS. Houghton Mifflin also recognized an extraordinary gain of $31.1 million ($18.0 million after tax), or $0.62 per share, on the extinguishment of the SAILS indebtedness. The acquisition of CAT in July 1998 included the purchase of certain technology under research and development which resulted in a restated charge of $3.5 million, or $0.12 per share. In Houghton Mifflin's previously reported results of operations for the third quarter of 1998, the charge for the in-process research and development was $7.0 million. Houghton Mifflin restated the third-quarter results for this item during January 1999 based on additional guidance provided to all registrants by the Securities and Exchange Commission. Houghton Mifflin also 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 in the third quarter of 1998. In the fourth quarter of 1998, Houghton Mifflin recognized a one-time loss of $3.0 million ($2.0 million after tax), or $0.07 per share, on the sale of its investment in Cassell Plc. Houghton Mifflin recognized a gain of $14.9 million ($8.6 million after tax), or $0.30 per share, during the first quarter of 1997 representing Houghton Mifflin's portion of the increase in INSO's net equity as a result of INSO's completion of a public offering in 1996. In the second quarter of 1997, Houghton Mifflin recognized a one-time charge of $0.5 million ($0.3 million after tax), or $0.01 per share, related to INSO's acquisition of the Mastersoft line of products from Adobe Systems Incorporated. In the third quarter of 1997, Houghton Mifflin recognized a one-time charge of $2.0 million ($1.2 million after tax), or $0.04 per share, related to the equity investment in INSO for: (1) the acquisition of Level Five Research, Inc. and (2) a restructuring charge affecting INSO's Information Products and certain of its Information Management Tools products. 60 63 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF HOUGHTON MIFFLIN Information about directors is incorporated by reference to the Proxy Statement for the 1999 Annual Meeting of Stockholders, and information about Executive Officers follows Part I, Item 4 of this report under the heading "Executive Officers of Houghton Mifflin" on pages 7 through 8. ITEM 11. EXECUTIVE COMPENSATION This information is incorporated by reference to the Proxy Statement for the 1999 Annual Meeting of Stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This information is incorporated by reference to the Proxy Statement for the 1999 Annual Meeting of Stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This information is incorporated by reference to the Proxy Statement for the 1999 Annual Meeting of Stockholders. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULE, AND REPORTS ON FORM 8-K (a) 1. Consolidated Financial Statements are listed in the accompanying Index to Consolidated Financial Statements on page 27. 2. Financial Statement Schedule for the three years ended December 31, 1998: Schedule II -- Consolidated Valuation and Qualifying Accounts, page 62. Houghton Mifflin has omitted all other schedules because we have included the required information in the consolidated financial statements or notes or are not required to submit the schedules. 3. Houghton Mifflin has filed the Exhibits listed in the accompanying Index to Exhibits on page 64 as part of this Report. They are included only on the Form 10-K filed with the Securities and Exchange Commission. (b) Reports on Form 8-K filed in the fourth quarter of 1998: None 61 64 HOUGHTON MIFFLIN COMPANY SCHEDULE II -- CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS OF DOLLARS)
ADDITIONS -------------------- CHARGED CHARGED BALANCE AT TO COST TO OTHER BALANCE BEGINNING AND ACCOUNTS DEDUCTIONS AT END OF YEAR EXPENSE -DESCRIBE -DESCRIBE OF YEAR ---------- ------- --------- ---------- ------- 1998 Allowance for bad debt.............. $ 4,356 $ 2,411 $ 105(1) $ 1,997(5) $ 4,875 Allowance for book returns.......... 20,734 71,967 -- 69,607(3) 23,094 Allowance for authors' advances..... 24,290 4,598 -- 5,299(4) 23,589 1997 Allowance for bad debt.............. $ 4,684 $ 1,985 $ 139(1) $ 2,452(5) $ 4,356 Allowance for book returns.......... 25,166 68,682 (6,837)(2) 66,277(3) 20,734 Allowance for authors' advances..... 20,975 3,849 -- 534(4) 24,290 1996 Allowance for bad debt.............. $ 1,541 $ 3,632 $ -- $ 489(5) $ 4,684 Allowance for book returns.......... 21,698 67,176 6,837(2) 70,545(3) 25,166 Allowance for authors' advances..... 21,848 2,793 2,033(1) 5,699(4) 20,975
- --------------- (1) Reflects additions to the allowance from acquisitions made during the year. (2) This amount represents the estimated book returns for products published by DK Publishing, Inc. and distributed by Houghton Mifflin. In 1997, these book returns reduced payments to DK Publishing, Inc. (3) Books actually returned during the year. (4) Write-offs of unearned author advances. (5) Write-offs of uncollectible customer receivables. 62 65 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Houghton Mifflin has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. HOUGHTON MIFFLIN COMPANY Registrant By: /s/ NADER F. DAREHSHORI ---------------------------------- Nader F. Darehshori Chairman of the Board, President, and Chief Executive Officer February 24, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: /s/ NADER F. DAREHSHORI Chairman of the Board, President, and - --------------------------------------- Chief Executive Officer, Director NADER F. DAREHSHORI February 24, 1999 /s/ GAIL DEEGAN Executive Vice President and Chief - --------------------------------------- Financial Officer GAIL DEEGAN February 24, 1999 /s/ DAVID R. CARON Vice President and Controller - --------------------------------------- DAVID R. CARON February 24, 1999 /s/ JOSEPH A. BAUTE Director - --------------------------------------- JOSEPH A. BAUTE February 24, 1999 /s/ JAMES O. FREEDMAN Director - --------------------------------------- JAMES O. FREEDMAN February 24, 1999 /s/ MICHAEL GOLDSTEIN Director - --------------------------------------- MICHAEL GOLDSTEIN February 24, 1999 /s/ GAIL H. KLAPPER Director - --------------------------------------- GAIL H. KLAPPER February 24, 1999 /s/ MARY H. LINDSAY Director - --------------------------------------- MARY H. LINDSAY February 24, 1999 /s/ CHARLES R. LONGSWORTH Director - --------------------------------------- CHARLES R. LONGSWORTH February 24, 1999 /s/ JOHN F. MAGEE Director - --------------------------------------- JOHN F. MAGEE February 24, 1999 /s/ CLAUDINE B. MALONE Director - --------------------------------------- CLAUDINE B. MALONE February 24, 1999 /s/ ALFRED L. MCDOUGAL Director - --------------------------------------- ALFRED L. MCDOUGAL February 24, 1999 /s/ GEORGE PUTNAM Director - --------------------------------------- GEORGE PUTNAM February 24, 1999 /s/ RALPH Z. SORENSON Director - --------------------------------------- RALPH Z. SORENSON February 24, 1999 /s/ ROBERT J. TARR, JR. Director - --------------------------------------- ROBERT J. TARR, JR. February 24, 1999
63 66 HOUGHTON MIFFLIN COMPANY INDEX TO EXHIBITS (ITEM 14(a)(3))
EXHIBIT NO. DESCRIPTION OF DOCUMENT PAGE NUMBER IN THIS REPORT - ----------- ----------------------- -------------------------- (3)(i) Restated Articles of Organization of the Filed as Exhibits (4.1) and (4.2) to Company Registration Statement No. 33-14850 as amended, and incorporated by reference into this report Amendment to Restated Articles of Page Organization of the Company in the form of a certificate of vote of directors establishing a series of a class of stock (3)(ii) By-laws of the Company Filed as Exhibit (3)(ii) to Form 10-K for the year ended December 31, 1995, and incorporated by reference into this report (4) Registration Statement under the Securities Filed on June 20, 1967, and incorporated by Exchange Act of 1934 on Form 10 dated June reference into this report 20, 1967, as amended, with particular reference to the description of the common stock of the Company Renewed Rights Agreement between the Filed as Exhibit (4) to Form 10-Q for the Company and BankBoston, N.A., as Rights quarter ended June 30, 1997, and Agent incorporated by reference into this report Indenture dated as of March 15, 1994 Filed as Exhibit (4.1) to Registration between the Company and State Street Bank Statement No. 33-51700 as amended, and and Trust Company, as successor trustee to incorporated by reference into this report the First National Bank of Boston First Supplemental Indenture dated as of Filed as Exhibit (4.2) to Registration July 27, 1995 between the Company and State Statement No. 33-64903 as amended, and Street Bank and Trust Company, as successor incorporated by reference into this report trustee to the First National Bank of Boston (10)(ii) Lease between Two Twenty Two Berkeley Filed as Exhibit (10)(ii)(D) to Form 10-K (D) Venture, as landlord, and Houghton Mifflin for the year ended December 31, 1996, and Company, as tenant incorporated by reference into this report Lease between New England Mutual Life Filed as Exhibit (10)(ii)(D) to Form 10-K Insurance Company, as sublandlord, and for the year ended December 31, 1996, and Houghton Mifflin Company, as subtenant incorporated by reference into this report (10)(iii) Benefits Trust Agreement between Houghton Filed as Exhibit (10)(iii)(A) to Form 10-K (A) Mifflin Company and State Street Bank and for the year ended December 31, 1997, and Trust Company dated June 3, 1992* incorporated by reference into this report (10)(iii) Severance Agreement between the Company and Filed as Exhibit (10)(iii)(A) to Form 10-K (A) Mr. Darehshori* for the year ended December 31, 1995, and incorporated by reference into this report Form of Senior Executive Severance Filed as Exhibit (10)(iii)(A) to Form 10-K Agreement* for the year ended December 31, 1995, and incorporated by reference into this report Form of Key Managers' Severance Agreement* Filed as Exhibit (10)(iii)(A) to Form 10-K for the year ended December 31, 1995, and incorporated by reference into this report Supplemental Benefits Plan* Filed as Exhibit (10)(iii)(A) to Form 10-K for the year ended December 31, 1995, and incorporated by reference into this report Non-Employee Directors Retirement Benefit Filed as Exhibit (10)(iii)(A) to Form 10-K Plan* for the year ended December 31, 1995, and incorporated by reference into this report
- --------------- * Denotes a management contract or compensatory plan. 64 67
EXHIBIT NO. DESCRIPTION OF DOCUMENT PAGE NUMBER IN THIS REPORT - ----------- ----------------------- -------------------------- 1998 Senior Executive Incentive Filed as Exhibit (10)(iii)(A) to Form 10-Q Compensation Plan* for the quarter ended March 31, 1998, and incorporated by reference into this report Restricted Stock Agreement between the Filed as Exhibit (10)(iii)(A) to Form 10-K Company and Mr. Darehshori* for the year ended December 31, 1996, and incorporated by reference into this report Restricted Stock Agreement between the Filed as Exhibit (10)(iii)(A) to Form 10-K Company and Ms. Deegan* for the year ended December 31, 1996, and incorporated by reference into this report 1995 Stock Compensation Plan* Filed as Exhibit (10)(iii)(A) to Form 10-K for the year ended December 31, 1996, and incorporated by reference into this report 1998 Stock Compensation Plan* Page Form of Non-Qualified Option Agreement* Page 1997 - 1998 Restricted Share Plan* Filed as Exhibit (10)(iii)(A) to Form 10-K for the year ended June 30, 1997, and incorporated by reference into this report Amended and Restated 1994 Executive Stock Filed as Exhibit (10)(iii)(A) to Form 10-Q Purchase Plan* for the quarter ended June 30, 1998, and incorporated by reference into this report (10)(iii) Form of Option Grant and Exercise Filed as Exhibit (10)(iii)(A) to Form 10-Q (A) Agreement* for the quarter ended September 30, 1994, and incorporated by reference into this report Form of Amendment Agreement to the Option Filed as Exhibit (10)(iii)(A) to Form 10-Q Grant and Exercise Agreement* for the quarter ended June 30, 1998, and incorporated by reference into this report Non-Employee Directors Stock Purchase Plan* Filed as Exhibit (10)(iii)(A) to Form 10-Q for the quarter ended September 30, 1994, and incorporated by reference into this report Forms of Stock Purchase Agreement* Filed as Exhibit (10)(iii)(A) to Form 10-Q for the quarter ended September 30, 1994, and incorporated by reference into this report (12) Computation of Ratio of Earnings to Fixed Page Charges (21) List of Subsidiaries Page (23) Consent of Experts and Counsel Page (27) Financial Data Schedule Page
- --------------- * Denotes a management contract or compensatory plan. 65 EX-3.(I) 2 CERTIFICATE OF VOTE OF DIRECTORS 1 Exhibit (3)(i) FEDERAL IDENTIFICATION NO. 04-1456030 ---------------------- - -------- Examiner THE COMMONWEALTH OF MASSACHUSETTS WILLIAM FRANCIS GALVIN Secretary of the Commonwealth One Ashburton Place, Boston, Massachusetts 02108-1512 CERTIFICATE OF VOTE OF DIRECTORS ESTABLISHING A CLASS OF A SERIES OF STOCK (GENERAL LAWS, CHAPTER 156B, SECTION 26) We, Nader F. Darehshori , *President/XXXXXX ------------------------------------------------ and Paul D. Weaver , *Clerk/XXXXXX ---------------------------------------------------- of Houghton Mifflin Company , ------------------------------------------------------------------ (Exact name of corporation) located at: 222 Berkeley Street, Boston, Massachusetts 02116 , ----------------------------------------------------------- (Street Address of corporation in Massachusetts) do hereby certify that at a meeting of the directors of the corporation held on July 30, 1997, the following vote establishing and designating a class or series of stock and determining the relative rights and preferences thereof was duly adopted: See Continuation Sheets 2A through 2L. - This Certificate of Vote of Directors Establishing a Class or Series of Stock replaces in its entirety the Certificate of Vote of Directors Establishing a Series of a Class of Stock filed by Houghton Mifflin Company (the "Corporation") with the Secretary of State of the Commonwealth of Massachusetts on December 9, 1988. As of the current date, no shares of Series A Junior Participating Preferred Stock of the Corporation have been issued. * Delete the inapplicable words. - -------- NOTE: VOTES FOR WHICH THE SPACE PROVIDED ABOVE IS NOT SUFFICIENT SHOULD P.C. BE PROVIDED ON ONE SIDE OF SEPARATE 8 1/2 X 11 SHEETS OF WHITE PAPER, NUMBERED 2A, 2B, ETC, WITH A LEFT MARGIN OF AT LEAST 1 INCH. 2 VOTED, that a new series of preferred stock of the Corporation is hereby created, pursuant to the authority vested in the Board of Directors of this Corporation in accordance with the provisions of its Restated Articles of Organization, as amended, and that the designation and amount of the series of preferred stock and the preferences, voting powers, qualifications and special or relative rights or privileges of the shares of such series are as follows: 1. DESIGNATION AND AMOUNT. The shares of such series shall be designated as "Series A Junior Participating Preferred Stock" and the number of shares constituting such series shall be 5,000. 2. DIVIDENDS AND DISTRIBUTIONS. (A) Subject to the prior and superior rights of the holders of any shares of any series of preferred stock of the Corporation ("Preferred Stock") ranking prior and superior to the shares of Series A Junior Participating Preferred Stock with respect to dividends, the holders of shares of Series A Junior Participating Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the 15th day of March, June, September and December in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Junior Participating Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $75.00 or (b) subject to the provision for adjustment hereinafter set forth, 10,000 times the aggregate per share amount of all cash dividends, and 10,000 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions other than a dividend payable in shares of common stock, par value $1.00 per share, of the Corporation (the "Common Stock") or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock, since the immediately preceding Quarterly Dividend Payment Date, or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Junior Participating Preferred 2A 3 Stock. In the event the Corporation shall at any time after July 30, 1997 (the "Rights Dividend Declaration Date") (i) declare any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide or split the outstanding Common Stock, or (iii) combine or consolidate the outstanding Common Stock into a smaller number of shares, then in each such case the amount of which holders of shares of Series A Junior Participating Preferred Stock were entitled immediately prior to such event under clause (b) of the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) The Corporation shall declare a dividend or distribution on the Series A Junior Participating Preferred Stock as provided in paragraph (A) above immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $75.00 per share on the Series A Junior Participating Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series A Junior Participating Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares of Series A Junior Participating Preferred Stock, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Junior Participating Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends 2B 4 shall not bear interest. Dividends paid on the shares of Series A Junior Participating Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Junior Participating Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be no more than 30 days prior to the date fixed for the payment thereof. 3. VOTING RIGHTS. The holders of shares of Series A Junior Participating Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Series A Junior Participating Preferred Stock shall entitle the holder thereof to 10,000 votes on all matters submitted to a vote of the stockholders of the Corporation. In the event the Corporation shall at any time after the Rights Dividend Declaration Date (i) declare any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide or split the outstanding Common Stock, or (iii) combine or consolidate the outstanding Common Stock into a smaller number of shares, then in each such case the number of votes per share to which holders of shares of Series A Junior Participating Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) Except as otherwise provided herein or as required by law, the holders of shares of Series A Junior Participating Preferred Stock and the holders of shares of Common Stock shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation. (C) (i) If at any time dividends on any Series A Junior Participating Preferred Stock shall be in arrears in an amount equal to six quarterly 2C 5 dividends thereon, the occurrence of such contingency shall mark the beginning of a period (herein called a "default period") which shall extend until such time when all accrued and unpaid dividends for all previous quarterly dividend periods and for the current quarterly dividend period on all shares of Series A Junior Participating Preferred Stock then outstanding shall have been declared and paid or set apart for payment. During each default period, all holders of preferred stock (including holders of the Series A Junior Participating Preferred Stock) with dividends in arrears in an amount equal to six quarterly dividends thereon, voting as a class, irrespective of series, shall have the right to elect two Directors. (ii) During any default period, such voting right of the holders of Series A Junior Participating Preferred Stock may be exercised initially at a special meeting called pursuant to subparagraph (iii) of this Section 3(C) or at any annual meeting of stockholders or special meeting in lieu of an annual meeting, and thereafter at annual meetings of stockholders or special meetings in lieu of an annual meeting, provided that neither such voting right nor the right of the holders of any other series of Preferred Stock, if any, to increase, in certain cases, the authorized number of Directors shall be exercised unless the holders of a majority in number of shares of Preferred Stock outstanding shall be present in person or by proxy. The absence of a quorum of the holders of Common Stock shall not affect the exercise by the holders of Preferred Stock of such voting right. At any meeting at which the holders of Preferred Stock shall exercise such voting right initially during an existing default period, they shall have the right, voting as a class, to elect Directors to fill such vacancies, if any, in the Board of Directors as may then exist up to two Directors or, if such right is exercised at an annual meeting or special meeting in lieu of an annual meeting, to elect two Directors. If the number which may be so elected at any special meeting (other than a special meeting in lieu of an 2D 6 annual meeting) does not amount to the required number, the holders of the Preferred Stock shall have the right to make such increase in the number of Directors as shall be necessary to permit the election by them of the required number. After the holders of the Preferred Stock shall have exercised their right to elect Directors in any default period and during the continuance of such period, the number of Directors shall not be increased or decreased except by vote of the holders of Preferred Stock as herein provided or pursuant to the rights of any equity securities ranking senior to or PARI PASSU with the Series A Junior Participating Preferred Stock. (iii) Unless the holders of Preferred Stock shall, during an existing default period, have previously exercised their right to elect Directors, the Board of Directors may order, or any stockholder or stockholders owning in the aggregate not less than ten percent of the total number of shares of Preferred Stock outstanding, irrespective of series, may request, the calling of a special meeting of the holders of Preferred Stock, which meeting shall thereupon be called by the President of the Corporation or the Board of Directors. Notice of such meeting and of any annual meeting or special meeting in lieu of an annual meeting at which holders of Preferred Stock are entitled to vote pursuant to this paragraph (C) (iii) shall be given to each holder of record of Preferred Stock by mailing a copy of such notice to him at his last address as the same appears on the books of the Corporation. Such meeting shall be called for a time not earlier than 20 days and not later than 60 days after such order or request or in default of the calling of such meeting within 60 days after such order or request, such meeting may be called on similar notice by any stockholder or stockholders owning in the aggregate not less than ten percent of the total number of shares of Preferred Stock outstanding. Notwithstanding the provisions of this paragraph (C) (iii), such holders of the Pre- 2E 7 ferred Stock shall not have the right to call such a special meeting during the period within 60 days immediately preceding the date fixed for the next annual meeting of the stockholders. (iv) In any default period, the holders of Common Stock, and other classes of stock of the Corporation if applicable, shall continue to be entitled to elect the whole number of Directors until the holders of Preferred Stock shall have exercised their right to elect two Directors voting as a class, after the exercise of which right (x) the Directors so elected by the holders of Preferred Stock shall continue in office until their successors shall have been elected by such holders or until the expiration of the default period, and (y) any vacancy in the Board of Directors may (except as provided in paragraph (C) (ii) of this Section 3) be filled by vote of a majority of the remaining Directors theretofore elected by the holders of the class of stock which elected the Director whose office shall have become vacant. References in this paragraph (C) to Directors elected by the holders of a particular class of stock shall include Directors elected by such Directors to fill vacancies as provided in clause (y) of the foregoing sentence. (v) Immediately upon the expiration of a default period, (x) the right of the holders of Preferred Stock as a class to elect Directors shall cease, (y) the term of any Directors elected by the holders of Preferred Stock as a class shall terminate, and (z) the number of Directors shall be such number as may be provided for in the articles of organization or by-laws as then in effect irrespective of any increase made pursuant to the provisions of paragraph (C) (ii) of this Section 3 (such number being subject, however, to change thereafter in any manner provided by law or in the articles of organization or by-laws as then in effect). Any vacancies in the Board of Directors effected by the provisions of 2F 8 clauses (y) and (z) in the preceding sentence may be filled by a majority of the remaining Directors. (D) Except as set forth herein, holders of Series A Junior Participating Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. 4. CERTAIN RESTRICTIONS. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series A Junior Participating Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Junior Participating Preferred Stock outstanding shall have been paid in full, the Corporation shall not (i) declare or pay dividends on, make any other distributions on, or redeem or purchase or otherwise acquire for consideration any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Junior Participating Preferred Stock; or (ii) declare or pay dividends on or make any other distributions on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Junior Participating Preferred Stock, except dividends paid ratably on the Series A Junior Participating Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; or (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking on a parity (either as to dividends or upon liquidation, dissolution or 2G 9 winding up) with the Series A Junior Participating Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such parity stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Junior Participating Preferred Stock; or (iv) purchase or otherwise acquire for consideration any shares of Series A Junior Participating Preferred Stock, or any shares of stock ranking on a parity with the Series A Junior Participating Preferred Stock, except pursuant to Section 8 or in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. 5. REACQUIRED SHARES. Any shares of Series A Junior Participating Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock to be created by resolution or resolutions of the Board of Directors, subject to the conditions and restrictions on issuance set forth herein. 2H 10 6. LIQUIDATION, DISSOLUTION OR WINDING UP. (A) Upon any liquidation (voluntary or otherwise), dissolution or winding up of the Corporation, no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidations, dissolution or winding up) to the Series A Junior Participating Preferred Stock unless, prior thereto, the holders of shares of Series A Junior Participating Preferred Stock shall have received $1,200.00 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment (the "Series A Liquidation Preference"). Following the payment of the full amount of the Series A Liquidation Preference, no additional distributions shall be made to the holders of shares of Series A Junior Participating Preferred Stock unless, prior thereto, the holders of shares of Common Stock shall have received an amount per share (the "Common Adjustment") equal to the quotient obtained by dividing (i) the Series A Liquidation Preference by (ii) 10,000 (as appropriately adjusted as set forth in subparagraph C below to reflect such events as stock splits, stock dividends and recapitalizations with respect to the Common Stock) (such number in clause (ii) immediately above being referred to as the "Adjustment Number"). Following the payment of the full amount of the Series A Liquidation Preference and the Common Adjustment in respect of all outstanding shares of Series A Junior Participating Preferred Stock and Common Stock, respectively, holders of Series A Junior Participating Preferred Stock and holders of shares of Common Stock shall receive their ratable and proportionate share of the remaining assets to be distributed in the ratio of the Adjustment Number to one with respect to such Preferred Stock and Common Stock, on a per share basis, respectively. (B) In the event, however, that there are not sufficient assets available to permit payment in full of the Series A Liquidation Preference and the liquidation preferences of all other series of preferred stock, if any, which rank on a parity with the Series A Junior Participating Preferred Stock, then such remaining assets shall be distributed ratably to the holders of such parity shares in proportion to their respective liquidation preferences. In the event, however, that there are not sufficient assets available to permit payment in full 2I 11 of the Common Adjustment, then such remaining assets shall be distributed ratably to the holders of Common Stock. (C) In the event the Corporation shall at any time after the Rights Dividend Declaration Date (i) declare any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide or split the outstanding Common Stock or (iii) combine or consolidate the outstanding Common Stock into a smaller number of shares, then in each such case the Adjustment Number in effect immediately prior to such event shall be adjusted by multiplying such Adjustment Number by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. 7. CONSOLIDATION, MERGER, ETC. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case the shares of Series A Junior Participating Preferred Stock shall at the same time be similarly exchanged or changed in an amount per share (subject to the provision for adjustment hereinafter set forth) equal to 10,000 times the aggregate amount of stock, securities, cash or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time after the Rights Dividend Declaration Date (i) declare any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide or split the outstanding Common Stock or (iii) combine or consolidate the outstanding Common Stock into a smaller number of shares, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A Junior Participating Preferred Stock shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. 2J 12 8. REDEMPTION. The outstanding shares of Series A Junior Participating Preferred Stock may be redeemed at the option of the Board of Directors as a whole, but not in part, at any time, or from time to time, at a cash price per share equal to 105 percent of (i) the product of the Adjustment Number times the Average Market Value (as such term is hereinafter defined) of the Common Stock, plus (ii) all dividends which on the redemption date have accrued on the shares to be redeemed and have not been paid, or declared and a sum sufficient for the payment thereof set apart, without interest. The "Average Market Value" is the average of the closing sale prices of the Common Stock during the 30-day period immediately preceding the date before the redemption date on the Composite Tape for New York Stock Exchange Listed Stocks, or, if such stock is not quoted on the Composite Tape, on the New York Stock Exchange, or, if such stock is not listed on such Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934, as amended, on which such stock is listed, or, if such stock is not listed on any such exchange, the average of the closing sale prices with respect to a share of Common Stock during such 30-day period, as quoted on the National Association of Securities Dealers, Inc. Automated Quotations System or any system then in use, or if no such quotations are available, the fair market value of the Common Stock as determined by the Board of Directors in good faith. 9. RANKING. The Series A Junior Participating Preferred Stock shall rank junior to all other series of the Corporation's Preferred Stock as to the payment of dividends and the distribution of assets, unless the terms of any such series shall provide otherwise. 10. AMENDMENT. The articles of organization of the Corporation shall not be further amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Junior Participating Preferred Stock so as to affect them adversely without the affirmative vote of the holders of a majority or more of the outstanding shares of Series A Junior Participating Preferred Stock, voting separately as a class. 11. FRACTIONAL SHARES. Series A Junior Participating Preferred Stock may be issued in fractions of 2K 13 a share which shall entitle the holder, in proportion to such holder's fractional shares, to exercise voting rights, receive dividends, participate in distributions and to have the benefit of all other rights of holders of Series A Junior Participating Preferred Stock. 2L 14 SIGNED UNDER THE PENALTIES OF PERJURY, this 18th day of December, 1998. /s/ Nader F. Darehshori , *President/XXXXXX - ------------------------------------------------------------ /s/ Paul D. Weaver , *Clerk/XXXXXXX - --------------------------------------------------------------- *Delete the inapplicable words. 15 THE COMMONWEALTH OF MASSACHUSETTS CERTIFICATE OF VOTE OF DIRECTORS ESTABLISHING A SERIES OF A CLASS OF STOCK (GENERAL LAWS, CHAPTER 156B, SECTION 26) ================================================= I hereby approve the within Certificate of Vote of Directors and, the filing fee in the amount of $__________________________ having been paid, said certificate is deemed to have been filed with me this ______________ day of ___, 19____. Effective date:__________________________________ WILLIAM FRANCIS GALVIN Secretary of the Commonwealth TO BE FILLED IN BY CORPORATION PHOTOCOPY OF DOCUMENT TO BE SENT TO: LOUIS A. GOODMAN, ESQ. SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP ONE BEACON STREET, BOSTON, MASSACHUSETTS 02108 Telephone: (617) 573-4800 EX-10.(III)(A)(1) 3 HOUGHTON MIFFLIN 1998 STOCK COMPENSATION PLAN 1 Exhibit (10)(iii)(A) HOUGHTON MIFFLIN COMPANY 1998 STOCK COMPENSATION PLAN The primary purpose of this Plan is to attract, retain, and motivate the employees of Houghton Mifflin Company (the "Company") and of any subsidiary corporation of which more than 50% of the outstanding voting stock is owned by the Company (a "Subsidiary") who will most assist the Company or its Subsidiaries in achieving the Company's long-term goals and objectives, and to provide an opportunity for these employees to acquire an interest in the Company through the granting of options or restricted or bonus stock or other performance awards, as herein provided. Additionally, the Plan is intended to provide an incentive to non-employee members of the Board of Directors of the Company ("director-participants") to increase their efforts for the success of the Company by increasing their proprietary interest in the Company, through the receipt of shares of the Company's common stock and options to purchase shares of the Company's Common Stock. To achieve those purposes, the Plan amends and restates the 1995 Stock Compensation Plan (the "1995 Plan"). 1. SHARES OF STOCK SUBJECT TO THE PLAN The stock that may be issued under the Plan shall not exceed, in the aggregate, the sum of 1,800,000 shares of the Company's common stock ("Company Stock"), which may be either authorized but unissued shares or treasury shares, plus any shares of Company stock that were authorized but unused under either the 1995 Plan or the 1992 Stock Compensation Plan (the "1992 Plan"), including, without limitation, shares represented by awards which are forfeited, expire, or are canceled without delivery of shares of Company Stock or which result in the forfeiture of shares of Company Stock back to the Company. In determining the number of shares of Company Stock available for grant under the Plan, (i) any shares of Company Stock granted or reserved for issue under the Plan that are forfeited because of the failure to meet an award contingency or condition, or shares reserved for issue on exercise of options under the Plan which have expired or been terminated shall again be available for use pursuant to new awards under the Plan; (ii) to the extent that shares of Company Stock covered by an award are not delivered to a participant because the award is forfeited or canceled, or the shares are not delivered because the award is settled in cash, such shares shall not be deemed to have been delivered for purposes of determining the maximum number of shares available for delivery under the Plan; (iii) if the exercise price of any stock option granted under the Plan, the 1995 Plan, or the 1992 -1- 2 Plan is paid by tendering shares of Company Stock to the Company or by withholding pursuant to an election under Section 8 of the Plan or Section 7 of the 1995 Plan, only the number of shares of Company Stock issued net of the shares tendered or withheld shall be deemed delivered for purposes of determining the maximum number of shares available for delivery under the Plan; and (iv) shares of Company Stock delivered under the Plan in settlement, assumption, or substitution of outstanding awards (or obligations to grant future awards) under the plans or arrangements of another entity shall not reduce the maximum number of shares of Company Stock available for delivery under the Plan to the extent that such settlement, assumption, or substitution is a result of the Company or a Subsidiary acquiring such other entity (or an interest in such other entity). The stock that may be issued under the Plan to any one individual between the Plan's Effective Date (as defined in Section 12 hereof) and its termination shall not exceed, in the aggregate, 500,000 shares of Company Stock. The number of shares subject to the Plan and the number of shares which can be issued to any one individual thereunder shall, however, be subject to adjustment as provided in Section 10 hereof. On and after the Effective Date of the Plan, no further grants of options or restricted stock shall be made under the 1995 Plan. Options and other awards granted under either the 1995 Plan or the 1992 Plan which are outstanding on and after the Effective Date shall be subject to and governed by the terms and conditions of the Plan. The actual provisions of any such outstanding option agreement or other award agreement, however, shall not be altered unless an amendment thereto is approved by the Committee (as defined in Section 2 below) and (if the affected participant's approval is required by the 1995 Plan, the 1992 Plan, the Plan, the appropriate agreement, or applicable law) approved by the affected participant. 2. ELIGIBILITY AND ADMINISTRATION Except with respect to director-participants, awards will be granted only to persons who are employees of the Company or a Subsidiary whose efforts are important to the continued success and growth of the Company and, in the case of incentive stock options, who are eligible to receive an incentive stock option under the Internal Revenue Code of 1986, as amended from time to time (the "Code"). The Board of Directors of the Company (the "Board") shall appoint a committee to administer the Plan (the "Committee"). The Committee shall consist of two or more directors of the Company, each of whom is a "non-employee director" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934, as amended, and an "outside director" within the meaning of Section 162(m) -2- 3 of the Code. The Committee, acting by a majority of its members, shall determine the participants in the Plan to whom grants will be made, the number of shares subject to each grant, and the terms of the grant, consistent with the provisions of this Plan. 3. GRANTS TO EMPLOYEES The Committee may make grants to employees under this Plan in the form of Stock Options (either Incentive Stock Options ("ISOs") or Non-Qualified Options ("NQOs")), Restricted Stock, Bonus Stock, or Performance Awards, each as defined below. Unless prohibited by law or regulation, the Committee may make grants under this Plan (except ISO grants) "in tandem" (i.e., the participant may be given the right to select the form in which the grant is exercised) or in combination with other grants. The Committee may also make cash awards (i) in connection with, or as part or all of, a Performance Award or (ii) pursuant to Section 9 hereof with respect to any Bonus Stock or Restricted Stock. * Incentive Stock Options ISOs are a right to buy shares of Company Stock in the future at the market price at the time of grant, subject to the requirements of Section 422 of the Code. A stock option intended to be an ISO shall be designated as an ISO in its grant. The aggregate fair market value (determined at the time the ISO is granted) of the Company Stock with respect to which ISOs are exercisable for the first time by an optionholder during any calendar year (under all plans of the Company and any Subsidiary) shall not exceed $100,000. * Non-Qualified Options NQOs are stock options (i) which do not meet the ISO restrictions, either in the grant itself or as the participant treats the grant, or (ii) the terms of which provide that the options will not be treated as ISOs. NQOs do not receive the special tax consequences given ISOs by the Code. * Restricted Stock Restricted Stock is a grant of Company Stock to an individual subject to forfeiture during the restriction period if specific requirements (including continued employment or -3- 4 performance goals) described in the grant documents are not met for the restriction period. * Bonus Stock Bonus Stock is a grant of Company Stock to an individual which is made free of any restrictions. Bonus Stock may be granted as a bonus or instead of cash under other compensatory arrangements of the Company or a Subsidiary. * Performance Awards Performance Awards are awards granted, subject to applicable law, with value, payment, or other terms contingent upon performance of the Company or specified Subsidiaries or any other factors designated by the Committee. Performance Awards, in whole or in part, may be (i) denominated or payable in cash, (ii) denominated or payable in, valued by reference to, or otherwise based on, or related to Company Stock, or (iii) denominated or payable in, valued by reference to, or otherwise based on, or related to, either Company Stock or cash, to be determined in the discretion of the Committee. 4. GRANTS TO DIRECTOR-PARTICIPANTS Each individual who has served as a non-employee member of the Board during any calendar year shall be a director-participant in the Plan with respect to such year. With respect to each calendar year each director-participant shall be granted, as compensation, (x) 1,000 shares of Company Stock, and (y) options to purchase 2,000 shares of Company Stock, in each case as of the day before the regularly scheduled meeting of the Board in the month of January following the close of such calendar year; provided, however, that the number of shares or options so granted shall be prorated in the case of any director-participant whose service on the Board began during such year or who retired or resigned from the Board during such year. The proration shall be based on the portion of such year the director-participant served as a non-employee member of the Board. For each calendar year beginning with 1999, a director-participant may elect to receive a whole number of shares of Company Stock equal in value to all or any part of his or her annual retainer fee earned for services as a director during such calendar year in place of payment in cash. A director-participant's election must be made in writing delivered to the Committee before the beginning of the calendar year in which the retainer fee is earned, and becomes irrevocable on the last day prior to the beginning of that -4- 5 calendar year. Any election shall continue and apply to subsequent calendar years until terminated or modified by written notice delivered to the Committee. A notice of termination or modification will be effective as of the end of the calendar year in which the notice is delivered, and shall apply to retainer fees payable in subsequent years. Any shares to be delivered pursuant to such an election shall be delivered quarterly, and shall be valued at the closing price per share of Company Stock as reported by the New York Stock Exchange on the last business day of each calendar quarter. The value of fractional shares shall be paid in cash. 5. GRANTS Grants may be made under this Plan to participants (including grants to director-participant which are in addition to grants made to such director-participant pursuant to Section 4 hereof) by the Committee at any scheduled or unscheduled meeting. In making a grant to a participant under this Plan, the Committee will specify (either at the time of grant or thereafter) the terms and conditions of the grant, all of which shall be subject to the terms and conditions of this Plan (including Section 13 hereof). Unless the Committee specifies otherwise or applicable law requires otherwise, with respect to any grant to an individual of Restricted Stock or Bonus Stock or of Company Stock in connection with a Performance Award, past services of that individual equal to the aggregate par value of Company Stock subject to such grant shall constitute the only consideration paid upon the issuance of such stock. If at any time, consideration other than past services is required by applicable law with respect to a grant, such consideration shall be paid within the sixty days immediately following such grant. 6. PERIOD OF OPTION AND PAYMENT OF EXERCISE PRICE Each stock option grant shall be exercisable at such time or times as the Committee shall from time to time determine but in no event after the expiration of ten years from the date of grant. Except as otherwise provided in this Section 6, the delivery of certificates representing shares under any stock option grant will be contingent upon receipt by the Company from the optionholder (or a purchaser acting in his or her stead, in accordance with the provisions of the grant) of the full purchase price for such shares in the form of cash and/or shares of Company Stock either previously owned by the optionholder (provided that such shares have been held for at least six months) or withheld by the Company pursuant to an election by the optionholder under Section 8 below, the total value of which is equal to the total purchase price of the optioned shares then being purchased and the fulfillment of any other requirements contained in the option or applicable provisions of law. The purchase price also may be paid in such -5- 6 other form of consideration as the Committee may authorize. The Company may permit a participant to elect to pay the exercise price by authorizing a third party to sell shares of Company Stock (or a sufficient portion of the shares) being acquired upon exercise of an option and to remit to the Company a sufficient portion of the sale proceeds to pay the entire exercise price and any tax withholding resulting from such exercise. No optionholder or person entitled to exercise the stock option grant shall be deemed to be a holder of any shares subject to the grant for any purpose until such shares are issued to him or her under the terms of the grant and the Plan. 7. TRANSFERABILITY OF OPTIONS BY OPTIONHOLDER; ASSIGNMENT OF OBLIGATIONS BY COMPANY The Committee, in its discretion, may grant transferable options or amend outstanding options to make them transferable (collectively, "Transferable Options"). The option agreement with respect to a Transferable Option shall provide that (i) the optionholder can transfer the Transferable Option to (x) members of his or her immediate family (i.e., children, grandchildren, or spouse), (y) trusts for the benefit of such family members, and (z) partnerships whose only partners are such family members; (ii) no consideration can be paid for the transfer of the Transferable Option; and (iii) the transferee of a Transferable Option is subject to all conditions applicable to the Transferable Option prior to its transfer. The option agreement with respect to any option granted hereunder shall state the transferability restrictions for such option determined by the Committee. The rights and obligations of the Company under the Plan and any grant may be assigned by the Company to a successor to the whole or any part of its business if the successor assumes in writing all of such rights and obligations. 8. WITHHOLDING The Company may defer making payment or delivery of any shares of Company Stock to a participant under the Plan until satisfactory arrangements have been made for the payment of any federal, state, or local income taxes required to be withheld with respect to such payment or delivery. Each participant may elect to have the Company withhold shares of Company Stock having an aggregate value equal to the amount required to be withheld. If no such election is in effect, the Company shall -6- 7 nevertheless have the right to impose a mandatory withholding of such shares. In addition, at the election of a participant, upon exercise of an option, the Company may withhold shares of Company Stock equal to all or a portion of the purchase price of the shares then being purchased. The value of fractional shares remaining after payment of the withholding taxes or the exercise price shall be paid to such participant in cash. Shares so withheld shall be valued at fair market value at the close of the regular business day on which the option is exercised. 9. CASH AWARDS If the payment or delivery of (or lapsing of restrictions with respect to) any Company Stock awarded to a participant under this Plan, the 1995 Plan or the 1992 Plan shall be subject to the imposition of any federal, state, or local income tax, the Committee, in its discretion, either at the time the award is granted or thereafter, may also grant the participant a cash award. 10. EQUITABLE ADJUSTMENTS In the event that any dividend or other distribution (whether in the form of cash, Company Stock, or other property), recapitalization, stock split, reverse split, reorganization, merger, consolidation, spin-off, combination, repurchase, or share exchange, or other similar corporate transaction or event, affects the Company Stock in such a way that an adjustment is appropriate to prevent dilution or enlargement of the rights of participants under the Plan, then the Committee shall make such equitable changes or adjustments as it deems appropriate and, in such manner as it may deem equitable, adjust any or all of (i) the number and kind of shares of stock of the Company (or other securities) which may thereafter be issued in connection with grants under the Plan, (ii) the number and kind of shares of stock of the Company (or other securities) issued or issuable in respect of outstanding grants, and (iii) the exercise price, grant price, or purchase price relating to any grant. 11. CHANGE IN CONTROL Immediately prior to a change in control of the Company, unless otherwise specified in any granting documents, all outstanding options granted under the Plan will become exercisable, all restrictions on restricted shares will lapse, and all performance-based awards will be paid out on a pro rata basis, depending on how much of the performance period has been completed as of the date of such change in control. For purposes of this Plan, a "change in control" of the Company shall be deemed to have occurred if any of the following occurs: -7- 8 (a) any "Person" (as defined in this Section 11) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding securities; (b) during any period of no more than two consecutive years beginning after the date of any award made under this Plan, individuals who at the beginning of such period constitute the Board, and any new director (other than a director whose initial assumption of office is in connection with an actual or threatened election contest relating to the election of the directors of the Company) whose election by the Board or nomination for election by the Company's stockholders was approved or recommended by a vote of at least two-thirds of the directors then still in office who either were directors at the beginning of the period or whose election or whose nomination for election was previously so approved or recommended, cease for any reason to constitute at least a majority thereof; (c) there occurs a merger or consolidation of the Company or a subsidiary thereof with or into any other entity, other than (x) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior to thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or any parent thereof), more than 75% of the combined voting power of the voting securities of the Company or such surviving entity or any parent thereof outstanding immediately after such merger or consolidation or (y) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no Person acquires 25% or more of the combined voting power of the Company's then outstanding securities; or (d) the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets. For purposes of this Plan, "Person" has the meaning given such term in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) of the Exchange Act, but excludes (a) the Company or any of its subsidiaries, (b) any trustee or other fiduciary holding securities under an employee benefit plan of the Company (or of any subsidiary of the Company), (c) any corporation owned, directly or indirectly by the stockholders of the Company and (d) an underwriter temporarily holding securities pursuant to an offering of such securities. -8- 9 12. EFFECTIVE DATE AND STOCKHOLDER APPROVAL The Effective Date of the Plan shall be the date the Plan is approved by the stockholders of the Company. Until the Effective Date of the Plan, the 1995 Plan shall continue in full force and effect in accordance with its terms. 13. ADMINISTRATION AND AMENDMENT OF THE PLAN The Plan shall be administered by the Committee, as provided in Section 2 hereof, which shall make the grants under the Plan, determine the form of options or other awards to be granted in each case (either at the time of grant or thereafter), and make any other determination under or interpretation of any provisions of the Plan. Any of the actions taken by the Committee shall be final and conclusive. Without the consent of the affected participant, however, no amendment or other action with respect to any outstanding award hereunder may impair or adversely affect the rights of the participant holding the award. The Board may amend the Plan as it may deem proper and in the best interest of the Company. However, no such action shall adversely affect or impair any options or other awards previously granted under the Plan, the 1995 Plan, or the 1992 Plan without the consent of the grantee. 14. EXPIRATION AND TERMINATION OF THE PLAN Unless earlier terminated by the Board, the Plan shall be unlimited in duration and, in the event of Plan termination, shall remain in effect as to awards granted under the Plan prior to its termination as long as any such awards are outstanding. Grants may be made under the Plan at any time, or from time to time, prior to the termination of the Plan. The Plan may be abandoned or terminated at any time by the Board, except with respect to any awards then outstanding. -9- EX-10.(III)(A)(2) 4 NON-QUALIFIED OPTION TO PURCHASE 1 Exhibit (10)(iii)(A) ((FIRST_NAME)) ((LAST_NAME)) NON-QUALIFIED OPTION TO PURCHASE SHARES OF COMMON STOCK UNDER THE HOUGHTON MIFFLIN COMPANY 1998 STOCK COMPENSATION PLAN (NON-TRANSFERABLE) Number of Shares: ((SHARES_)) As of December 1, 1998 Pursuant to its 1998 Stock Compensation Plan (the "Plan"), approved on April 29, 1998, by its shareholders, Houghton Mifflin Company (the "Company"), which term shall include its successors as provided in the Plan, hereby grants to ((FIRST_NAME)) ((LAST_NAME)) (the "Optionee"), an option (the "Option") to purchase, prior to November 30, 2008 (the "Expiration Date"), all or any part of ((SHARES_)) shares of Common Stock of the Company (the "Option Shares") at a price of $42.9375 per share in accordance with the schedule set forth in Section 1 of this Agreement and subject to the terms and conditions set forth hereinafter and in the Plan. 1. VESTING SCHEDULE. Subject to the provisions of Section 4 of this Agreement and except as provided below, this Option shall become vested and exercisable with respect to the following number of Option Shares at the expiration of the following periods from the date of this Option: - -------------------------------------------------- NUMBER OF OPTION DATE SHARES EXERCISABLE EXERCISABLE - -------------------------------------------------- ((Shares1_)) December 1, 2002 - -------------------------------------------------- ((Shares2_)) December 1, 2003 - -------------------------------------------------- ((Shares3_)) December 1, 2004 - -------------------------------------------------- The foregoing vesting schedule notwithstanding, if the Company achieves its stated financial goals of $1 billion in revenue and 17% operating margin and repayment of $200 million of debt by December 31, 2000, then this Option shall become vested and exercisable in full on February 15, 2001. Notwithstanding the foregoing, this Option shall become fully vested and exercisable with respect to all of the Option Shares in the event of a "Change in Control" of the Company, as defined in Section 11 of the Plan. In any event, this Option shall become fully vested and exercisable with respect to all of the Option Shares six years after the date hereof. Once vested, options shall continue to be exercisable at any time or times prior to the Expiration Date. Page 1 2 2. MANNER OF EXERCISE. The Optionee may exercise this Option only in the following manner: From time to time prior to the Expiration Date of this Option, the Optionee may give written notice to the Company of an election to purchase some or all vested Option Shares purchasable at the time of such notice. Said notice shall specify the number of shares to be purchased and shall be accompanied by payment therefor in cash or shares of the Company's common stock, valued at their fair market value on the date of exercise. Such shares may be either previously owned by the Optionee or, at the Optionee's election, the Company may withhold shares of the Option Stock equal to all or a portion of the purchase price of the shares then being purchased. Unless otherwise determined by a committee of the Board of Directors of the Company acting under the Plan, the fair market value of the Company's Common Stock on the date of exercise shall be determined by the Company by reference to the last sale price of the Common Stock on the New York Stock Exchange or any applicable national trading and quotation system on that date, or on the next prior trading date if no trading occurred on that date. No Certificates for the shares so purchased will be issued to the Optionee until the Company has completed all steps required by law to be taken in connection with the issue and sale of the shares, including without limitation, receipt of any agreements or representations from the Optionee necessary to prevent a resale or distribution of the shares in violation of federal or state securities laws. If requested upon the exercise of the Option, certificates for shares may be issued in the name of the Optionee jointly with another person with rights of survivorship or in the name of the executor or administrator of the estate of the Optionee, and the foregoing representations and agreements shall be modified accordingly. 3. TRANSFERABILITY. Except as provided in Section 4 of this Agreement, this option is personal to the Optionee, is not transferable by the Optionee in any manner by operation of law or otherwise, and is exercisable, during the Optionee's lifetime, only by him or her. 4. TERMINATION OF EMPLOYMENT. This option, as to any shares not theretofore purchased, shall terminate whenever the Optionee is no longer employed by the Company or a Subsidiary (as defined in the Plan); provided, however, that (a) if such termination of employment results from the Optionee's death or disability as defined in Section 22 of the Internal Revenue Code of 1986, as amended (the "Code"), this Option may be exercised by the Optionee or his or her executors or administrators within one year after his or her death or disability respectively, but only to the extent that this Option was exercisable by the Optionee on the date of death or disability; (b) if such termination of employment occurs by reason of the Optionee's retirement at a time at which the Optionee is at least 55 years of age with at least five (5) years of credited service under the provisions of the Houghton Mifflin Retirement Plan, this Option may be exercised, in accordance with the vesting schedule set forth in Section 1 above, by the Optionee (or in the event of the Optionee's death by his or her executors or administrators) at any time prior to the earlier of the Expiration Date or expiration of one (l) year after the Optionee's death; and (c) if such termination is effected by the Company without the consent of the Optionee for reasons other than his or her dishonest or willful misconduct, this Option may be exercised by the Optionee within three (3) months after termination, but only to the extent exercisable on the date of termination. In no such event shall exercise be permitted after the Expiration Date of this Option. No Option will confer upon any Optionee any right with respect to continuance of employment by the Company or a subsidiary, nor will it interfere in any way with any right of his or her employer to terminate his or her employment at any time. Page 2 3 5. OPTION SHARES. The shares of stock which are the subject of this Option are shares of the Common Stock of the Company as constitute on the date of this Option, subject to adjustment as provided in Section 10 of the Plan. 6. EFFECT OF CERTAIN TRANSACTIONS. In the case of (a) the dissolution or liquidation of the Company, (b) the sale or exchange of all or substantially all of the assets of the Company, or (c) a merger or consolidation of the Company with another corporation in which the Company is not the surviving corporation or in which its outstanding stock is converted into cash or securities of a third party, the Company shall give written notice thereof to the Optionee at least twenty days prior to the effective date of any such transaction or the record date on which shareholders of the Company entitled to participate in such transaction shall be determined, whichever shall first occur, and the Optionee shall be entitled to purchase, subject to the consummation of such transaction, all or any part of the Option Shares which have vested as provided in Section 1 above, during the period in which any such transaction may become effective, and this Option shall expire as to any Option Shares not purchased prior to the effective date of such transaction, unless the Board of Directors otherwise determines. 7. MISCELLANEOUS. Notices hereunder shall be mailed or delivered to the Company at its principal place of business, 222 Berkeley Street, Boston, Massachusetts 02116, Attention: Senior Vice President, Administration and shall be mailed or delivered to the Optionee at his or her address set forth below, or in either case at such other address as one party may subsequently furnish to the other party in writing. This Agreement is entered into by the Optionee and the Company pursuant to the terms and provisions of the Plan and expressly incorporates herein all of the terms and provisions of the Plan. Notwithstanding anything in this Agreement to the contrary, in the event that any inconsistency arises between any term or provision of the Plan and any term or provision of this Agreement, then the applicable terms and provision of the Plan shall control. 8. INCOME TAX WITHHOLDING. In connection with the exercise of all or any part of the Option granted hereunder, the Company is expressly authorized to take any and all steps it deems necessary to comply with its tax withholding obligations under state and federal laws including without limitation (i) withholding cash in an amount sufficient to satisfy the Company's tax withholding obligations with respect to the Optionee from the compensation then or thereafter payable to the Optionee, (ii) conditioning the delivery of stock to the Optionee upon the payment to the Company of an amount sufficient to satisfy the Company's tax withholding obligations with respect to the Optionee, or (iii) reducing the number of shares deliverable to the Optionee by such number as is sufficient in value to satisfy the Company's tax withholding obligations with respect to the Optionee, provided that such reduction does not cause the Optionee to incur liability under Section 16(b) of the Securities Exchange Act of 1934, as amended. Page 3 4 HOUGHTON MIFFLIN COMPANY By:_____________________________________ Senior Vice President, Administration Receipt is acknowledged of the foregoing Option and its terms and conditions are hereby agreed to as of ((Issuedate)). _______________________________________ ((FirstName)) ((LastName)) ((Address1)) ((City)), ((State)) ((PostalCode)) Page 4 EX-12 5 COMPUTATION OF RATIO OF EARNINGS 1 HOUGHTON MIFFLIN COMPANY EXHIBIT 12 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (DOLLARS IN MILLIONS)
Years Ended December 31, -------------------------------------------------------------------- 1998 1997 1996 1995(B) 1994(A) ------ ------ ------ ------- ------- Earnings (loss) before fixed charges: Net income (loss) before extraordinary item and cumulative effect of accounting changes $ 45.6 $ 49.8 $ 43.6 $ (7.2) $52.4 Provision (benefit) for income taxes 33.6 33.7 30.3 (4.2) 32.7 ------ ------ ------ ------ ----- Income (loss) from continuing operations before taxes, extraordinary item, and cumulative effect of accounting changes 79.2 83.5 74.0 (11.4) 85.1 Interest expense 34.7 39.7 41.6 15.2 7.7 Interest portion of rent expense* 4.7 2.7 3.0 3.8 3.4 ------ ------ ------ ------ ----- Earnings (loss) before fixed charges $118.6 $125.9 $118.6 $ 7.6 $96.2 Fixed charges: Interest expense 34.7 39.7 41.6 15.2 7.7 Interest portion of rent expense* 3.1 2.7 3.0 3.8 3.4 ------ ------ ------ ------ ----- Total fixed charges $ 39.4 $ 42.4 $ 44.6 $ 19.0 $11.1 Ratio of earnings to fixed charges 3.0 3.0 2.7 0.4 8.6
(A) On March 30, 1994, Houghton Mifflin completed an early redemption of $25 million in senior notes due March 30, 1997. Houghton Mifflin recognized an extraordinary loss of $1.2 million, net of a tax benefit of $0.8 million. This extraordinary loss is excluded from earnings before fixed charges and interest expense in calculating the ratio of earning to fixed charges. (B) Houghton Mifflin would need $11.4 million in additional income to cover its fixed charges in 1995. * Includes the portion of rent expense for each period presented that is deemed by management to be the interest component of such rentals. 64 EX-21 6 SUBSIDIARIES 1 HOUGHTON MIFFLIN COMPANY EXHIBIT 21 LIST OF SUBSIDIARIES Houghton Mifflin directly or indirectly owns all of its subsidiaries, including those significant subsidiaries on the list below. The consolidated financial statements include all of Houghton Mifflin's subsidiaries. 1. McDougal Littell Inc., a Delaware corporation. 2. The Riverside Publishing Company, a Delaware corporation. 3. Great Source Educational Group, Inc., a Delaware corporation. 4. Houghton Mifflin Interactive Corporation, a Delaware corporation. 5. Computer Adaptive Technologies, Inc., a Delaware corporation. 65 EX-23 7 CONSENT OF ERNST & YOUNG LLP 1 HOUGHTON MIFFLIN COMPANY EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 2-69298, 33-59015, 33-51098, and 333-58377) pertaining to the Houghton Mifflin Company 401(k) Savings Plan, the 1992 Stock Compensation Plan, the 1995 Stock Compensation Plan, and the 1998 Stock Compensation Plan of Houghton Mifflin Company and in the Registration Statement (Form S-3 No. 33-64903) of Houghton Mifflin Company and in the related prospectuses pertaining to the $300 million debt securities of our report dated January 26, 1999, except for the third paragraph in Note 14, as to which the date is February 28, 1999, with respect to the consolidated financial statements and schedule of Houghton Mifflin Company included in this Annual Report (Form 10-K) for the year ended December 31, 1998. Ernst & Young LLP Boston, Massachusetts March 25, 1999 66 EX-27 8 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1998 DEC-31-1997 DEC-31-1998 3,953 49,203 170,706 (27,969) 151,669 349,841 323,542 (193,277) 975,567 244,312 0 0 0 30,550 367,738 975,567 861,657 861,657 390,922 759,637 11,230 0 33,981 79,269 33,630 45,639 0 18,010 0 63,649 2.22 2.19
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