Fitch Ratings has affirmed Houghton Mifflin's Issuer
Default Rating (IDR) at 'B-' and at the same time assigned a 'CCC-'
rating to Houghton Mifflin LLC and Houghton Mifflin Finance Inc's $300
million senior unsecured PIK notes. Fitch has also upgraded Houghton
Mifflin Company's senior unsecured notes due 2011 to 'B+' from 'B-'
and affirmed the other security ratings. The notching of the newly
rated debt reflects Fitch's analysis of the minimal recovery prospects
for this debt under a distressed scenario. The Rating Outlook is
Stable.
Houghton Mifflin LLC and Houghton Mifflin Finance, Inc.
-- Issuer Default Rating (IDR) rated 'B-';
-- Senior PIK notes due 2011 rated 'CCC-/RR6'.
Houghton Mifflin Company
-- Issuer Default Rating at 'B-';
-- Bank Credit Facility at 'BB-/RR1';
-- Senior secured notes due 2011 at 'BB-/RR1';
-- Senior unsecured notes due 2011 to 'B+/RR2' from 'B-/RR4';
-- Senior subordinate notes due 2013 at 'CCC/RR6'.
HM Publishing Corp.
-- Issuer Default Rating at 'B-';
-- Senior discount notes due 2013 at 'CCC-/RR6'.
The rating and rating actions incorporate Houghton Mifflin Company's (the company) increased debt load, weak credit metrics and the risk that further capital extraction by the equity sponsors could continue to pressure the company's financial flexibility and bondholder protection measures. The ratings continue to incorporate the company's modest cash flow coverage, significant working capital swings and heavy investment in advance of potential sales and cash flow. In addition, mounting capital constraints may negatively affect the company's capacity to compete with higher rated competitors with greater financial resources. These concerns are balanced somewhat by the predictable nature of education expenditures, solid industry fundamentals -- which are expected to underlie low single digit growth for the next several years -- and the educational publishing industry structure characterized by meaningful barriers to entry within the company's elementary through high school (El-Hi) markets. In addition, Fitch believes the company's equity sponsors have a material financial incentive to help the company avoid financial distress.
In the first quarter of 2006, the company experienced modest revenue growth of 1.5%. For the full year 2005, the company's operations benefited from a rebound in adoption spending following a difficult 2004. Spending is projected to remain healthy through 2010 and should provide the opportunity for modest top line growth. The company's El-Hi segment (87.3% of EBITDA) experienced 8.9% revenue growth while margins expanded over 200 basis points. Solid adoptions of reading, social studies and math programs bolstered performance in elementary education while social studies and science program adoptions supported secondary education spending. Its College Publishing segment (15.8% of EBITDA) grew 3.4% with margins expanding approximately 200 basis points on strong sales of college textbooks and reference materials. The smallest unit, the Trade and Reference Publishing division (1% of EBITDA) had a 13.6% reduction in the top-line and experienced contracting margins of over 500 basis points due to lower sales tied to movie releases. Fitch believes that adjusted operating EBITDA margins around 13.6% (including pre-publication expenditures) could continue to expand as revenues improve and the company keeps its focus on tight cost controls. However, cashflow will be constrained as working capital drains and capital expenditures negatively affect free cashflow conversion of operating EBITDA at around 17%.
Adjusted financial metrics (calculated by deducting pre-publication expenditures from EBITDA) have improved slightly as operating EBITDA has increased due to modest top line growth and tight cost controls. Debt increased modestly from 2003 through Mar. 31, 2006, with the most meaningful increase being the new $300 million new PIK issue. Pro forma debt to EBITDA is high for the rating at 9.4x. The company is within its covenant ranges, but Fitch is concerned that EBITDA less pre-publication expenditures less capital expenditures to interest expense is below 1x. Fitch recognizes that capital expenditures are discretionary to an extent and could provide some flexibility in severe distress scenario. Also, the PIK nature of the new debt does not negatively affect the company's capacity to cover interest costs.
At Mar. 31, 2006, internal liquidity in the form of $95.5 million in cash and marketable securities was supplemented by $225.3 million in credit facility availability. Financial flexibility is further supported by the tenor of the company's debt obligations, with no debt maturing over the next four years.
The recovery ratings and notching reflect Fitch's recovery expectations under a distress scenario. Fitch applied an enterprise value analysis for these recovery ratings due to the company's limited tangible asset base and the negligible recovery prospects under the liquidation scenario. A more modest stress of 25% to adjusted EBITDA for the company was used given Fitch's prior adjustments and the required stress necessary to trigger an event of default under the company's interest coverage and total leverage covenant. In addition, the general stability of the educational publishing business was considered, as there have only been a few instances of companies in this industry experiencing significant distress. The 'RR1' recovery rating for the company's bank facility and senior secured notes reflects Fitch's belief that greater than 90% recovery is realistic given their priority position. The 'RR2' recovery rating for the senior unsecured Houghton Mifflin Company debt reflects our estimate that 71-90% recovery is reasonable. There were two key drivers behind this rating upgrade: the company downsized its revolver in late 2005, which makes $75 million in additional enterprise value available for the senior unsecured tranche; and even with a more severe EBITDA discount (25% compared to 20% previously), increases in EBITDA resulted in approximately $140 million in additional adjusted distressed enterprise value available for creditors in distress. The 'RR6' recovery rating for the Houghton Mifflin Company subordinated notes, HM Publishing senior discount dotes and the newly issued Houghton Mifflin LLC/Houghton Mifflin Finance Inc. PIK notes reflects Fitch's estimate that negligible recovery would be achievable due to their deep subordination to other securities in the capital structure.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
Houghton Mifflin LLC and Houghton Mifflin Finance, Inc.
-- Issuer Default Rating (IDR) rated 'B-';
-- Senior PIK notes due 2011 rated 'CCC-/RR6'.
Houghton Mifflin Company
-- Issuer Default Rating at 'B-';
-- Bank Credit Facility at 'BB-/RR1';
-- Senior secured notes due 2011 at 'BB-/RR1';
-- Senior unsecured notes due 2011 to 'B+/RR2' from 'B-/RR4';
-- Senior subordinate notes due 2013 at 'CCC/RR6'.
HM Publishing Corp.
-- Issuer Default Rating at 'B-';
-- Senior discount notes due 2013 at 'CCC-/RR6'.
The rating and rating actions incorporate Houghton Mifflin Company's (the company) increased debt load, weak credit metrics and the risk that further capital extraction by the equity sponsors could continue to pressure the company's financial flexibility and bondholder protection measures. The ratings continue to incorporate the company's modest cash flow coverage, significant working capital swings and heavy investment in advance of potential sales and cash flow. In addition, mounting capital constraints may negatively affect the company's capacity to compete with higher rated competitors with greater financial resources. These concerns are balanced somewhat by the predictable nature of education expenditures, solid industry fundamentals -- which are expected to underlie low single digit growth for the next several years -- and the educational publishing industry structure characterized by meaningful barriers to entry within the company's elementary through high school (El-Hi) markets. In addition, Fitch believes the company's equity sponsors have a material financial incentive to help the company avoid financial distress.
In the first quarter of 2006, the company experienced modest revenue growth of 1.5%. For the full year 2005, the company's operations benefited from a rebound in adoption spending following a difficult 2004. Spending is projected to remain healthy through 2010 and should provide the opportunity for modest top line growth. The company's El-Hi segment (87.3% of EBITDA) experienced 8.9% revenue growth while margins expanded over 200 basis points. Solid adoptions of reading, social studies and math programs bolstered performance in elementary education while social studies and science program adoptions supported secondary education spending. Its College Publishing segment (15.8% of EBITDA) grew 3.4% with margins expanding approximately 200 basis points on strong sales of college textbooks and reference materials. The smallest unit, the Trade and Reference Publishing division (1% of EBITDA) had a 13.6% reduction in the top-line and experienced contracting margins of over 500 basis points due to lower sales tied to movie releases. Fitch believes that adjusted operating EBITDA margins around 13.6% (including pre-publication expenditures) could continue to expand as revenues improve and the company keeps its focus on tight cost controls. However, cashflow will be constrained as working capital drains and capital expenditures negatively affect free cashflow conversion of operating EBITDA at around 17%.
Adjusted financial metrics (calculated by deducting pre-publication expenditures from EBITDA) have improved slightly as operating EBITDA has increased due to modest top line growth and tight cost controls. Debt increased modestly from 2003 through Mar. 31, 2006, with the most meaningful increase being the new $300 million new PIK issue. Pro forma debt to EBITDA is high for the rating at 9.4x. The company is within its covenant ranges, but Fitch is concerned that EBITDA less pre-publication expenditures less capital expenditures to interest expense is below 1x. Fitch recognizes that capital expenditures are discretionary to an extent and could provide some flexibility in severe distress scenario. Also, the PIK nature of the new debt does not negatively affect the company's capacity to cover interest costs.
At Mar. 31, 2006, internal liquidity in the form of $95.5 million in cash and marketable securities was supplemented by $225.3 million in credit facility availability. Financial flexibility is further supported by the tenor of the company's debt obligations, with no debt maturing over the next four years.
The recovery ratings and notching reflect Fitch's recovery expectations under a distress scenario. Fitch applied an enterprise value analysis for these recovery ratings due to the company's limited tangible asset base and the negligible recovery prospects under the liquidation scenario. A more modest stress of 25% to adjusted EBITDA for the company was used given Fitch's prior adjustments and the required stress necessary to trigger an event of default under the company's interest coverage and total leverage covenant. In addition, the general stability of the educational publishing business was considered, as there have only been a few instances of companies in this industry experiencing significant distress. The 'RR1' recovery rating for the company's bank facility and senior secured notes reflects Fitch's belief that greater than 90% recovery is realistic given their priority position. The 'RR2' recovery rating for the senior unsecured Houghton Mifflin Company debt reflects our estimate that 71-90% recovery is reasonable. There were two key drivers behind this rating upgrade: the company downsized its revolver in late 2005, which makes $75 million in additional enterprise value available for the senior unsecured tranche; and even with a more severe EBITDA discount (25% compared to 20% previously), increases in EBITDA resulted in approximately $140 million in additional adjusted distressed enterprise value available for creditors in distress. The 'RR6' recovery rating for the Houghton Mifflin Company subordinated notes, HM Publishing senior discount dotes and the newly issued Houghton Mifflin LLC/Houghton Mifflin Finance Inc. PIK notes reflects Fitch's estimate that negligible recovery would be achievable due to their deep subordination to other securities in the capital structure.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.