<PAGE>   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, 2000

                         COMMISSION FILE NUMBER 1-5406

[ ]            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

           FOR THE TRANSITION PERIOD FROM             TO
                            ------------------------

                            HOUGHTON MIFFLIN COMPANY
             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                            <C>
                MASSACHUSETTS                                    04-1456030
       (State or other jurisdiction of                        (I.R.S. Employer
        incorporation or organization)                      Identification No.)

           222 BERKELEY ST., BOSTON                              02116-3764
   (Address of principal executive offices)                      (Zip Code)
</TABLE>

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (617) 351-5000
                            ------------------------
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

<TABLE>
<CAPTION>
                                                   NAME OF EACH EXCHANGE
       TITLE OF EACH CLASS                          ON WHICH REGISTERED
       -------------------                        -----------------------
<S>                                               <C>
Common Stock, $1 par value                        New York Stock Exchange
Preferred Stock Purchase Rights
</TABLE>

      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.  [X]

     The aggregate market value of voting stock of the registrant held by
nonaffiliates of the registrant was approximately $1,225,591,542 as of February
28, 2001.

     The registrant had outstanding 28,851,025 shares of common stock (exclusive
of Treasury shares) and 28,851,025 Preferred Stock Purchase Rights as of
February 28, 2001.
                            ------------------------
                      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 2001 Annual Meeting of Stockholders are incorporated into Part
III.
================================================================================
<PAGE>   2

                            HOUGHTON MIFFLIN COMPANY

                               TABLE OF CONTENTS

                                   FORM 10-K

<TABLE>
<CAPTION>
                                                                         PAGE
                                                                         ----
<S>        <C>                                                           <C>
                                     PART I

Item 1.    Business....................................................    1
Item 2.    Properties..................................................    6
Item 3.    Legal Proceedings...........................................    6
Item 4.    Submission of Matters to a Vote of Securities Holders.......    6

                                    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....   25
Item 9.    Changes in and Disagreements with Accountants on Accounting
           and Financial Disclosure....................................   59

                                    PART III

Item 10.   Directors and Executive Officers of Houghton Mifflin........   59
Item 11.   Executive Compensation......................................   59
Item 12.   Security Ownership of Certain Beneficial Owners and
           Management..................................................   59
Item 13.   Certain Relationships and Related Transactions..............   59

                                    PART IV

Item 14.   Exhibits, Financial Statements and Schedule, and Reports on
           Form 8-K....................................................   59
           Index to Consolidated Financial Statements and Financial
           Schedules...................................................   59
           Financial Statement Schedule................................   59
           Signatures..................................................   61
           Index to Exhibits...........................................   62
</TABLE>

     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 12 of this Form 10-K.
<PAGE>   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's principal business is publishing, and our
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, includes the following operating divisions:

      - The School Division, Boston, Massachusetts, which publishes educational
        materials for the elementary school market;

      - McDougal Littell Inc., Evanston, Illinois, which publishes educational
        materials for the secondary school market;

      - Great Source Education Group, Inc., or Great Source, Wilmington,
        Massachusetts, which publishes supplementary educational materials for
        both the elementary and secondary school markets;

      - Sunburst Technology Corporation, or Sunburst (formerly Houghton Mifflin
        Interactive Corporation), Pleasantville, New York, which develops and
        sells multimedia instructional products for both the elementary and
        secondary school markets; and

      - The Riverside Publishing Company, or Riverside, Itasca, Illinois, which
        publishes assessment materials for the educational and clinical testing
        markets.

     - College Publishing, which includes textbooks and other educational
       materials and services for the post-secondary higher education market.
       The College Division is the only operating division included in this
       segment.

     - Other, which consists of operating divisions not involved in educational
       publishing, including:

      - The Trade & Reference Division, or Trade, Boston, Massachusetts, which
        publishes fiction, nonfiction, children's books, dictionaries, and
        reference materials in a variety of formats and media; and

      - Computer Adaptive Technologies, Inc., or CAT, Evanston, Illinois, which
        specializes in the development and delivery of computer-based testing
        solutions to corporations and associations worldwide.

     In this description of our business, all divisions are treated as part of
Houghton Mifflin.

     In May 2000, we acquired the net assets of Virtual Learning Technologies,
Inc., or VLT, an educational testing company that specializes in online
assessments, for approximately $14.6 million in cash. VLT has been integrated
into Riverside, which is reported in the K-12 Publishing segment.

     In May 1999, we acquired all of the outstanding stock of Sunburst
Communications, Inc., a developer of software and video instructional materials
for the elementary and secondary school markets, for approximately $34.4 million
in cash. Our consolidated financial statements include Sunburst's operating
results from the date of acquisition in the K-12 Publishing segment.

     In January 1999, we acquired the assets of Little Planet Literacy Series, a
leading technology-based pre-kindergarten to grade three literacy program, from
Applied Learning Technologies, Inc. for approximately $4.6 million in cash. Our
consolidated financial statements include the effect of Little Planet Literacy
from the date of acquisition in the K-12 Publishing segment.

     In March 1994, Houghton Mifflin's former Software Division successfully
completed an initial public offering. We retained an equity interest in the
successor company, INSO Corporation, of approximately 40%.

                                        1
<PAGE>   4

On August 2, 1999, we elected to deliver approximately 1.9 million shares of
INSO common stock to repay the remaining 6% Exchangeable Notes due 1999 - Stock
Appreciation Income Linked Securities, or SAILS. In December 1999, we sold our
remaining shares of INSO common stock.

(b)  FINANCIAL INFORMATION ABOUT THE OPERATING SEGMENTS

     Financial information about Houghton Mifflin's operating segments is in
Part II, Item 8, Notes to Consolidated Financial Statements, in Note 12 under
the heading "Segment and Related Information" on page 53 and the schedule titled
"Five-Year Financial Summary" on page 10.

(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. We seek out, select, and
generate worthwhile concepts and then enhance 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, we publish many programs or
works in other formats including computer software, laser discs, CD-ROM, and
Internet-based platforms.

K-12 PUBLISHING

     This operating segment includes textbooks and instructional materials,
tests for measuring achievement and aptitude, clinical/special needs testing
products, and multimedia instructional programs for the K-12 market. The
principal markets for these products are elementary and secondary schools.
Beginning in 1999, we focused Sunburst's business on the growing educational
technology marketplace rather than on the retail market. Therefore, beginning in
1999, the information relating to Sunburst is included in the K-12 Publishing
segment.

     Houghton Mifflin's major regional sales offices for this segment are in
California, Georgia, Illinois, Massachusetts, New Jersey, New York, and Texas.
Each division in the segment has its own dedicated sales force. We distribute
products of the School Division, McDougal, and Great Source from two facilities
located in Indianapolis, Indiana and Geneva, Illinois. In addition, some states
require us to use in-state textbook depositories for educational materials sold
in that state. Sunburst's products are shipped from its facility located in
Pleasantville, New York, and 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 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 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.

     Educational materials are usually described as being either basal or
supplemental materials. Basal materials are comprehensive programs intended to
provide a complete course of study in a subject, either at a single grade level
or across grade levels, and which are the primary source of classroom
instruction. They typically include a student textbook and a variety of
ancillary materials such as teacher's editions, charts, classroom displays,
classroom handouts, and tests. Supplemental materials, as the name implies, are
intended to provide focused information about a topic, or practice in a
particular skill, but not the comprehensive system of materials offered in a
basal program.

                                        2
<PAGE>   5

     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, we may provide a variety of ancillary
materials to purchasers at no cost. We also conduct training sessions within a
school district that has purchased our materials to help teachers learn to use
our products effectively. These free materials and services, 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 English, spelling, and
       handwriting),

     - mathematics,

     - science and health, and

     - social studies.

     The School Division 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 five of these disciplines:
literature and language arts, mathematics, social studies, world languages, and
science and health.

     Great Source develops and distributes supplemental materials for the
kindergarten through twelfth grade market principally in the following
disciplines: reading and language arts, mathematics, and social studies.

     Sunburst develops and distributes educational software and video
instructional materials for the kindergarten through twelfth grade market.
Sunburst develops computer-based programs in areas such as problem solving,
early learning tools, language arts, and mathematics, and video instructional
programs on subjects such as conflict resolution, self esteem, drug education,
and success skills.

     Riverside publishes tests for educational and psychological assessment.
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 which are
available in both print form and online. Psychological tests are administered to
one person at a time by a trained clinician or specialist.

COLLEGE PUBLISHING

     This operating segment, which consists of the College Division, includes
textbooks, ancillary products such as workbooks and study guides,
technology-based instructional materials, and other services for introductory
and upper level courses in the post-secondary higher education market. Products
may be in print or electronic form or Internet based. Virtually all major
textbooks have an integrated technology component such as a website and/or
multimedia CD-ROM. 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
                                        3
<PAGE>   6

sales office in St. Charles, Illinois. Houghton Mifflin also sells these
products, principally mathematics, history, chemistry, and world languages, 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 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 materials 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 these materials from
several different sources:

     - retail booksellers, both in stores and through Internet sites, or

     - direct from the publisher.

     A bookstore or Internet site may purchase materials for a course "new" from
the publisher or, in the case of product with a copyright older than one year,
"used" from other students. Approximately 30% of all student purchases in the
college market are used books. 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 market is comprised of approximately thirty-five disciplines.
The College Division publishes in eighteen of these, including mathematics,
chemistry, business, history, English, and modern languages, which are the
largest disciplines. 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 the Trade Division,
CAT, and unallocated corporate-related items.

     The Trade Division publishes fiction and nonfiction for adults and
children, dictionaries, and other reference works. Its principal markets are
retail stores, including Internet bookstore sites, and wholesalers. The division
also sells reference materials to schools, colleges, office supply distributors,
and businesses. The sales volume for trade books and reference works may vary
significantly from year to year based on the success of one or more titles. The
division also licenses book rights and content to paperback publishers, book
clubs, websites, and other publishers and electronic businesses in the United
States and abroad. 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. Trade Division products are distributed from our
leased facility in Indianapolis, Indiana.

     CAT specializes in developing and delivering computer-based testing
solutions. It markets these products to corporations and associations worldwide.
CAT's products are sold by its own sales force, whose major corporate sales and
support offices are located 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.
                                        4
<PAGE>   7

     We derive approximately 90% of our revenues from educational publishing in
the K-12 and College Publishing segments, which are markedly seasonal
businesses. Schools and colleges make most of their purchases in the second and
third quarters of the calendar year, in preparation for the beginning of the
school year in September. Thus, we realize approximately 50% of net sales and a
substantial portion of annual net income during the third quarter, making
third-quarter results material to full-year performance. We also
characteristically post a net loss in the first and fourth quarters of the year,
when fewer educational institutions are making purchases.

     Sales of K-12 instructional materials are also cyclical, with some years
offering more sales opportunities than others. The amount of funding available
at the state level for educational materials also has a significant 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 our business,
schedules of school adoptions and market acceptance of our products can
materially affect year-to-year revenue performance. In 2000, Houghton Mifflin
had increased sales in adoption states in the elementary school social studies
and math disciplines and secondary school literature and language arts and world
languages disciplines, which more than offset fewer sales in open territory and
adoption states in the elementary school reading and language arts disciplines
and secondary school social studies and math disciplines as compared to 1999.
See "Summary of Quarterly Results of Operations (unaudited)" for the two-year
period ended December 31, 2000 on page 57.

     Houghton Mifflin expects that in 2001 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. The adoption opportunities will be primarily in
elementary school mathematics and reading and language arts and secondary school
literature and language arts and math. Houghton Mifflin also expects growth
opportunities in the other divisions to contribute to higher revenues in 2001
compared to 2000. During 2001, we will continue to invest in new products and
services to take advantage of opportunities in all publishing segments. Houghton
Mifflin will also continue to invest in and improve operating and support
systems. These investments will help us maintain a market-leading educational
product line, as well as improve our efficiency, profitability, and service to
customers.

     We sell our products in highly competitive markets. In these markets,
product quality and customer service are major factors in generating sales
growth. Profitability is affected by industry developments including
increasingly competitive selling costs; rising development costs due to
customers' requirements for more customized instructional materials; and higher
technology costs due to the increased number of textbook program components
developed in technology formats.

     There are four significant publishers serving the elementary and secondary
school markets, and seven significant publishers serving the college market.

     At December 31, 2000, Houghton Mifflin employed approximately 3,500 people.

     We anticipate 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
<PAGE>   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, principal
uses, and the years of expiration on leased premises of Houghton Mifflin's
significant operating properties at December 31, 2000. We believe that these
properties are suitable and adequate for our present and anticipated business
needs, satisfactory for the uses to which each is put, and, in general, fully
utilized.

<TABLE>
<CAPTION>
                                                    APPROXIMATE
                                     EXPIRATION         AREA
                                    YEAR: LEASED     IN SQUARE      PRINCIPAL USE OF
             LOCATION                 PREMISES          FEET             SPACE                SEGMENT USED BY
             --------               ------------   --------------   ----------------   ------------------------------
<S>                                 <C>            <C>              <C>                <C>
OWNED PREMISES
Indianapolis, Indiana.............                    503,000       Offices &          K-12 Publishing and College
                                                                    Warehouse          Publishing
Geneva, Illinois..................                    486,000       Offices &          K-12 Publishing; sales office
                                                                    Warehouse
Pleasantville, New York...........                     50,000       Offices &          K-12 Publishing
                                                                    Warehouse
LEASED PREMISES
Indianapolis, Indiana.............      2007          310,000       Warehouse          Other
Boston, Massachusetts                   2007          301,000       Executive &        All segments and corporate
  222 Berkeley Street/                                              Business offices   headquarters
  500 Boylston Street.............
West Chicago, Illinois............      2001          129,000       Warehouse          K-12 Publishing
Itasca, Illinois..................      2006           75,000       Offices            K-12 Publishing; sales office
Evanston, Illinois................      2004           70,000       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
Morris Plains, New Jersey.........      2006           40,000       Offices            K-12 Publishing; sales office
Kennesaw, Georgia.................      2004           39,000       Warehouse          K-12 Publishing
New York, New York................      2004           30,000       Offices            College Publishing and Other
Evanston, Illinois................      2004           20,000       Offices            K-12 Publishing
Evanston, Illinois................      2004           19,000       Offices            Other
St. Charles, Illinois.............      2006           20,000       Offices            College Publishing; sales
                                                                                       office
Somerville, Massachusetts.........      2001           12,000       Offices            K-12 Publishing
</TABLE>

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, 2000.

                                        6
<PAGE>   9

EXECUTIVE OFFICERS OF HOUGHTON MIFFLIN

<TABLE>
<CAPTION>
                                                                                                     OTHER
                                                                                         OFFICE    POSITIONS
                          AGE AT                                                          HELD     WITH THE
          NAME            2/28/01                         OFFICE                         SINCE      COMPANY
          ----            -------    ------------------------------------------------    ------    ---------
<S>                       <C>        <C>                                                 <C>       <C>
Nader F. Darehshori.....    64       Chairman, President, and Chief Executive Officer     1991     Director
Arthur S. Battle, Jr....    50       Vice President, Human Resources                      1998           --
Albert Bursma, Jr.......    63       Executive Vice President; President, Great           1995           --
                                     Source Education Group, Inc.
David R. Caron..........    40       Vice President, Controller                           1997           --
Gail Deegan.............    54       Executive Vice President and Chief Financial         1996           --
                                     Officer
Elizabeth L. Hacking....    59       Senior Vice President, Strategic Development         1993           --
John E. Laramy..........    56       Senior Vice President; President, The Riverside      1999           --
                                     Publishing Company
George A. Logue.........    50       Executive Vice President, School Division            1997           --
Mark E. Mooney..........    48       Senior Vice President, Chief Technology Officer      1997           --
John H. Oswald..........    51       Executive Vice President; President, Computer        1999           --
                                     Adaptive Technologies, Inc.
Conall E. Ryan..........    43       Executive Vice President; President, Sunburst        2000           --
                                     Technology Corporation
Rita H. Schaefer........    47       Senior Vice President, McDougal Littell Inc.         2000           --
Gary L. Smith...........    56       Senior Vice President, Administration                1991           --
June Smith..............    57       Executive Vice President, College Division           1994           --
Wendy J. Strothman......    50       Executive Vice President, Trade & Reference          1996           --
                                     Division
Paul D. Weaver..........    58       Senior Vice President, Clerk, Secretary, and         1989           --
                                     General Counsel
</TABLE>

     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. Caron, Ms. Deegan, and Mr. Mooney 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.

Albert Bursma, Jr.
1995--Executive Vice President; President, Great Source Education Group, Inc.*

David R. Caron
1997--Vice President, Controller
1996--Assistant Controller
1995--Director-Corporate Accounting, 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

Elizabeth L. Hacking
1993--Senior Vice President, Strategic Development

John E. Laramy
1999--Senior Vice President; President, The Riverside Publishing Company*
1994--Vice President, Director of Sales, The Riverside Publishing Company*

                                        7
<PAGE>   10

George A. Logue
1998--Executive Vice President, School Division
1997--Senior Vice President, School Division
1994--Vice President, Sales and Marketing, School Division

Mark E. Mooney
1997--Senior Vice President, Chief Technology Officer
1996--Vice President, Director of Information Technology, The Bureau of
National Affairs

John H. Oswald
1999--Executive Vice President; President, Computer Adaptive Technologies, Inc.*
1993--Executive Vice President; President, The Riverside Publishing Company*

Conall E. Ryan
2000--Executive Vice President; President, Sunburst Technology Corporation*
1999--Senior Vice President; President, Sunburst Technology Corporation*
1997--Senior Vice President; President, Houghton Mifflin Interactive
Corporation*
1996--President, Houghton Mifflin Interactive Corporation*
1995--Vice President, Publisher, Houghton Mifflin Interactive Corporation*

Rita H. Schaefer
2000--Senior Vice President, McDougal Littell Inc.*
1994--Vice President, National Sales Manager, McDougal Littell Inc.*

Gary L. Smith
1991--Senior Vice President, Administration

June Smith
1994--Executive Vice President, College Division

Wendy J. Strothman
1996--Executive Vice President, Trade & Reference Division
1995--Vice President, Publisher, Adult Trade and Reference

Paul D. Weaver
1989--Senior Vice President, Clerk, Secretary, and General Counsel

* A subsidiary of Houghton Mifflin

                                        8
<PAGE>   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, 2001, Houghton Mifflin had approximately 5,859 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

<TABLE>
<CAPTION>
                                                  2000                             1999
                                     ------------------------------    ----------------------------
                                                           DIVIDEND                        DIVIDEND
                                      HIGH        LOW        PAID       HIGH      LOW        PAID
                                     ------      ------    --------    ------    ------    --------
<S>                                  <C>         <C>       <C>         <C>       <C>       <C>
First Quarter......................  $43.88      $38.06     $0.130     $47.63    $40.00     $0.125
Second Quarter.....................   50.69       36.88      0.130      50.31     42.63      0.125
Third Quarter......................   51.82       37.75      0.130      52.50     40.50      0.130
Fourth Quarter.....................   47.19       29.50      0.130      43.25     34.88      0.130
                                                            ------                          ------
Year...............................                         $0.520                          $0.510
                                                            ======                          ======
</TABLE>

ITEM 6.  SELECTED FINANCIAL DATA

     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 calculated using the diluted weighted
average shares outstanding, unless the per-share amounts are specifically
identified as basic. For further discussion of earnings per share, see Note 13
in the Notes to the Consolidated Financial Statements on page 55.

                                        9
<PAGE>   12

                            HOUGHTON MIFFLIN COMPANY
                          FIVE-YEAR FINANCIAL SUMMARY
              (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                    YEARS ENDED DECEMBER 31,
                                                 --------------------------------------------------------------
                                                    2000         1999         1998         1997         1996
                                                 ----------   ----------   ----------   ----------   ----------
<S>                                              <C>          <C>          <C>          <C>          <C>
OPERATING RESULTS
Net sales......................................  $1,027,637   $  949,448   $  886,266   $  821,545   $  738,165
Operating income...............................     136,290      111,960       98,520      106,558       87,382
Net interest expense...........................      31,806       29,770       33,981       38,926       40,875
Gains (losses) on INSO Corporation common stock
  and equity in earnings (losses) of INSO
  Corporation..................................          --       (5,100)      18,797       15,901       27,446
Equity in losses of equity method investee.....      (2,737)          --           --           --           --
Loss on sale of investment.....................          --           --       (3,017)          --           --
Write-down of investment.......................      (4,553)          --           --           --           --
Other expense..................................          --           --       (1,050)          --           --
Income before taxes and extraordinary item.....      97,194       77,090       79,269       83,533       73,953
Extraordinary gain on extinguishment of debt,
  net of tax...................................          --       30,320       18,010           --           --
Net income.....................................      55,824       76,304       63,649       49,822       43,622
PER COMMON SHARE
Basic:
    Income before extraordinary item...........       $1.94        $1.60        $1.59        $1.76        $1.57
    Extraordinary gain on extinguishment of
      debt.....................................          --         1.05         0.63           --           --
                                                      -----        -----        -----        -----        -----
    Basic net income per share.................       $1.94        $2.65        $2.22        $1.76        $1.57
                                                      -----        -----        -----        -----        -----
                                                      -----        -----        -----        -----        -----
Diluted:
    Income before extraordinary item...........       $1.92        $1.57        $1.57        $1.73        $1.56
    Extraordinary gain on extinguishment of
      debt.....................................          --         1.03         0.62           --           --
                                                      -----        -----        -----        -----        -----
    Diluted net income per share...............       $1.92        $2.60        $2.19        $1.73        $1.56
                                                      -----        -----        -----        -----        -----
                                                      -----        -----        -----        -----        -----
Dividends declared per share...................      $ 0.52       $ 0.51       $ 0.50       $ 0.49       $ 0.48
Book value.....................................       14.38        14.41        13.20        10.61         9.22
Stock price--High..............................       51.82        52.50        47.25        40.25        28.32
    Low........................................       29.50        34.88        26.94        26.31        20.25
    Close......................................       46.38        42.19        47.25        38.38        28.32
FINANCIAL DATA
Total assets...................................  $1,123,974   $1,038,743   $  983,668   $1,000,648   $1,017,283
Long-term debt less current portion............     224,687      254,638      274,521      371,081      500,999
Additions to book plates and property, plant,
  and equipment................................     112,293       98,314       73,984       67,903       74,943
Dividends paid.................................      14,980       14,748       14,388       13,959       13,371
Weighted average shares outstanding:
    Basic......................................      28,749       28,823       28,689       28,237       27,801
    Diluted....................................      29,045       29,308       29,111       28,826       27,919
NET SALES--CLASSES OF SIMILAR PRODUCTS
K-12 Publishing................................  $  750,660   $  684,336   $  634,199   $  581,617   $  514,086
College Publishing.............................     174,406      173,694      162,518      150,934      140,566
Other..........................................     102,571       91,418       89,549       88,994       83,513
                                                 ----------   ----------   ----------   ----------   ----------
                                                 $1,027,637   $  949,448   $  886,266   $  821,545   $  738,165
                                                 ==========   ==========   ==========   ==========   ==========
</TABLE>

                                        10
<PAGE>   13

     In the fourth quarter of 2000, Houghton Mifflin implemented the consensus
of the Emerging Issue Task Force Issue 00-10, "Accounting for Shipping and
Handling Fees and Costs," or EITF 00-10, and reclassified its shipping and
handling fees from selling and administrative expenses to net sales. The effect
of the reclassification was to increase net sales and selling and administrative
expenses by $34.8 million in 2000, $29.3 million in 1999, $24.6 million in 1998,
$24.2 million in 1997, and $20.3 million in 1996. The reclassification has no
effect on operating income or net income.

     In the third quarter of 2000, Houghton Mifflin reviewed the value of its
investment in a distance learning company and estimated that the value had
suffered a decline which was other than temporary. Therefore, the investment was
written down to its estimated net realizable value, resulting in a charge of
$4.6 million ($2.9 million after tax), or $0.10 per share.

     During 2000, Houghton Mifflin recorded a $2.7 million loss, or $0.09 per
share, reflecting its share of the losses in Classwell Learning Group, recorded
on the equity method.

     On August 2, 1999, the remaining 50%, or $65.3 million in aggregate
principal amount, of the outstanding 6% Exchangeable Notes, or SAILS, matured.
Houghton Mifflin elected to deliver approximately 1.9 million shares of INSO
common stock to repay the remaining SAILS. The transaction represented a
surrender of the shares and generated a non-cash loss of $5.6 million ($3.2
million after tax), or $0.11 per share. In addition, we also recognized a $52.3
million extraordinary gain ($30.3 million after tax), or $1.03 per share, as a
result of the extinguishment of the SAILS indebtedness. In 1999, we recorded a
gain of $0.5 million ($0.3 million after tax), or $0.01 per share, on the sale
of our remaining shares of INSO common stock.

     Beginning in 1999, Houghton Mifflin implemented a change in the method of
accounting for the amortization of book plate assets. The change is from a class
of assets method previously used to a specific identification method by which
amortization commences in the year of publication. This change was made
prospectively for book plate additions beginning in 1999. This change resulted
in a decrease in amortization expense of approximately $5.1 million ($3.1
million after tax), or $0.10 per share, for the twelve months ended December 31,
1999.

     On August 1, 1998, Houghton Mifflin redeemed 50%, or $65.3 million in
aggregate principal amount, of the outstanding 6% Exchangeable Notes, or SAILS,
with approximately 1.9 million shares of INSO common stock. The redemption
represented a surrender of the shares and generated a non-cash gain of $15.4
million ($8.9 million after tax), or $0.31 per share. In addition, we 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 million in connection with its acquisitions of Henderson Software, Inc. and
ViewPort Development AB. Our portion of these charges amounted to approximately
$0.8 million ($0.5 million after tax), or $0.01 per share. We 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 our investment in Cassell Plc in 1998.

     In 1997, Houghton Mifflin recognized a gain of $14.9 million ($8.6 million
after tax), or $0.30 per share, representing our 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 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. We also recorded special charges in 1996 of $11.7 million ($7.1 million
after tax), or $0.25 per share, related to our investment in INSO, resulting
from INSO's acquisitions of ImageMark Software Labs, Inc. and Electronic Book
Technologies, Inc.
                                        11
<PAGE>   14

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 2000

     "SAFE HARBOR" STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: This report includes forward-looking statements that reflect Houghton
Mifflin's current views about future events and financial performance. Words
such as "will," "should," "believe," "expect," "anticipate," "outlook," and
other similar expressions that predict or indicate future events or trends, or
that are not statements of historical matters, identify forward-looking
statements. Investors should not rely on forward-looking statements because they
are subject to a variety of risks, uncertainties, and other factors that could
cause actual results to differ materially from our expectations, and we
expressly do not undertake any duty to update forward-looking statements, which
speak only as of the date of this report. These risks, uncertainties, and
factors include, but are not limited to: (1) market acceptance of new
educational and testing products and services, particularly reading, literature,
English and other language arts, and mathematics programs; The Iowa Tests of
Basic Skills(R); and Sunburst's technology products; (2) the seasonal and
cyclical nature of educational sales; (3) changes in funding in school systems
throughout the nation, which may result in cancellation of planned purchases of
educational and testing products and/or services and shifts in timing of
purchases; (4) how much is actually spent in key states such as California,
Texas, and Florida, and the Company's share of that spending; (5) changes in
purchasing patterns in elementary and secondary schools and, particularly in
college markets, the effect of textbook prices, technology, and the used book
market on sales of texts; (6) changes in the competitive environment, including
those which could adversely affect selling expenses, such as the increased
amount of material given away at no cost in the elementary and secondary school
markets and increased demand for customized products; (7) the relative
profitability of products sold; (8) regulatory changes which could affect the
purchase of educational and testing products and services; (9) strength of the
retail market for general-interest publications and market acceptance of
newly-published titles and new electronic products; (10) Computer Adaptive
Technologies' ability to enter into new agreements for testing services and
generate revenue growth; (11) delays and unanticipated expenses in developing
new technology products, and market acceptance and use of online instruction and
assessment materials, such as the products and services offered by Riverside and
the College Division; (12) the potential effect of a weakening economy on sales
of college and general interest publications; (13) risks related to the
operating and capital needs of companies in which we have invested that could
impair the value of those investments; (14) the effect of changes in accounting
and/or tax policies and practices; and (15) other factors detailed from time to
time in Houghton Mifflin's filings with the Securities and Exchange Commission.

RESULTS OF OPERATIONS

     In the fourth quarter of 2000, Houghton Mifflin implemented the consensus
of the Emerging Issue Task Force Issue 00-10, "Accounting for Shipping and
Handling Fees and Costs," or EITF 00-10, and reclassified its shipping and
handling fees from selling and administrative expenses to net sales. The effect
of the reclassification was to increase net sales and selling and administrative
expenses by $34.8 million in 2000, $29.3 million in 1999, and $24.6 million in
1998. The reclassification has no effect on operating income or net income.

                                        12
<PAGE>   15

Net income:

<TABLE>
<CAPTION>
                                                    TWELVE MONTHS ENDED DECEMBER 31,
                                         ------------------------------------------------------
                                                                           DILUTED EARNINGS
                                                                           (LOSS) PER SHARE
                                                                       ------------------------
                                          2000      1999      1998      2000     1999     1998
                                         -------   -------   -------   ------   ------   ------
                                          (IN THOUSANDS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS)
<S>                                      <C>       <C>       <C>       <C>      <C>      <C>
Income after tax, but excluding
  extraordinary and nonrecurring
  items:...............................  $58,681   $48,943   $37,250   $ 2.02   $ 1.67   $ 1.28
Extraordinary and nonrecurring items,
  net of taxes, where applicable:
     Extraordinary gain on
       extinguishment of debt..........       --    30,320    18,010       --     1.03     0.62
     Gain (loss) on surrender of INSO
       Corporation common stock to
       satisfy indebtedness............       --    (3,241)    8,913       --    (0.11)    0.31
     Gain on sale of INSO Corporation
       common stock....................       --       282        24       --     0.01       --
     Loss on sale of investment........       --        --    (1,961)      --       --    (0.07)
     Write-down of investment..........   (2,857)       --        --    (0.10)      --       --
     Other gains.......................       --        --     1,413       --       --     0.05
                                         -------   -------   -------   ------   ------   ------
Net income.............................  $55,824   $76,304   $63,649   $ 1.92   $ 2.60   $ 2.19
                                         =======   =======   =======   ======   ======   ======
</TABLE>

     Consolidated net income in 2000 was $55.8 million, or $1.92 per share,
compared to net income of $76.3 million, or $2.60 per share, in 1999 and net
income of $63.6 million, or $2.19 per share, in 1998.

     Income after tax, excluding extraordinary and nonrecurring expenses, for
2000 was $58.7 million, or $2.02 per share, compared to $48.9 million, or $1.67
per share, for the same period in 1999. The primary reasons for the increase
were higher sales and operating efficiencies, partially offset by higher selling
costs, higher losses at Computer Adaptive Technologies, Inc. (CAT), an asset
impairment charge, increased intangible asset amortization, higher interest
expense, and equity in losses of Classwell Learning Group, or Classwell.

     Income after tax, excluding extraordinary and nonrecurring items, for 1999
was $48.9 million, or $1.67 per share, compared to $37.3 million, or $1.28 per
share, in 1998. The primary reasons for the increase were higher net sales,
operating efficiencies, product mix, lower interest expense, and the 1998
acquired in-process research and development charge for the CAT acquisition,
partially offset by higher development costs, increased selling expenses related
to sales opportunities in 2000 and beyond, and additional intangible asset
amortization resulting from the acquisitions of CAT, the DiscoveryWorks
elementary science program, and Sunburst Communications.

     During 2000, the Company recorded a special charge for the write-down of an
investment in a distance learning start-up company, which resulted in a loss of
$4.6 million ($2.9 million after-tax), or $0.10 per share

     During 1999, Houghton Mifflin recorded a loss of $5.6 million ($3.2 million
after tax), or $0.11 per share, resulting from the surrender of INSO common
stock upon maturity of the remaining outstanding SAILS. We also recognized an
extraordinary gain of $52.3 million ($30.3 million after tax), or $1.03 per
share, on the extinguishment of the SAILS indebtedness. In addition, we sold our
remaining shares of INSO and recognized a gain of $0.5 million ($0.3 million
after tax), or $0.01 per share.

     During 1998, Houghton Mifflin recognized a gain of $15.4 million ($8.9
million after tax), or $0.31 per share, resulting from the surrender of INSO
common stock used to redeem one-half of the outstanding SAILS. We 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 our investment in Cassell Plc. 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.
                                        13
<PAGE>   16

Net sales:

<TABLE>
<CAPTION>
                                                                        INCREASE (DECREASE)
                                                                   ------------------------------
                                TWELVE MONTHS ENDED DECEMBER 31,   2000 VS. 1999    1999 VS. 1998
                                --------------------------------   --------------   -------------
                                   2000        1999       1998        $       %        $       %
                                ----------   --------   --------   -------   ----   -------   ---
                                        (IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS)
<S>                             <C>          <C>        <C>        <C>       <C>    <C>       <C>
K-12 Publishing...............  $  750,660   $684,336   $634,199   $66,324    9.7%  $50,137   7.9%
College Publishing............     174,406    173,694    162,518       712    0.4    11,176   6.9
Other.........................     102,571     91,418     89,549    11,153   12.2     1,869   2.1
                                ----------   --------   --------   -------          -------
          Total net sales.....  $1,027,637   $949,448   $886,266   $78,189    8.2%  $63,182   7.1%
                                ==========   ========   ========   =======          =======
</TABLE>

     Net sales for 2000 were $1,027.6 million, an increase of 8.2% from the
$949.4 million reported in 1999. The K-12 Publishing segment's net sales
increased $66.3 million, or 9.7%, to $750.7 million in 2000 from $684.3 million
in 1999. Each division in the segment reported higher net sales, benefiting from
adoption opportunities and product introductions. The School Division, McDougal
Littell, and Great Source experienced significant sales increases in California.
Riverside reported significant sales increases from the new edition of the
Woodcock-Johnson(R) III Tests of Achievement and Tests of Cognitive Abilities.
Sunburst Technology also reported a large sales increase resulting from higher
product sales and the full-year ownership of Sunburst Communications, purchased
in May 1999. The College Publishing segment's net sales in 2000 increased 0.4%,
to $174.4 million from $173.7 million in 1999. Strong sales of new frontlist
titles and higher sales in international markets were offset by lower sales of
backlist titles and lower sales to alternative markets, particularly the high
school advanced placement market, as well as higher college book returns. The
Other segment's net sales in 2000 increased $11.2 million, or 12.2%, to $102.6
million from $91.4 million in 1999. This increase was primarily due to increased
sales of the Trade Division's adult and children's titles and publishing rights
as well as higher dictionary sales.

     Houghton Mifflin's net sales in 1999 increased $63.2 million, or 7.1%, to
$949.4 million from $886.3 million in 1998. The K-12 Publishing segment's net
sales of $684.3 million in 1999 were $50.1 million, or 7.9%, above 1998 net
sales of $634.2 million. All divisions in the K-12 Publishing segment reported
increased revenues in 1999 even though the sales opportunities were limited in
elementary and secondary school reading and language arts. New product lines
such as reading intervention and MathSteps contributed to the net sales gain, as
did the inclusion of sales of DiscoveryWorks, the elementary school science
program we acquired in December 1998, and multimedia instructional materials we
acquired with Sunburst in May 1999. The College Publishing segment's net sales
of $173.7 million in 1999 increased $11.2 million, or 6.9%, from $162.5 million
in 1998. The increase was primarily due to higher sales of frontlist titles and
additional sales to the high school advanced placement market. The Other
segment's net sales in 1999 increased by $1.9 million, or 2.1%, to $91.4 million
from $89.5 million in 1998. This was primarily due to the Trade Division's
increased sales from its adult trade list, partially offset by the shift of
Sunburst Technology, formerly Houghton Mifflin Interactive, to the K-12
Publishing segment in 1999.

Costs and expenses:

<TABLE>
<CAPTION>
                                                                           INCREASE (DECREASE)
                                                                     -------------------------------
                                 TWELVE MONTHS ENDED DECEMBER 31,    2000 VS. 1999    1999 VS. 1998
                                 ---------------------------------   --------------   --------------
                                   2000        1999        1998         $       %        $       %
                                 ---------   ---------   ---------   -------   ----   -------   ----
                                          (IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS)
<S>                              <C>         <C>         <C>         <C>       <C>    <C>       <C>
Cost of sales..................  $434,267    $411,114    $390,922    $23,153    5.6%  $20,192    5.2%
Selling and administrative,
  excluding intangible asset
  amortization.................   419,314     394,506     364,816     24,808    6.3    29,690    8.1
Intangible asset
  amortization.................    33,978      31,868      28,508      2,110    6.6     3,360   11.8
Asset impairment charge........     2,488          --          --      2,488     --        --     --
Acquired in-process research
  and development..............     1,300          --       3,500      1,300     --    (3,500)    --
                                 --------    --------    --------    -------          -------
          Total costs and
            expenses...........  $891,347    $837,488    $787,746    $53,859    6.4%  $49,742    6.3%
                                 ========    ========    ========    =======          =======
</TABLE>

                                        14
<PAGE>   17

Cost of sales:

     In 2000, cost of sales increased $23.2 million, or 5.6%, to $434.3 million
from $411.1 million in 1999. The increased cost of sales was primarily due to
higher net sales. As a percentage of sales, cost of sales decreased to 42.3% for
2000 from 43.3% in 1999. The lower percentage was primarily due to higher net
sales and lower editorial expense.

     In 1999, cost of sales increased $20.2 million, or 5.2%, to $411.1 million
from $390.9 million during 1998. The increased cost of sales was primarily due
to higher net sales and increased editorial expense related to new program
development and product revisions in preparation for the sales opportunities in
the year 2000 and beyond. This increase was partially offset by lower plate
amortization primarily due to the accounting change regarding book plate
amortization. Beginning in 1999, Houghton Mifflin implemented a change in the
method of accounting for the amortization of book plate assets. The change is
from a class of assets method previously used to a specific identification
method by which amortization commences in the year of publication. This change
was made prospectively for book plate additions beginning in 1999. This change
resulted in a decrease in amortization expense of approximately $5.1 million for
the twelve months ended December 31, 1999. As a percent of sales, cost of sales
decreased to 43.3% in 1999 from 44.1% in 1998. The lower percentage was
primarily due to higher net sales and lower plate amortization expense,
partially offset by higher editorial expense.

Selling and administrative:

     Selling and administrative expenses, excluding intangible asset
amortization, were $419.3 million in 2000, an increase of $24.8 million, or
6.3%, from $394.5 million in 1999. The primary reasons for this increase were
higher selling and implementation costs, the additional selling and
administrative costs for the operations of Sunburst, additional distribution and
administrative costs for the operations of CAT, and increased spending on
technology initiatives. The increases were partially offset by lower
administrative costs due to lower employee-related costs and lower spending to
address the Year 2000 computer issue than in 1999. Overall, as a percentage of
sales, selling and administrative expenses decreased to 40.8% in 2000 from 41.6%
in 1999.

     Selling and administrative expenses, excluding intangible asset
amortization, were $394.5 million in 1999, an increase of $29.7 million, or
8.1%, over the $364.8 million recorded in 1998. As a percent of sales, selling
and administrative expense increased slightly to 41.6% in 1999 from 41.2% in
1998. The primary reasons for this increase were higher selling costs related to
sales opportunities in 2000 and beyond, the additional selling and
administrative costs for the operations of CAT and Sunburst, and increased
spending on efforts to improve customer support systems and to address the Year
2000 computer issue. The increases were partially offset by lower distribution
costs. Implementation of a new warehouse automation system and in-sourcing of
the Trade Division's distribution function contributed to the lower distribution
costs.

Intangible asset amortization:

     Due to the May 2000 acquisition of VLT and the May 1999 acquisition of
Sunburst Communications, intangible asset amortization increased to $34.0
million in 2000 from $31.9 million in 1999.

     Due to the 1998 acquisitions of CAT and DiscoveryWorks, the January 1999
acquisition of Little Planet, and the May 1999 acquisition of Sunburst
Communications, intangible asset amortization increased to $31.9 million in 1999
from $28.5 million in 1998.

Asset impairment charge:

     In 2000, Houghton Mifflin recorded a special charge of $2.5 million,
related to the write-down of a portion of the goodwill and other long-lived
assets attributable to the Little Planet Series, a Sunburst Technology product,
to their estimated fair values as determined from estimated future cash flows.
In January 1999, Houghton Mifflin purchased the assets of the Little Planet
Series, a pre-kindergarten to grade three literacy program. During 1999, sales
for the Little Planet Series fell short of goals established at the time of the
acquisition, and plans were put into place to improve sales of this product by
the third quarter of

                                        15
<PAGE>   18

2000, when a number of sales are made in the education marketplace. A
significant improvement failed to materialize by the third quarter, and as a
result, future sales are now expected to be lower than originally expected.
Based on these indicators, the goodwill and other long-lived assets recorded at
the time of acquisitions were re-evaluated and compared to the estimated
undiscounted cash flows from the Little Planet products. The undiscounted cash
flows indicated there was an impairment, and the assets were written down to
their estimated fair values, as determined from the estimated anticipated
discounted future cash flows. This amount is reported as an "Asset impairment
charge" in a separate line item of Costs and Expenses in the accompanying
consolidated financial statements.

     As part of our impairment assessment, we have also considered the
long-lived assets, identifiable intangibles and goodwill attributable to our CAT
business. An impairment assessment was performed due to CAT's operating cash
flow losses. While losses had been forecast, certain aspects of our CAT business
have not performed as originally planned. Plans are in place to improve CAT's
operating cash flows, which are dependent on CAT's ability to enter into new
agreements for testing services and generate the related revenue. Based on these
plans at this time, the undiscounted cash flows are expected to recover the
assets carrying amounts.

Net interest expense:

     Net interest expense of $31.8 million in 2000 increased $2.0 million from
$29.8 million in 1999. The increase reflected higher interest rates and
increased borrowings due primarily to the purchase of Houghton Mifflin common
stock in the fourth quarter of 2000. This increase was partially offset by the
maturity on August 2, 1999, of $65.3 million in aggregate principal amount of
SAILS. Houghton Mifflin also had interest rate swaps and the effect was to
decrease interest expense for 2000 by $0.2 million and to increase interest
expense for 1999 by $0.4 million.

     Net interest expense of $29.8 million in 1999 decreased $4.2 million from
$34.0 million in 1998. The reduction was primarily due to the maturity on August
2, 1999, of $65.3 million of SAILS, the redemption of $65.3 million in aggregate
principal amount of SAILS on August 1, 1998, and the repayment of $39.5 million
of debt at the end of 1998. The effect of the interest rate swaps was to
increase interest expense by $0.4 million in 1999 and $0.2 million in 1998.

Equity in losses of equity method investee:

     During 2000, Houghton Mifflin recorded a $2.7 million loss reflecting its
share of the losses in Classwell Learning Group, recorded on the equity method.

Equity in earnings (losses) of INSO Corporation:

     During 1998, Houghton Mifflin recognized $3.4 million in equity earnings of
INSO, representing a one-time gain of $3.2 million and $1.0 million of INSO's
earnings, partially offset by $0.8 million of one-time charges recognized by
INSO.

Other expense:

     In 1998, Houghton Mifflin recognized a $1.1 million charge related to our
unsuccessful bid for a portion of Simon & Schuster's publishing assets.

Income taxes:

     The provision for taxes in 2000 increased by $10.3 million, or 33.0%, from
1999. This increase was due to higher income and an increase in the effective
tax rate to 42.6% in 2000 from 40.4% in 1999. The increase in the effective rate
was primarily due to higher non-deductible costs, including the equity losses of
Classwell and goodwill from previous acquisitions.

     The provision for taxes in 1999 decreased $2.5 million, or 7.5%, from 1998.
This decrease was primarily due to lower income and a decrease in the effective
rate to 40.4% in 1999 from 42.4% in 1998. The decrease in
                                        16
<PAGE>   19

the effective rate reflected the non-deductible charge for acquired in-process
research and development from CAT in 1998.

     Houghton Mifflin recognized net deferred tax assets aggregating $5.1
million at December 31, 2000 and $7.6 million at December 31, 1999. The assets
related principally to pension and post-retirement benefits, inventory, and tax
liabilities related principally to differences in the depreciation of fixed
assets and amortization of book plates. In view of the consistent profitability
of our past operations, we believe that these assets will be substantially
recovered and that no significant additional valuation allowances are necessary.

K-12 PUBLISHING

     The K-12 Publishing segment's net sales of $750.7 million in 2000
represented a $66.3 million, or 9.7%, increase over 1999 net sales of $684.3
million. All divisions in this segment reported higher net sales in 2000
compared to 1999. Due to increased sales opportunities, especially in
California, the School Division, McDougal Littell, and Great Source had higher
sales. Great Source sales increased more than 25%, primarily due to higher sales
of the Write Source product line and new products in math and reading and
language arts. Riverside Publishing reported significant sales increases from
the new edition of the Woodcock-Johnson(R) III Tests of Achievement and Tests of
Cognitive Abilities. McDougal's net sales increased due to higher sales of
literature and language arts and world languages programs. School's net sales
increased only slightly and were lower than expected. Increases in math and
social studies sales were offset by lower than expected sales in reading and
language arts and science. Sunburst Technology also reported higher sales
resulting from sales gains and the full-year ownership of Sunburst
Communications, purchased in May 1999.

     Operating income for the K-12 Publishing segment increased $19.1 million,
or 19.7% in the twelve months ended December 31, 2000, to $116.2 million from
$97.1 million for the same period in 1999. The resulting operating margin for
2000 was 15.5% compared to 14.2% in 1999. The increase in operating margin was
primarily due to higher net sales and lower editorial and administrative
expenses, partially offset by higher manufacturing and royalty costs, higher
selling expenses, higher intangible asset amortization due to the acquisitions
of Sunburst and VLT, the acquired in-process research and development charge
related to the VLT acquisition, and an adjustment associated with the impaired
assets of the Little Planet Literacy Series. Lower editorial expense was due to
the winding down of a heavy product development cycle in preparation for sales
opportunities in the year 2000 and beyond. Higher manufacturing and royalty
costs were due to higher inventory markdown expense and a change in the mix of
products sold, which resulted in a higher percentage of revenues from products
with a higher royalty rate. Lower administrative expense was due to lower
employee-related costs. The increase in selling expense was due to higher
sampling and implementation expense related to the increase in sales
opportunities in 2000 and beyond.

     The K-12 Publishing segment's net sales of $684.3 million in 1999
represented a $50.1 million, or 7.9%, increase over 1998 net sales of $634.2
million. All divisions in this segment reported higher net sales in 1999
compared to 1998. Although sales opportunities were limited in elementary school
reading and language arts, the School Division's strongest markets and the
markets to which its customers direct the most funding, the School Division's
net sales increased year over year. This increase was due to the acquisition of
DiscoveryWorks and new product lines such as reading intervention, designed to
help students with difficulties in learning to read, and MathSteps. Great Source
reported increased net sales primarily due to higher sales of the Write Source
product line and new products in mathematics and reading and language arts.
Riverside's slightly higher sales were primarily due to increased sales of
clinical and custom products, mostly offset by lower state contract sales.
McDougal's net sales increased only slightly over 1998 and were lower than
expected. Increases in social studies revenues were offset by
lower-than-expected funding in both adoption and open territory states and lower
math sales. Sunburst Technology's net sales rose sharply, reflecting the May
acquisition of Sunburst Communications.

     Operating income for the K-12 Publishing segment decreased $0.8 million, or
0.8%, to $97.1 million in 1999 from $97.9 million in 1998. The resulting
operating margin for 1999 was 14.2% compared to 15.4% in 1998. This decrease in
operating margin was primarily due to increases in cost of sales, selling and
administrative expenses, and intangible asset amortization. Cost of sales
increased due to higher editorial

                                        17
<PAGE>   20

expenses incurred for new program development and product revisions in
preparation for sales opportunities in the year 2000 and beyond, partially
offset by lower plate amortization. Selling expenses increased due to expansion
of the sales staff and higher sampling and promotional expenses in anticipation
of the increased sales opportunities in the year 2000 and beyond. Administrative
expenses rose due to efforts to improve customer support systems and to address
the Year 2000 computer issue. The shift of Sunburst Technology to the K-12
Publishing segment also accounted for some of the increase in selling and
administrative costs. The increase in intangible asset amortization was due to
the 1998 acquisition of DiscoveryWorks and the 1999 acquisitions of Little
Planet and Sunburst Communications.

COLLEGE PUBLISHING

     The College Publishing segment reported 2000 net sales of $174.4 million, a
0.4% increase over 1999 net sales of $173.7 million. Strong sales of new
frontlist titles, including Zumdahl's Basic Chemistry, Aufmann's Intermediate
Algebra, and Cooper's Literacy, and higher sales in international markets were
offset by lower sales of backlist titles and lower sales to alternative markets,
particularly the high school advanced placement market, as well as higher
college book returns.

     The College Publishing segment's operating income was $24.4 million in
2000, an increase of $0.7 million, or 2.9%, from $23.7 million in 1999. The
resulting operating margin for 2000 was 14.0% compared to 13.7% in 1999. The
increase in operating margin was due to lower royalty and administrative costs.
Lower royalty costs were due to a change in the mix of products sold, which
resulted in a higher percentage of revenues from products with a lower royalty
rate. Lower administrative costs were primarily due to lower employee-related
costs partially offset by higher bad debt expense.

     The College Publishing segment reported 1999 net sales of $173.7 million, a
6.9% increase over 1998 net sales of $162.5 million. This increase was primarily
due to strong sales of new products and higher sales to the high school advanced
placement market.

     In 1999, operating income for the College Publishing segment increased $4.0
million, or 20.3%, to $23.7 million from $19.7 million in 1998. The resulting
operating margin for 1999 was 13.7% compared to 12.1% in 1998. The operating
margin improvement was primarily due to the increase in net sales and lower
manufacturing, editorial, and distribution expenses as a percent of sales in
1999 compared to 1998. These decreases were partially offset by higher
administrative expenses.

OTHER

     In 2000, the Other segment's net sales increased by $11.2 million, or
12.2%, to $102.6 million from $91.4 million in 1999. The Trade Division was the
major contributor to this gain due to its strong list of adult and children's
titles as well as the successful launch of The American Heritage(R) Dictionary
4th Edition.

     The Other segment's operating loss was $4.4 million for the twelve months
ended December 31, 2000, compared to $8.9 million in the same period of 1999.
The decrease in operating loss was primarily due to higher net sales and lower
manufacturing costs as a percentage of sales in the Trade Division, partially
offset by higher losses at CAT and higher spending on technology initiatives.

     In 1999, the Other segment's net sales increased by $1.9 million, or 2.1%,
to $91.4 million from $89.5 million in 1998. The Trade Division was the major
contributor to this gain with higher sales of adult trade titles. The sales
increase for the segment was also due to the inclusion of CAT, which was
acquired in July 1998. Lower revenues due to the shift of Sunburst Technology to
the K-12 Publishing segment beginning in 1999 partially offset these increases.

     The Other segment's operating loss was $8.9 million in 1999 compared to
$19.2 million in 1998. The lower operating loss was primarily due to the shift
of Sunburst Technology to the K-12 publishing segment, higher net sales, lower
manufacturing and distribution costs for the Trade Division, and the acquired
in-process research and development charge related to the CAT acquisition in
1998, partially offset by the higher operating expenses and intangible asset
amortization of CAT.

                                        18
<PAGE>   21

LIQUIDITY AND CAPITAL RESOURCES

     Houghton Mifflin's principal businesses are seasonal, with approximately
90% of revenues derived from educational publishing in the K-12 and College
Publishing segments, markedly seasonal businesses. We realize approximately
one-half of our net sales and a substantial portion of net income during the
third quarter and characteristically post a net loss in the first and fourth
quarters of the year.

     This sales seasonality affects our operating cash flow. Houghton Mifflin
normally incurs a net cash deficit from all of our activities through the middle
of the third quarter of the year. We fund the deficit through the draw-down of
cash and marketable securities, supplemented by short-term borrowings,
principally commercial paper.

     Net cash provided by operating activities was $121.7 million in 2000, a
decrease of $22.1 million from $143.8 million in 1999. Net income excluding
non-cash items increased $25.1 million in 2000 from 1999. Changes in operating
assets and liabilities used $47.2 million more cash in 2000 than 1999 due to
higher accounts receivable and inventories. Higher accounts receivable were
primarily due to the timing of sales, as fourth-quarter sales in 2000 increased
over the fourth quarter of 1999. Inventory levels increased in anticipation of
greater sales opportunities in 2001.

     Net cash provided by operating activities was $143.8 million in 1999, a
decrease of $3.0 million from $146.8 million in 1998. Net income excluding
non-cash items increased $12.2 million in 1999 from 1998. Changes in operating
assets and liabilities used $15.2 million more cash in 1999 than 1998 due to an
increase in tax payments and higher accounts receivable and inventories,
partially offset by higher accounts payable. Higher accounts receivable were
primarily due to the timing of sales, as fourth-quarter sales in 1999 increased
significantly over the fourth quarter of 1998. Inventory levels increased in
anticipation of greater sales opportunities in 2000.

     Cash used for investing activities was $132.1 million in 2000, a decrease
of $11.9 million from the $144.0 million required in 1999. The decrease reflects
a $26.9 million decrease for acquisitions of publishing and technology assets
and a $8.8 million decrease in property, plant, and equipment expenditures,
partially offset by a $22.8 million increase for book plate expenditures. The
net decrease was due to the 1999 acquisition of Sunburst Communications
partially offset by the May 2000 acquisition of VLT and higher plate
expenditures resulting from increased investments in new products for sales
opportunities in 2000 and beyond.

     Houghton Mifflin used $144.0 million in cash for investing activities in
1999, an increase of $46.2 million over the $97.8 million used during 1998. The
increase reflects a $20.4 million increase for acquisitions of publishing and
technology assets, a $13.7 million increase for book plate expenditures, and a
$10.6 million increase in property, plant, and equipment expenditures. The
increases were principally due to the following: the acquisitions of Sunburst
Communications and the Little Planet Literacy Series and a contingent
consideration payment related to the 1998 acquisition of CAT; higher investments
in new products; increased spending on information systems initiatives; and the
build out of the Trade Division's distribution facility.

     Net proceeds from financing activities were $13.3 million in 2000, due
primarily to the net issuance of $92.4 million in debt partially offset by
purchases of Houghton Mifflin common stock of $74.7 million and common stock
dividend payments of $15.0 million. Total debt increased to $438.5 million as of
December 31, 2000 from $346.0 million at the end of 1999. Houghton Mifflin's
percentage of debt (commercial paper borrowings, current portion of long-term
debt, and long-term debt) to total capitalization (debt plus stockholder's
equity) increased to 51.5% from the 44.4% at the end of 1999. We financed the
higher debt by increased commercial paper borrowings of $162.4 million,
partially offset by the repayment of $20 million of borrowings under the expired
five-year revolving credit facility and repayment of $50 million of floating
rate notes.

                                        19
<PAGE>   22

     Net proceeds from financing activities were $8.3 million in 1999, primarily
due to the net issuance of $39.3 million of debt partially offset by common
stock repurchases of $17.9 million and common stock dividend payments of $14.7
million. Total debt decreased to $346.0 million as of December 31, 1999 from
$369.7 million at the end of 1998. 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
44.4% at the end of 1999 from 48.1% at the end of 1998. The decrease in debt was
due to the non-cash redemption of the remaining $65.3 million in aggregate
principal amount of outstanding SAILS using INSO common stock, repayment of
$20.0 million of medium-term notes, and repayment of $30.0 million outstanding
under Houghton Mifflin's five-year revolving credit facility, offset by the
issuance of $80.0 million of medium-term notes and commercial paper borrowings
of $9.5 million.

     In 2000, Houghton Mifflin's average short-term borrowings were $160.2
million, an increase of $46.6 million from 1999. Seasonal borrowing needs
increased as a result of higher operating expenditures, increased working
capital requirements, acquisition of VLT, and common stock repurchases.

     In 1999, Houghton Mifflin's average short-term borrowings were $113.6
million, an increase of $41.3 million from 1998. Seasonal borrowing needs
increased as a result of higher operating expenditures, increased working
capital requirements, and the acquisition of Sunburst Communications, Inc.

     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, we redeemed 50%, or $65.3 million in aggregate principal
amount, of the outstanding SAILS. The SAILS were redeemed at an exchange rate
equal to two shares of the common stock of INSO, par value $0.01 per share, for
each SAILS, or approximately 1.9 million shares, and cash of $2.0 million for
the payment of accrued and unpaid interest at the date of the redemption. On
August 2, 1999, the remaining 50%, or $65.3 million in aggregate principal, of
the outstanding SAILS matured. In accordance with the terms of the SAILS, we
elected to deliver two shares of the common stock of INSO for each SAILS, or
approximately 1.9 million shares, and cash of $2.0 million for the payment of
all accrued and unpaid interest on the outstanding SAILS.

     In May 1999, Houghton Mifflin filed a registration statement on Form S-3
with the Securities and Exchange Commission covering up to $200 million of debt
securities and common stock, which may be issued in one or more offerings from
time to time. At December 31, 2000, we had not issued any debt securities or
common stock covered by this registration statement.

     At December 31, 2000, Houghton Mifflin Company had an aggregate of $400
million unsecured revolving credit facilities for which we pay annual commitment
fees. The $400 million is comprised of a $200 million 364-day revolving credit
facility and a $200 million five-year revolving credit facility. The $200
million 364-day credit facility, entered into on December 18, 2000, will mature
on December 17, 2001. The $200 million five-year revolving credit facility,
entered into on December 18, 2000, will expire on December 18, 2005. The
revolving credit facilities require us to comply with certain covenants, the
most restrictive of which include maintenance of a fixed-charge coverage ratio
and debt-to-earnings before interest, taxes, depreciation, and amortization
(EBITDA) ratio. At December 31, 2000, there was no amount outstanding on the
revolving credit facility. At December 31, 1999, the outstanding balance on the
revolving credit facility which expired on October 31, 2000 was $20 million, at
a weighted average interest rate of 6.75%. Management routinely evaluates
interest rates available to Houghton Mifflin under the revolving credit facility
compared to those available through the issuance of commercial paper.

     Houghton Mifflin currently expects that cash flow from operations for 2001
will be sufficient to cover investment activities and dividend payments as well
as to repay by year-end a portion of debt outstanding at the beginning of 2001.
We intend to continue using the short-term debt market, primarily commercial
paper, for seasonal liquidity needs. During 2001, Houghton Mifflin may refinance
a portion of existing short-term borrowings with long-term debt that would be
issued under our shelf registration statement.

                                        20
<PAGE>   23

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. Our 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 moderated in 1999 and 2000. Overall, we expect modest
increases in paper prices in 2001.

     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 $24.5 million in
2000 compared with $20.0 million in 1999.

     Houghton Mifflin's publishing business requires a high level of investment
in book plates for our educational and reference works, which represented
approximately 12.1% of total assets at December 31, 2000, and in other property,
plant, and equipment, which represented 7.0% of consolidated assets at December
31, 2000. We expect to continue to commit funds to the publishing areas through
both internal growth and acquisitions.

     Houghton Mifflin believes that by valuing our inventory using the LIFO
method, continuing to emphasize technological improvements, and quality control,
we can continue to moderate the impact of inflation on our operating results and
financial position.

ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT

     In connection with the acquisition of VLT in May 2000, Houghton Mifflin
wrote off in-process research and development totaling $1.3 million ($0.8
million after tax) in the second quarter of 2000. The charge was necessary
because we determined that the acquired technology had not yet reached
technological feasibility and had no future alternative use. This amount
represents an allocation of the purchase price related to new versions of
Assess2Learn (formerly CyberSTAR) and Assess2Know (formerly ActNow!).

     Assess2Learn is a web-based assessment product specifically targeted at the
K-12 market that provides student testing, scoring, and reporting. The
Assess2Learn in-process project will replace the existing Assess2Learn product
and will include the following features and functions: (1) test
formatting/printing which will allow for production of a test booklet from
Assess2Learn; (2) database storage, which involves storing test results to a new
area of the database and production of reports from that new area; (3) grouping
student-specific records written in Java, which will replace the existing Visual
Basic Code that exists around student and course management; and (4) a portal,
which provides online delivery of the test and view of the grade report.

     Assess2Know is a complete web-based training program that offers
educational professionals anytime, anywhere, precision training in a wide
variety of industry-standard desktop software applications. The Assess2Know
in-process project involves the creation of fully web-enabled delivery software;
the current Assess2Know product delivers assessments from the local PC drive.

     Houghton Mifflin anticipates that the products using the acquired
in-process research and development will be released during 2001. We expect that
the acquired in-process research and development will be successfully developed,
but we cannot be sure that the products will be commercially successful.

     The nature of the efforts required to develop the acquired in-process
research and development into commercially viable products principally relate to
the completion of all planning, designing, prototyping, verification, and
testing activities necessary to establish that the products can meet design
specifications, including functions, features and technical performance
requirements.
                                        21
<PAGE>   24

     We determined the value of the acquired in-process research and development
by estimating the projected net cash flows related to the products and the stage
of completion of the products and discounting these cash flows to their net
present value. We based the resulting projected net cash flows on management's
estimates of revenues and operating profits related to the products. The revenue
estimates we used to value the in-process research and development were based on
estimates of relevant market sizes and growth factors, expected trends in the
related technology, and the nature and expected timing of new product
introductions by Houghton Mifflin and our competitors. The rates utilized to
discount the net cash flows to the net present value were based on a discount
rate of 30% for Assess2Learn and 25% for Assess2Know. These discount rates took
into account the time value of money and investment risk factors described
above.

     The stage of completion at the time of the acquisition was 29% for
Assess2Learn and 41% for Assess2Know. The expected costs to complete are $0.3
million for Assess2Learn and $0.2 million for Assess2Know, and both projects are
expected to be completed by the first quarter of 2001.

     In connection with the acquisition of CAT in July 1998, Houghton Mifflin
wrote off in-process research and development totaling $3.5 million in 1998. The
charge was necessary because the acquired technology had not yet reached
technological feasibility and had no future alternative use. This amount
represented an allocation of the purchase price related to an application module
called CAT Software System Version 7. This project represented an integrated
application suite of products whose functionality included test development,
automated assembly and test production, test administration, scoring, automated
test reporting, and test security.

     The original estimate was to complete the development of CAT Software
System Version 7 in 1998 at a cost of an additional $0.1 million. Initial market
availability of the product was expected by 1999. Due to technology issues, the
CAT Software System Version 7 release was cancelled. Instead, Houghton Mifflin
decided to improve the product with a new release, CAT System Software Version
8. Version 8 was completed in the second quarter of 2000 for an additional cost
of approximately $1.4 million and incorporated some features created with
Version 7.

     The estimates used in valuing the in-process research and development were
based upon assumptions we believed to be reasonable but which are inherently
uncertain and unpredictable. Our assumptions may be incomplete or inaccurate,
and unanticipated events and circumstances may occur. Accordingly, actual
results may vary from the projected results. Any such variances may adversely
affect the sales and profitability of future periods. Additionally, the value of
other intangible assets may become impaired.

OUTLOOK

     Houghton Mifflin anticipates net sales growth of more than 10% in 2001
based on continued strong funding for instructional materials, particularly in
California, and the larger number of statewide adoption opportunities in our key
disciplines: reading, literature, and language arts. In addition, three states,
including California, the largest adoption state, are expected to be buying
mathematics. California has a large amount of funding available for purchase of
instructional materials, and the extent to which its school districts buy new
materials will have a significant effect on the industry and on our sales in
2001.

     Higher net sales are key to net income growth, since incremental sales are
relatively more profitable. If we achieve net sales growth of more than 10%, we
also expect the increase in operating income to be more than 10%. We expect to
achieve this growth even though we expect the effect of leverage from higher
sales to be moderated by factors including an expected $30 million increase in
plate amortization due to the large number of new programs published for 2001
sales opportunities and fewer residual textbook sales in the sales mix, which
are more profitable than new business due to lower selling costs. We expect our
ownership in Classwell to result in equity losses in 2001 of $6.6 million, or
$0.24 per diluted share, compared to $2.7 million, or $0.09 per diluted share,
in 2000. Even after this higher loss, Houghton Mifflin still expects earnings
per share to grow in the mid-single digit range.

     Achieving our targeted net sales growth in 2001 depends on a number of
factors. In the educational publishing segments of the business, these factors
include successful sales campaigns in both adoption and

                                        22
<PAGE>   25

open territory states for the School Division's new reading, mathematics, and
English programs and McDougal Littell's new literature, grammar, and mathematics
programs; sales of Riverside Publishing's new version of The Iowa Tests of Basic
Skills(R) and market acceptance and use of its new online assessment products; a
return to mid-single digit growth rates in the college market; and CAT's ability
to enter into new agreements for testing services and generate the related
revenue. We also expect college book returns to decrease to levels we have
experienced during recent years prior to 2000. Houghton Mifflin's ability to
achieve our targets is also subject to industry developments that affect net
income. We believe that college market purchases are affected by changing
developments in delivering educational content through technology and by the
growth of the used-book market. In the elementary and secondary markets, there
has been an increase in the amount of materials given away at no cost as
implementation, and greater competitive pressure to produce customized
instructional materials. Both of these factors increase the cost of doing
business. Finally, the number of textbook program components developed in
technology formats continues to grow, increasing the cost to develop new
programs. We will continue to monitor and evaluate these and any other emerging
developments, but acceleration of any of these developments will affect our
ability to achieve targeted earnings per share growth.

                                        23
<PAGE>   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 our commercial paper program and our
unsecured credit facility. Houghton Mifflin does not enter into speculative or
leveraged derivative transactions.

     Houghton Mifflin from time to time enters into transactions involving
financial instruments in order to manage our 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 attempts to achieve a
predetermined mix of fixed and floating-rate debt. During 2000, Houghton Mifflin
had two interest-rate swaps in place, each with a notional amount of $25
million. We pay the fixed rate on both swaps (5.90% and 5.95%) and receive a
variable rate based upon a commercial paper index. Both swaps terminated on
December 1, 2000.

     Each interest rate swap agreement was 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, 2000.

                                        24
<PAGE>   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.

                           INTEREST RATE SENSITIVITY
                        PRINCIPAL (NOTIONAL) AMOUNTS AND
                             AVERAGE INTEREST RATES

<TABLE>
<CAPTION>
                                                                                                              FAIR
                                                                                                             MARKET
                                                                                                              VALUE
                             2001       2002       2003       2004       2005     THEREAFTER     TOTAL      12/31/00
                           --------   --------   --------   --------   --------   -----------   --------   -----------
                                                (IN THOUSANDS OF DOLLARS, EXCEPT PERCENT AMOUNTS)
<S>                        <C>        <C>        <C>        <C>        <C>        <C>           <C>        <C>
LIABILITIES
Commercial paper.........  $183,791         --         --         --         --          --     $183,791    $183,791
Average interest rate....     7.56%         --         --         --         --          --           --          --
Long-term debt, including
  current portion........  $ 30,057         --         --   $ 99,805         --    $124,882     $254,744    $250,129
  Average interest
    rate.................     5.99%         --         --      7.13%         --       7.00%           --          --
</TABLE>

ITEM 8.  CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Management's Responsibility for Financial Statements........   26

Report of Independent Auditors..............................   27

Consolidated Balance Sheets at December 31, 2000 and 1999...   28

Consolidated Statements of Income for the years ended
  December 31, 2000, 1999 and 1998..........................   30

Consolidated Statements of Cash Flows for the years ended
  December 31, 2000, 1999 and 1998..........................   31

Consolidated Statements of Stockholders' Equity for the
  years ended December 31, 2000, 1999 and 1998..............   32

Notes to Consolidated Financial Statements..................   34
</TABLE>

SUPPLEMENTARY DATA

Summary of Quarterly Results of Operations (unaudited) is presented on page 57.

                                        25
<PAGE>   28

              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 four independent 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 of company
policies 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.

<TABLE>
<S>                                            <C>
Nader F. Darehshori                            Gail Deegan
Chairman, President,                           Executive Vice President and
and Chief Executive Officer                    Chief Financial Officer
</TABLE>

                                        26
<PAGE>   29

                         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, 2000 and 1999, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. 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, 2000 and 1999, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States. 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.

     As discussed in Note 1 to the financial statements, in 1999 Houghton
Mifflin Company changed its method of accounting for the amortization of book
plate assets.

                                            /s/ ERNST & YOUNG LLP

Boston, Massachusetts
January 26, 2001

                                        27
<PAGE>   30

                            HOUGHTON MIFFLIN COMPANY

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                        DECEMBER 31,
                                                              --------------------------------
                                                                   2000              1999
                                                              --------------    --------------
                                                              (IN THOUSANDS OF DOLLARS, EXCEPT
                                                                SHARE AND PER-SHARE AMOUNTS)
<S>                                                           <C>               <C>
                                            ASSETS

CURRENT ASSETS
     Cash and cash equivalents..............................    $   14,947        $   12,041
     Marketable securities and time deposits available for
      sale, at fair value...................................           638               638
     Accounts receivable....................................       193,919           178,887
          Less: allowance for bad debts and book returns....        30,857            31,207
                                                                ----------        ----------
                                                                   163,062           147,680
     Inventories............................................       207,537           164,228
     Deferred income taxes..................................        33,839            35,889
     Prepaid expenses.......................................         5,234             3,000
     Notes receivable.......................................            --             1,633
                                                                ----------        ----------
          Total current assets..............................       425,257           365,109
Property, plant, and equipment, net.........................        78,834            73,342
Book plates, less accumulated amortization of $105,596 in
  2000 and $115,222 in 1999.................................       135,980            98,894
OTHER ASSETS
     Royalty advances to authors, less allowance of $29,029
      in 2000 and $29,631 in 1999...........................        26,625            26,711
     Goodwill and other intangible assets, net..............       430,516           452,338
     Other investments and long-term receivables............        26,762            22,349
                                                                ----------        ----------
          Total other assets................................       483,903           501,398
                                                                ----------        ----------
                                                                $1,123,974        $1,038,743
                                                                ==========        ==========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.
                                        28
<PAGE>   31

                            HOUGHTON MIFFLIN COMPANY

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                     DECEMBER 31,
                                                              --------------------------
                                                                 2000           1999
                                                              -----------    -----------
                                                              (IN THOUSANDS OF DOLLARS,
                                                              EXCEPT SHARE AND PER-SHARE
                                                                       AMOUNTS)
<S>                                                           <C>            <C>
                          LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
     Accounts payable.......................................  $   57,016     $   55,601
     Commercial paper.......................................     183,791         21,358
     Royalties..............................................      53,581         51,141
     Salaries, wages, and commissions.......................      27,365         29,814
     Income taxes payable...................................       2,956          3,351
     Other..................................................      32,387         27,895
     Current portion of long-term debt......................      30,057         70,037
                                                              ----------     ----------
          TOTAL CURRENT LIABILITIES.........................     387,153        259,197
Long-term debt..............................................     224,687        254,638
Accrued royalties payable...................................       2,054            967
Other liabilities...........................................      38,735         33,406
Accrued postretirement benefits.............................      28,791         29,213
Deferred income taxes.......................................      28,692         28,301
Commitments and contingencies (Notes 3, 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; 31,861,472 shares issued in 2000 and
      31,098,023 shares issued in 1999......................      31,861         31,098
     Capital in excess of par value.........................     139,532        108,627
     Retained earnings......................................     433,069        392,225
                                                              ----------     ----------
                                                                 604,462        531,950
     Notes receivable from stock purchase agreements........     (16,145)        (4,645)
     Unearned compensation related to restricted stock......      (2,141)        (3,029)
     Common shares held in treasury, at cost, 3,081,701
      shares in 2000 and 1,045,493 shares in 1999...........    (112,032)       (36,411)
     Benefits Trust assets, at market.......................     (60,282)       (54,844)
                                                              ----------     ----------
          TOTAL STOCKHOLDERS' EQUITY........................     413,862        433,021
                                                              ----------     ----------
                                                              $1,123,974     $1,038,743
                                                              ==========     ==========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.
                                        29
<PAGE>   32

                            HOUGHTON MIFFLIN COMPANY

                       CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                              FOR THE YEARS ENDED DECEMBER 31,
                                                             ----------------------------------
                                                                2000         1999        1998
                                                             ----------    --------    --------
                                                              (IN THOUSANDS OF DOLLARS, EXCEPT
                                                                     PER-SHARE AMOUNTS)
<S>                                                          <C>           <C>         <C>
NET SALES..................................................  $1,027,637    $949,448    $886,266
COSTS AND EXPENSES
     Cost of sales.........................................     434,267     411,114     390,922
     Selling and administrative............................     453,292     426,374     393,324
     Asset impairment charge...............................       2,488          --          --
     Acquired in-process research and development..........       1,300          --       3,500
                                                             ----------    --------    --------
                                                                891,347     837,488     787,746
                                                             ----------    --------    --------
OPERATING INCOME...........................................     136,290     111,960      98,520
OTHER INCOME (EXPENSE)
     Net interest expense..................................     (31,806)    (29,770)    (33,981)
     Equity in losses of equity method investee............      (2,737)         --          --
     Write-down of investment..............................      (4,553)         --          --
     Gains (losses) on INSO Corporation common stock and
       equity in earnings (losses) of INSO Corporation.....          --      (5,100)     18,797
     Loss on sale of investment............................          --          --      (3,017)
     Other expense.........................................          --          --      (1,050)
                                                             ----------    --------    --------
                                                                (39,096)    (34,870)    (19,251)
                                                             ----------    --------    --------
Income before taxes and extraordinary item.................      97,194      77,090      79,269
Income tax provision.......................................      41,370      31,106      33,630
                                                             ----------    --------    --------
Income before extraordinary item...........................      55,824      45,984      45,639
Extraordinary gain on extinguishment of debt, net of tax of
  $21,956 in 1999 and $13,042 in 1998......................          --      30,320      18,010
                                                             ----------    --------    --------
Net income.................................................  $   55,824    $ 76,304    $ 63,649
                                                             ==========    ========    ========
EARNINGS PER SHARE:
Basic
     Income before extraordinary item......................  $     1.94    $   1.60    $   1.59
     Extraordinary gain on extinguishment of debt..........          --        1.05        0.63
                                                             ----------    --------    --------
     Net income............................................  $     1.94    $   2.65    $   2.22
                                                             ==========    ========    ========
Diluted
     Income before extraordinary item......................  $     1.92    $   1.57    $   1.57
     Extraordinary gain on extinguishment of debt..........          --        1.03        0.62
                                                             ----------    --------    --------
     Net income............................................  $     1.92    $   2.60    $   2.19
                                                             ==========    ========    ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.
                                        30
<PAGE>   33

                            HOUGHTON MIFFLIN COMPANY

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                              FOR THE YEARS ENDED DECEMBER 31,
                                                              ---------------------------------
                                                                 2000        1999        1998
                                                              ----------   ---------   --------
                                                                  (IN THOUSANDS OF DOLLARS)
<S>                                                           <C>          <C>         <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
     Net income.............................................  $   55,824   $  76,304   $ 63,649
     Adjustments to reconcile net income to net cash
       provided by operating activities:
          Equity in losses of equity method investee........       2,737          --         --
          Extraordinary gain on extinguishment of debt, net
            of tax..........................................          --     (30,320)   (18,010)
          Depreciation and amortization expense.............     103,564      94,115     95,681
          Amortization of unearned compensation on
            restricted stock................................       1,061       1,200      5,177
          Losses (gains) on INSO Corporation common stock
            and equity in earnings of INSO Corporation......          --       5,100    (18,797)
          Write-down of investment..........................       4,553          --         --
          Asset impairment charge...........................       2,488          --         --
          Acquired in-process research and development......       1,300          --      3,500
          Loss on sale of long-term investment..............          --          --      3,017
     Changes in operating assets and liabilities:
          Accounts receivable...............................     (14,022)     (1,534)    16,805
          Inventories.......................................     (43,309)    (11,266)    (1,626)
          Accounts payable..................................       1,349      15,640     (9,006)
          Royalties, net....................................       2,718      (1,619)     6,356
          Deferred and income taxes payable.................       2,046     (12,283)   (10,877)
          Other, net........................................       1,377       8,449     10,928
                                                              ----------   ---------   --------
               NET CASH PROVIDED BY OPERATING ACTIVITIES....     121,686     143,786    146,797
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
     Book plate expenditures................................     (89,766)    (66,979)   (53,255)
     Acquisition of publishing and technology assets, net of
       cash acquired........................................     (18,372)    (45,266)   (24,845)
     Property, plant, and equipment expenditures............     (22,527)    (31,335)   (20,729)
     Issuance of notes receivable...........................      (1,407)     (1,133)        --
     Proceeds from the sale of INSO Corporation stock.......          --         682        210
     Proceeds from the sale of long-term investment.........          --          --        835
     Purchase of marketable securities......................          --          --        (24)
                                                              ----------   ---------   --------
               NET CASH USED IN INVESTING ACTIVITIES........    (132,072)   (144,031)   (97,808)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
     Dividends paid on common stock.........................     (14,980)    (14,748)   (14,388)
     Issuance (repayment) of commercial paper...............     162,433       9,464    (49,452)
     Proceeds from the issuance of long-term financing......          --      80,000     50,000
     Payment of long-term financing.........................     (70,049)    (50,181)   (40,000)
     Exercise of stock options..............................       9,849       1,583      2,875
     Purchase of common stock...............................     (74,690)    (17,873)        --
     Other..................................................         729          88        308
                                                              ----------   ---------   --------
               NET CASH PROVIDED BY (USED IN) FINANCING
                 ACTIVITIES.................................      13,292       8,333    (50,657)
Increase (decrease) in cash and cash equivalents............       2,906       8,088     (1,668)
Cash and cash equivalents at beginning of year..............      12,041       3,953      5,621
                                                              ----------   ---------   --------
CASH AND CASH EQUIVALENTS AT END OF YEAR....................  $   14,947   $  12,041   $  3,953
                                                              ==========   =========   ========
SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION:
     Income taxes paid......................................  $   35,935   $  43,416   $ 40,693
     Interest paid..........................................  $   32,816   $  29,242   $ 33,875
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.
                                        31
<PAGE>   34

                            HOUGHTON MIFFLIN COMPANY

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                COMMON         CAPITAL
                                                                STOCK         IN EXCESS      RETAINED
   FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998      $1 PAR VALUE    OF PAR VALUE    EARNINGS
      (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)        ------------    ------------    --------
<S>                                                          <C>             <C>             <C>
BALANCE AT JANUARY 1, 1998.................................    $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
                                                               =======         ========      ========
Comprehensive income:
Net income.................................................         --               --        76,304
Other comprehensive income, net of tax:
     Reclassification adjustment on realized loss on sale
       of security.........................................         --               --            --
     Total comprehensive income............................         --               --            --
Common stock dividends, $0.51 per share....................         --               --       (14,748)
Stock options exercised....................................        463           10,318            --
Issuance of restricted stock...............................         48            2,231            --
Restricted stock forfeited.................................         --               --            --
Executive stock repurchases................................         --               --            --
Purchases of treasury stock................................         --               --            --
Other equity transactions, net.............................         37            1,601            (3)
Benefits Trust asset remeasurement.........................         --           (6,581)           --
Amortization of unearned compensation on restricted
  stock....................................................         --               --            --
Tax benefit related to stock plan activities...............         --            5,318            --
                                                               -------         --------      --------
BALANCE AT DECEMBER 31, 1999...............................     31,098          108,627       392,225
                                                               =======         ========      ========
Comprehensive income:
Net income.................................................         --               --        55,824
Common stock dividends, $0.52 per share....................         --               --       (14,980)
Stock options exercised....................................        716           20,623            --
Issuance of restricted stock...............................         17              695            --
Restricted stock forfeited.................................         --               --            --
Executive stock repurchases................................         --               --            --
Issuance of notes receivable for stock purchases...........         --               --            --
Purchases of treasury stock................................         --               --            --
Other equity transactions, net.............................         30            1,170            --
Benefits Trust asset remeasurement.........................         --            5,444            --
Amortization of unearned compensation on restricted
  stock....................................................         --               --            --
Tax benefit related to stock plan activities...............         --            2,973            --
                                                               -------         --------      --------
BALANCE AT DECEMBER 31, 2000...............................    $31,861         $139,532      $433,069
                                                               =======         ========      ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.
                                        32
<PAGE>   35

<TABLE>
<CAPTION>
                              UNEARNED                                                  ACCUMULATED
     NOTES RECEIVABLE       COMPENSATION           TREASURY STOCK                          OTHER
        FROM STOCK           RELATED TO       ------------------------    BENEFITS     COMPREHENSIVE
    PURCHASE AGREEMENTS   RESTRICTED STOCK      SHARES        AMOUNT        TRUST      INCOME (LOSS)     TOTAL
    -------------------   ----------------    -----------    ---------    ---------    -------------    --------
<S> <C>                   <C>                 <C>            <C>          <C>          <C>              <C>
         $ (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
         ========             =======         ===========    =========    =========      ========       ========
               --                  --                  --           --           --            --
               --                  --                  --           --           --       (18,378)
               --                  --                  --           --           --            --         57,926
               --                  --                  --           --           --            --        (14,748)
               --                  --            (201,500)      (9,198)          --            --          1,583
               --              (2,279)                 --           --           --            --             --
               --                 368             (11,069)        (368)          --            --             --
              148                  --                  --           --           --            --            148
               --                  --            (452,281)     (17,873)          --            --        (17,873)
             (172)                 --              (6,591)        (291)           7            --          1,179
               --                  --                  --           --        6,581            --             --
               --               1,200                  --           --           --            --          1,200
               --                  --                  --           --           --            --          5,318
         --------             -------         -----------    ---------    ---------      --------       --------
           (4,645)             (3,029)         (1,045,493)     (36,411)     (54,844)            0        433,021
         ========             =======         ===========    =========    =========      ========       ========
               --                  --                  --           --           --            --         55,824
               --                  --                  --           --           --            --        (14,980)
               --                  --              (1,154)         (47)          --            --         21,292
               --                (712)                 --           --           --            --             --
               --                 539             (16,176)        (539)          --            --             --
              536                  --                  --           --           --            --            536
          (11,204)                 --                  --           --           --            --        (11,204)
               --                  --          (2,010,273)     (74,690)          --            --        (74,690)
             (832)                 --              (8,605)        (345)           6            --             29
               --                  --                  --           --       (5,444)           --             --
               --               1,061                  --           --           --            --          1,061
               --                  --                  --           --           --            --          2,973
         --------             -------         -----------    ---------    ---------      --------       --------
         $(16,145)            $(2,141)         (3,081,701)   $(112,032)   $ (60,282)     $      0       $413,862
         ========             =======         ===========    =========    =========      ========       ========
</TABLE>

          See accompanying Notes to Consolidated Financial Statements.


                                        33
<PAGE>   36

                            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 our 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:

     Houghton Mifflin accounts for our investment in debt and equity securities
in accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," or SFAS 115.

     Marketable securities included in current assets consist of instruments
with original maturities of three months or greater. At December 31, 2000, the
securities consisted of time deposits and are stated at fair value, which
approximates cost due to the short maturity of the instruments. The fair values
are estimated based on quoted market prices.

INVENTORIES:

     Inventory balances at December 31, 2000 and 1999, were as follows:

<TABLE>
<CAPTION>
                                                             2000       1999
                                                           --------   --------
                                                             (IN THOUSANDS)
<S>                                                        <C>        <C>
Finished goods...........................................  $193,136   $152,818
Work in process..........................................     6,585      5,584
Raw materials............................................     7,816      5,826
                                                           --------   --------
                                                           $207,537   $164,228
                                                           ========   ========
</TABLE>

     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, net of any reserves needed on a FIFO basis,
inventory values would have been higher by approximately $19.8 million at both
December 31, 2000 and December 31, 1999.

                                        34
<PAGE>   37
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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:

<TABLE>
<CAPTION>
                                                       ESTIMATED USEFUL LIFE
                                                -----------------------------------
<S>                                             <C>
Building and building equipment...............  10 to 35 years
Machinery, equipment, and capitalized
  software....................................  3 to 15 years
Leasehold improvements........................  Lesser of useful life or lease term
</TABLE>

     Balances of major classes of assets and allowances for depreciation and
amortization at December 31, 2000 and 1999, were as follows:

<TABLE>
<CAPTION>
                                                             2000       1999
                                                           --------   --------
                                                             (IN THOUSANDS)
<S>                                                        <C>        <C>
Land and land improvements...............................  $  1,712   $  2,164
Building and building equipment..........................    21,133     20,822
Machinery, equipment, and capitalized software...........   135,707    113,626
Leasehold improvements...................................    13,910     13,517
                                                           --------   --------
          Total..........................................   172,462    150,129
Less: allowances for depreciation and amortization.......   (93,628)   (76,787)
                                                           --------   --------
Property, plant, and equipment, net......................  $ 78,834   $ 73,342
                                                           ========   ========
</TABLE>

     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 $16.9 million in 2000; $12.5
million in 1999; and $10.4 million in 1998.

BOOK PLATES:

     Beginning in 1999, Houghton Mifflin implemented a change in the method of
accounting for the amortization of book plate assets. The change was from a
class of assets method previously used to a specific identification method by
which amortization commences in the year of publication. This change was made
prospectively for book plate additions beginning in 1999. We believe the change
reflects a better matching of amortization expense with the related revenue and
is consistent with the method used by other major publishers. This change
resulted in a decrease in amortization expense of approximately $5.1 million
($3.1 million after tax), or $0.10 per share, for the twelve months ended
December 31, 1999.

     Houghton Mifflin's investment in book plates is capitalized and amortized
over three to five years using the sum-of-the-years digits method. This policy
is used by all divisions, except for Riverside, which uses the straight-line
method, and the Trade Division, which expenses its book plates for all products
except reference and dictionary materials. Amortization expense was
approximately $52.7 million in 2000; $49.8 million in 1999; and $56.8 million in
1998.

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," or SFAS 109. 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.

                                        35
<PAGE>   38
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

GOODWILL AND OTHER INTANGIBLE ASSETS:

     Goodwill and other intangible assets at December 31, 2000 and 1999,
consisted of the following:

<TABLE>
<CAPTION>
                                                          2000        1999
                                                        ---------   ---------
                                                           (IN THOUSANDS)
<S>                                                     <C>         <C>
Goodwill.............................................   $ 554,946   $ 545,251
Publishing rights and titles.........................      24,634      24,874
Other................................................      15,330      15,860
                                                        ---------   ---------
          Total......................................     594,910     585,985
Less: accumulated amortization.......................    (164,394)   (133,647)
                                                        ---------   ---------
Goodwill and other intangibles, net..................   $ 430,516   $ 452,338
                                                        =========   =========
</TABLE>

     Intangible assets are amortized using the straight-line method over the
estimated useful lives as follows: Goodwill (7-20 years); Publishing rights and
titles (5-15 years); Other intangibles (various). Amortization expense on
intangible assets, principally goodwill, was approximately $34.0 million in
2000; $31.9 million in 1999; and $28.5 million in 1998.

IMPAIRMENT EVALUATION:

     Houghton Mifflin examines periodically the carrying value of our long-lived
assets, certain identifiable intangibles, and goodwill to determine whether
there are any impairment losses. We perform an impairment assessment if certain
indicators are present, such as a significant decrease in demand for a product
related to an asset, a history of operating cash flow losses, or a projection or
forecast that demonstrates continuing losses associated with a revenue producing
asset. We use the undiscounted cash flow method to determine if impairment has
occurred. If indicators of impairment are present, and we do not expect the
estimated undiscounted cash flows to be derived from the related assets to be
sufficient to recover the asset's carrying amount, an impairment loss is charged
to expense in the period identified based upon the difference between the
carrying amount and the discounted cash flows. The rates that would be utilized
to discount the net cash flows to net present value would take into account the
time value of money and investment risk factors.

     See Note 15, Special Charges, for the impairment of the value of certain
long-lived assets, identifiable intangibles, and goodwill recorded as of
December 31, 2000. As part of our impairment assessment we have considered the
long-lived assets, identifiable intangibles and goodwill attributable to our
Computer Adaptive Technologies, Inc., or CAT business. An impairment assessment
was performed due to CAT's operating cash flow losses. While losses had been
forecast, certain aspects of our CAT business have not performed as originally
planned. Plans are in place to improve CAT's operating cash flows, which are
dependent on CAT's ability to enter into new agreements for testing services and
generate the related revenue. Based on these plans at this time, the
undiscounted cash flows are expected to recover the assets' carrying amounts.

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 prices in 1992. The Trust is available to fund certain
compensation and benefit plan obligations. The common stock is carried at market
value with changes in share price from prior reporting periods reflected as an
adjustment to capital in excess of par value.

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

                                        36
<PAGE>   39
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

stock option grants in accordance with Accounting Principle Board Opinion No.
25, "Accounting for Stock Issued to Employees," or APB 25, 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 during which the restriction lapses. For performance
restricted stock awards, adjustments are also made to recognize expense based
upon achievement of the applicable financial goals.

     Houghton Mifflin has adopted the disclosure-only provision of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," or SFAS 123 (see Note 6).

COMPREHENSIVE INCOME:

     Houghton Mifflin reports comprehensive income as required by Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," or
SFAS 130. 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.

     Total comprehensive income amounted to $55.8 million for the twelve months
ended December 31, 2000, $57.9 million for the twelve months ended December 31,
1999, and $83.9 million for the twelve months ended December 31, 1998. There
were no items of other comprehensive income in 2000.

SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION:

     Houghton Mifflin reports segment information in accordance with Statement
of Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information," or SFAS 131. SFAS 131 requires public
companies to report financial and descriptive information about their operating
segments in interim financial reports to shareholders as well. 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 and
corporations.

  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, allowance for bad debts, recoverability of advances to
authors, inventory valuation, amortization periods, and recoverability of
long-term assets such as book plates, intangibles, and goodwill.

                                        37
<PAGE>   40
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

REVENUE RECOGNITION:

     Houghton Mifflin derives revenue primarily from the sale of textbooks and
instructional materials, trade books, test materials, multimedia instructional
programs, license fees for book rights and content, and services which include
test scoring, test development, and training.

     Beginning in the fourth quarter of 2000, Houghton Mifflin implemented Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," or
SAB 101. SAB 101 requires that the following criteria must be met before
revenues can be recorded: (1) persuasive evidence that an arrangement exists,
(2) delivery has occurred or services have been rendered, (3) the seller's price
to the buyer is fixed or determinable, and (4) collectibilty is reasonably
assured. There was no cumulative effect associated with implementing SAB 101.

     Revenues from textbooks and instructional materials, trade books, test
materials, and multimedia instructional programs are recognized in the period
when persuasive evidence of an arrangement with the customer exists, the
products are shipped and title has transferred to the customer, all significant
obligations have been delivered, and collection is considered probable. As our
products are shipped with right of return, a provision for estimated returns on
these sales is made at the time of sale, in accordance with Statement of
Financial Accounting Standards No. 48, "Revenue Recognition When Right of Return
Exists," or SFAS 48, based on historical experience. Also, the cost of any
inconsequential obligation related to the sale is accrued at that time.
Textbooks shipped from a depository location are recorded one month in arrears
based on information received from the depository.

     Revenues for test scoring are recognized in the period when the scoring
services have been completed, the scoring fee is fixed and determinable, and
collection is probable. Revenues for fixed-priced contracts that require
significant test development are recognized on a percentage-of-completion
method.

     Houghton Mifflin also enters into license agreements to license certain
book publishing rights. Houghton Mifflin recognizes revenue on such arrangements
only when the contract is signed, the license term has begun, all obligations
have been delivered to the customer, and collection is probable.

SHIPPING AND HANDLING FEES:

     As required in the fourth quarter of 2000, Houghton Mifflin implemented the
consensus of the Emerging Issues Task Force Issue 00-10, "Accounting for
Shipping and Handling Fees and Costs," or EITF 00-10, and reclassified its
shipping and handling fees from selling and administrative expenses to net
sales. Previously, Houghton Mifflin classified shipping and handling fees, net
of shipping and handling costs, as selling and administrative expenses. The
effect of reclassification was to increase net sales and selling and
administrative expenses by $34.8 million in 2000, $29.3 million in 1999, and
$24.6 million in 1998. This reclassification had no effect on net income in any
period.

PENDING ACCOUNTING PRONOUNCEMENTS:

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," or SFAS 133. As amended in June 2000 by Statement of
Financial Accounting Standards No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," or SFAS 138, it requires companies
to recognize all derivatives as either assets or liabilities in the balance
sheet and measure such instruments at fair value. Derivatives that are not
determined to be hedges must be adjusted to fair value through net income. As
amended by Statement of Financial Accounting Standards No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133," or SFAS 137, the provisions of SFAS 133 will require
adoption no later than the beginning of our fiscal year ending December 31,
2001. Houghton Mifflin had two interest rate swaps which expired on December 1,
2000. We

                                        38
<PAGE>   41
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

do not anticipate holding any derivative instruments in the near future.
Accordingly, adoption of SFAS 133, as amended by SFAS 138, is not expected to
have a material effect on our consolidated financial statements.

NOTE 2.  ACQUISITIONS AND INVESTMENTS

     On May 3, 2000, Houghton Mifflin acquired the net assets of Virtual
Learning Technologies, Inc., or VLT, an educational testing company that
specializes in online assessments. VLT has been integrated into The Riverside
Publishing Company. This acquisition was accounted for as a purchase, and the
assets acquired, liabilities assumed, and results of operations are included in
Houghton Mifflin's consolidated financial statements from the date of the
acquisition. Net cash consideration for the acquisition amounted to
approximately $14.6 million paid to the former shareholders of VLT. The cost of
the acquisition was allocated on the basis of the estimated fair market value of
the assets acquired and liabilities assumed, including acquired in-process
research and development. A charge for acquired in-process research and
development of $1.3 million was also recorded as part of the acquisition.
Goodwill and other intangible assets of $12.8 million were recorded as part of
the acquisition and are being amortized on a straight-line basis over periods
ranging from approximately 2 to 7 years.

     On May 5, 1999, Houghton Mifflin acquired all of the outstanding stock of
Sunburst Communications, Inc., or Sunburst, a leading developer of software and
video instructional materials. This acquisition was accounted for as a purchase,
and the net assets acquired, liabilities assumed, and results of operations are
included in Houghton Mifflin's consolidated financial statements from the date
of the acquisition. Net cash consideration for the acquisition amounted to
approximately $34.4 million, of which $32.0 million was paid to the former
shareholders of Sunburst and $2.4 million was expended to repay debt and pay
other acquisition-related fees. The cost of the acquisition was allocated on the
basis of the estimated fair market value of the assets acquired and liabilities
assumed. Goodwill and other intangible assets of $31.0 million were recorded as
part of the acquisition and are being amortized on a straight-line basis over
periods ranging from approximately 7 to 20 years.

     On January 8, 1999, Houghton Mifflin acquired the assets of the Little
Planet Literacy Series, a technology-based pre-kindergarten to grade three
literacy program, from Applied Learning Technologies, Inc. The acquisition was
accounted for as a purchase, and the net assets and results of operations are
included in Houghton Mifflin's consolidated financial statements from the date
of the acquisition. Net cash consideration for the acquisition amounted to
approximately $4.6 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 purchase price over the net assets
acquired, or goodwill, will be amortized on a straight-line basis over a period
of approximately 8 years.

     On December 23, 1998, Houghton Mifflin acquired the assets of
DiscoveryWorks, a science program for the elementary school market, from Silver
Burdett Ginn Inc., a subsidiary of Pearson Plc. The acquisition was accounted
for as a purchase, and the net assets and results of operations are included in
Houghton Mifflin's consolidated financial statements from the date of the
acquisition. Net cash consideration for the acquisition amounted to
approximately $11.1 million. The cost of the acquisition was allocated on the
basis of the estimated fair market value of the assets acquired. The excess of
the net assets acquired, or goodwill, is being amortized on a straight-line
basis over a period of 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 in 1998 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.

                                        39
<PAGE>   42
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The acquisition agreement allowed for up to an additional $6 million of
consideration, contingent upon the achievement of certain operational and
financial targets. In January 1999, an additional $2 million was paid to the
former shareholders of CAT based on the achievement of operational targets set
forth in the acquisition agreement, which resulted in additional goodwill. The
remaining additional contingent consideration of up to $4 million was contingent
on achievement of certain financial targets which were not achieved, and
accordingly, no additional consideration is owed. A charge for acquired
in-process research and development of $3.5 million was also recorded as part of
the acquisition. As of the acquisition date, CAT had only one product that
qualified as in-process research and development, CAT Software System Version 7.
This project represented an integrated application suite of products whose
functionality included test development, automated assembly and test production,
test administration, scoring, automated test reporting, and test security. The
amount of the charge represented 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. Including the contingent
payment made in 1999, goodwill and other intangible assets of $9.4 million were
recorded as part of the acquisition and are being amortized on a straight-line
basis over periods ranging from approximately 3 to 10 years.

     Since none of the above acquisitions materially affected consolidated
results, no pro forma information is provided.

     On September 6, 2000, Houghton Mifflin Company, Sylvan Ventures, and
Inception Capital launched Classwell Learning Group Inc., or Classwell, a
start-up online education company which will provide K-12 teachers with new
teaching and learning resources to meet their individual classroom needs and
those of their students. Houghton Mifflin committed to invest $7 million of
cash, $2.3 million of which was paid in 2000, and the remainder to be paid in
2001. We also contributed other assets for a fully-diluted ownership interest in
Classwell of approximately 32%. Houghton Mifflin accounts for this investment on
the equity method and records its share of Classwell's undistributed losses.

     In the third quarter of 2000, Houghton Mifflin reviewed the value of our
investment in a distance learning company and estimated that the value had
suffered a decline which was other than temporary. The assessment that this
investment was impaired as of September 30, 2000, was due to the following: (1)
changes in the investee's expectation regarding the timing of its profitability,
(2) the investee's present lack of resources to fund future operations, and (3)
an inability of this investee to raise additional capital at valuations
acceptable to its management and board of directors. As a result of these
factors, Houghton Mifflin decided not to extend additional financing to the
investee in the third quarter of 2000. Houghton Mifflin believes that if the
investee is able to raise additional financing in the future, its investment
will be significantly diluted, reducing our ability to recover this investment.
Therefore, at September 30, 2000, the investment was written down to its
estimated net realizable value, resulting in a charge of $4.6 million ($2.9
million after tax), or $0.10 per share. This amount is reported as "Write-down
of investment" in a separate line item in the accompanying consolidated
financial statements.

                                        40
<PAGE>   43
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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:

<TABLE>
<CAPTION>
                                                           2000        1999
                                                         --------    --------
                                                            (IN THOUSANDS)
<S>                                                      <C>         <C>
Tax asset-related:
     Pension and postretirement benefits...............  $ 24,329    $ 23,658
     Publishing expense................................    34,759      28,962
     Allowance for book returns........................     4,488       5,046
     Deferred compensation.............................     5,638       3,962
     Other, net........................................     2,139       3,901
                                                         --------    --------
                                                           71,353      65,529
                                                         --------    --------
Tax liability-related:
     Depreciation and amortization expense.............   (22,577)    (10,926)
     Intangible assets.................................   (39,003)    (39,446)
     Deferred income...................................      (623)       (666)
     Other, net........................................    (4,003)     (6,903)
                                                         --------    --------
                                                          (66,206)    (57,941)
                                                         --------    --------
Net deferred tax asset.................................  $  5,147    $  7,588
                                                         ========    ========
</TABLE>

     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.

     The net deferred tax asset balance included $5.3 million in 2000 and $5.9
million in 1999 for a deferred tax liability due to differences between the book
and tax basis of the intangible assets acquired from Sunburst Communications,
Inc.

     Significant components of the provision for income taxes attributable to
income before taxes consist of the following:

<TABLE>
<CAPTION>
                                                 2000       1999       1998
                                                -------    -------    -------
                                                       (IN THOUSANDS)
<S>                                             <C>        <C>        <C>
Current:
     Federal..................................  $32,314    $26,865    $29,034
     State and other..........................    6,615      4,041      2,434
                                                -------    -------    -------
          Total current.......................   38,929     30,906     31,468
Deferred:
     Federal..................................    2,099        171      1,520
     State and other..........................      342         29        642
                                                -------    -------    -------
          Total deferred......................    2,441        200      2,162
                                                -------    -------    -------
                                                $41,370    $31,106    $33,630
                                                =======    =======    =======
</TABLE>

                                        41
<PAGE>   44
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     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:

<TABLE>
<CAPTION>
                                                         2000    1999    1998
                                                         ----    ----    ----
<S>                                                      <C>     <C>     <C>
Federal statutory rate.................................  35.0%   35.0%   35.0%
State income taxes, net of federal benefit.............   3.3     3.0     3.1
Non-deductible goodwill amortization...................   3.6     2.5     2.7
Acquired in-process research and development...........   0.0     0.0     1.5
Other..................................................   0.7    (0.1)    0.1
                                                         ----    ----    ----
Effective tax rate.....................................  42.6%   40.4%   42.4%
                                                         ====    ====    ====
</TABLE>

     As part of the normal examination of Houghton Mifflin's federal income tax
returns for the fiscal years ended 1992 through 1998, the Internal Revenue
Service (IRS) has made inquiries related to our corporate-owned life insurance
(COLI) program. The inquiries have principally focused on the deductibility of
interest on policy loans associated with Houghton Mifflin's COLI program.
Houghton Mifflin is aware that the IRS has challenged other taxpayers' COLI
programs and that recent court cases have been decided in favor of the IRS
position on such COLI programs, although the cases and the related decisions are
being appealed. No adjustments to Houghton Mifflin's taxable income have been
proposed by the IRS on this matter. Houghton Mifflin estimates that it is
reasonably possible that the IRS may assert that the COLI interest deductions
were not deductible. Houghton Mifflin estimates that, should such a claim be
asserted by the IRS, the maximum potential exposure for an unfavorable
adjustment would be approximately $9 million, including interest through
December 31, 2000. Houghton Mifflin would likely contest any such proposed
adjustment or assessment relating to the COLI program. However, the outcome of
any such assertion, if made, or the success of any such contest cannot be
estimated at this time. Houghton Mifflin does not have any provision for the
related tax and interest in our consolidated financial statements should the IRS
assert such a claim and ultimately be successful.

NOTE 4.  DEBT AND BORROWING AGREEMENTS

     At December 31, 2000, Houghton Mifflin had $400 million in unsecured
revolving credit facilities for which we pay annual commitment fees. The
revolving credit facilities replace the $300 million credit facility that
expired on October 31, 2000. The $400 million revolving credit facilities are
structured as follows: a $200 million five-year revolving commitment, which
expires on December 18, 2005, and a $200 million 364-day facility, which expires
on December 17, 2001. The revolving credit facilities requires Houghton Mifflin
to comply with certain covenants, the most restrictive of which include
maintenance of a fixed-charge coverage ratio and debt-to-earnings before
interest, taxes, depreciation, and amortization (EBITDA) ratio. At December 31,
2000, there was no outstanding balance on the revolving credit facilities. At
December 31, 1999, the outstanding balance on the revolving credit facility
which expired on October 31, 2000 was $20 million, at a weighted average
interest rate of 6.75%. Management routinely compares and evaluates interest
rates available to Houghton Mifflin under the revolving credit facility to those
available through the issuance of commercial paper.

                                        42
<PAGE>   45
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
                                                                2000        1999
                                                              --------    --------
                                                                 (IN THOUSANDS)
<S>                                                           <C>         <C>
7.00% Notes due March 1, 2006, interest payable
  semi-annually.............................................  $124,882    $124,859
7.125% Notes due April 1, 2004, interest payable
  semi-annually.............................................    99,805      99,745
Borrowings from financial institutions, unsecured, under
  committed five-year credit facility, expiring October 31,
  2000......................................................        --      20,000
Floating Rate Notes due December 1, 2000, interest payable
  quarterly.................................................        --      50,000
5.99% Notes due December 3, 2001, interest payable
  semi-annually.............................................    30,000      30,000
Other.......................................................        57          71
                                                              --------    --------
                                                               254,744     324,675
Less: portion included in current liabilities...............    30,057      70,037
                                                              --------    --------
          Total long-term debt..............................  $224,687    $254,638
                                                              ========    ========
</TABLE>

     Long-term debt due in each of the next five years is as follows:

<TABLE>
<CAPTION>
YEARS                                                         IN THOUSANDS
-----                                                         ------------
<S>                                                           <C>
2001........................................................    $30,057
2002........................................................         --
2003........................................................         --
2004........................................................     99,805
2005........................................................         --
</TABLE>

     Houghton Mifflin had approximately $183.8 million of commercial paper
outstanding at December 31, 2000, with a weighted average interest rate of
7.56%. At the end of 1999, the amount of Houghton Mifflin's outstanding
commercial paper was approximately $21.4 million, with a weighted average
interest rate of 6.42%.

     Houghton Mifflin has issued $125 million of non-callable unsecured 7.00%
notes that mature on March 1, 2006. Houghton Mifflin also issued $100 million of
7.125% 10-year notes in a public debt offering. These notes, which mature on
April 1, 2004, were priced at 99.4% of principal amount to yield an effective
interest rate of 7.21%. Houghton Mifflin has issued $30 million of 5.99%
medium-term notes that mature on December 3, 2001.

     In May 1999, Houghton Mifflin filed a shelf registration statement with the
Securities and Exchange Commission covering up to $200 million of debt
securities and common stock, which may be issued in one or more offerings from
time to time. As of December 31, 2000 and 1999, there had not been any issuances
of debt securities or common stock under this registration statement.

     In prior years, 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 $65.3 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 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

                                        43
<PAGE>   46
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 diluted
share. Houghton Mifflin also recognized an $18.0 million extraordinary after-tax
gain, or $0.62 per diluted share, on the extinguishment of the debt resulting
from the redemption.

     The remaining 50%, or $65.3 million in aggregate principal amount, of the
outstanding SAILS matured on August 2, 1999. In accordance with the terms of
SAILS, Houghton Mifflin elected to deliver (i) two shares of the common stock of
INSO 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 on the outstanding
SAILS. The transaction represented a disposition of the shares and generated a
non-cash loss of $5.6 million ($3.2 million after tax), or $0.11 per diluted
share. Houghton Mifflin also recognized an extraordinary gain of $52.3 million
($30.3 million after tax), or $1.03 per diluted share, on the extinguishment of
debt resulting from the maturity.

     On December 1, 2000, Houghton Mifflin's two interest rate swaps expired.
There were no swaps in place at December 31, 2000. At December 31, 1999, there
were two interest-rate swaps in place, each with a notional amount of $25
million and terminating on December 1, 2000. Houghton Mifflin paid the fixed
rate on both swaps (5.90% and 5.95%) and received a variable rate based upon a
commercial paper index. In 2000, interest income from the interest rate swaps
was $167,932. In 1999, interest expense from the interest rate swap was
$440,494.

     Houghton Mifflin from time to time enters into transactions involving
financial instruments in order to manage our 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 attempts to achieve a
predetermined mix of fixed- and floating-rate debt.

     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, 2000 or December 31, 1999.

                                        44
<PAGE>   47
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 5.  RETIREMENT AND POSTRETIREMENT BENEFITS PLANS

     Houghton Mifflin has a noncontributory, qualified defined benefit pension
plan, the Retirement Plan, that covers substantially all employees. The
Retirement Plan is a cash balance plan which accrues benefits based on pay,
length of 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.

     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 healthcare 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 $60.3 million at December 31,
2000, and $54.8 million at December 31, 1999.

     For the Retirement Plan, Houghton Mifflin uses a September 30 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 Statement of Financial
Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other
Post Retirement Benefits," or SFAS 132, set forth the pension and postretirement
benefit liability recognized in the consolidated balance sheet at December 31:

<TABLE>
<CAPTION>
                                                    PENSION BENEFITS      POSTRETIREMENT BENEFITS
                                                   -------------------    -----------------------
                                                     2000       1999         2000         1999
                                                   --------   --------    ----------   ----------
                                                                  (IN THOUSANDS)
<S>                                                <C>        <C>         <C>          <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at January 1..................  $123,268   $127,521    $  28,824    $  29,741
Service cost (benefits earned during the year)...     5,171      5,382          408          436
Interest cost on projected benefit obligation....     8,829      8,300        2,224        1,918
Plan amendment...................................        --         --           --         (840)
Actuarial (gain) loss............................     3,217     (5,433)       1,465         (452)
Benefits paid....................................    (8,232)   (12,502)      (2,960)      (1,979)
                                                   --------   --------    ---------    ---------
Benefit obligation at December 31................  $132,253   $123,268    $  29,961    $  28,824
                                                   ========   ========    =========    =========
CHANGE IN PLAN ASSETS
Fair market value at beginning of year...........  $116,673   $114,736    $      --    $      --
Actual return....................................    13,313     14,056           --           --
Company contribution.............................        84        383        2,960        1,979
Benefits paid....................................    (8,232)   (12,502)      (2,960)      (1,979)
                                                   --------   --------    ---------    ---------
Fair market value at end of year.................  $121,838   $116,673    $      --    $      --
                                                   ========   ========    =========    =========
FUNDED STATUS....................................  $(10,415)  $ (6,595)   $ (29,961)   $ (28,824)
</TABLE>

                                        45
<PAGE>   48
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
                                                    PENSION BENEFITS      POSTRETIREMENT BENEFITS
                                                   -------------------    -----------------------
                                                     2000       1999         2000         1999
                                                   --------   --------    ----------   ----------
                                                                  (IN THOUSANDS)
<S>                                                <C>        <C>         <C>          <C>
Unrecognized items:
     Net (gain) loss.............................   (21,768)   (21,442)       1,928          463
     Prior service cost..........................     1,623      1,796         (758)        (852)
     Transition asset............................      (326)      (509)          --           --
                                                   --------   --------    ---------    ---------
Net amount recognized............................  $(30,886)  $(26,750)   $ (28,791)   $ (28,213)
                                                   ========   ========    =========    =========
AMOUNTS RECOGNIZED IN THE BALANCE SHEET CONSIST
  OF:
Accrued benefit liability........................  $(31,680)  $(28,045)   $ (28,791)   $ (29,213)
Intangible asset.................................       794      1,295           --           --
                                                   --------   --------    ---------    ---------
Net amount recognized............................  $(30,886)  $(26,750)   $ (28,791)   $ (29,213)
                                                   ========   ========    =========    =========
</TABLE>

     Net periodic pension cost for 2000, 1999, and 1998 included the following
components:

<TABLE>
<CAPTION>
                                                      PENSION BENEFITS
                                                -----------------------------
                                                 2000       1999       1998
                                                -------    -------    -------
                                                       (IN THOUSANDS)
<S>                                             <C>        <C>        <C>
Service cost..................................  $ 5,171    $ 5,382    $ 4,639
Interest cost on projected benefit
  obligation..................................    8,829      8,300      8,182
Expected return on plan assets................   (9,566)    (9,168)    (8,967)
Amortization of unrecognized:
     Net (gain) loss..........................     (132)        79         89
     Prior service cost.......................      174        174        133
     Transition (asset).......................     (183)      (183)      (183)
                                                -------    -------    -------
Net pension expense...........................  $ 4,293    $ 4,584    $ 3,893
                                                =======    =======    =======
</TABLE>

     Net periodic postretirement benefit cost included the following components
for the twelve months ended December 31:

<TABLE>
<CAPTION>
                                                    POSTRETIREMENT BENEFITS
                                                  ----------------------------
                                                   2000      1999       1998
                                                  ------    ------    --------
                                                         (IN THOUSANDS)
<S>                                               <C>       <C>       <C>
Service cost....................................  $  408    $  436    $    498
Interest cost on accumulated postretirement
  benefit obligation............................   2,224     1,918       1,757
Amortization of unrecognized:
  Prior service cost............................     (94)       (1)         (1)
                                                  ------    ------    --------
Net periodic postretirement benefit expense.....  $2,538    $2,353    $  2,254
                                                  ======    ======    ========
</TABLE>

                                        46
<PAGE>   49
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Significant actuarial assumptions:

<TABLE>
<CAPTION>
                                                    PENSION       POSTRETIREMENT
                                                    BENEFITS         BENEFITS
                                                  ------------    --------------
                                                  2000    1999    2000     1999
                                                  ----    ----    -----    -----
<S>                                               <C>     <C>     <C>      <C>
Discount rate...................................  7.75%   7.50%   7.50%    7.75%
Increase in future compensation.................  4.75    4.75     N/A      N/A
Expected long-term rate of return on assets.....  9.25    9.00     N/A      N/A
Ultimate medical inflation trend factor.........   N/A     N/A    4.50     4.50
</TABLE>

     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:

<TABLE>
<CAPTION>
                                                  ONE PERCENTAGE    ONE PERCENTAGE
                                                  POINT INCREASE    POINT DECREASE
                                                  --------------    --------------
                                                           (IN THOUSANDS)
<S>                                               <C>               <C>
Effect on total service and interest cost
  components....................................      $  165           $  (170)
Effect on postretirement benefit obligation.....       1,867            (1,849)
</TABLE>

     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
eligible employees. Participants may elect to contribute up to 15% of their
compensation subject to an annual limit ($10,500 in 2000) 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.

     The Houghton Mifflin 401(k) Savings Plan provides a matching Company
contribution 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 $4.8 million in 2000, $3.8 million in 1999, and $3.6
million in 1998.

NOTE 6.  STOCK COMPENSATION PLANS

     At December 31, 2000, Houghton Mifflin had two stock-based compensation
plans which are described on the next page. Houghton Mifflin applies APB 25 and
related Interpretations in accounting for our plans. Houghton Mifflin has
adopted the disclosure-only provision of SFAS 123. Accordingly, no compensation
cost has been recognized for our fixed stock compensation plans. Had
compensation cost for Houghton Mifflin's two 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:

<TABLE>
<CAPTION>
                                                      2000     1999     1998
                                                      -----    -----    -----
                                                       (IN MILLIONS, EXCEPT
                                                        PER-SHARE AMOUNTS)
<S>                                                   <C>      <C>      <C>
NET INCOME
     As reported....................................  $55.8    $76.3    $63.6
     Pro forma......................................   52.0     73.4     62.3
EARNINGS PER SHARE
     As reported - basic............................  $1.94    $2.65    $2.22
     Pro forma - basic..............................   1.81     2.55     2.17
     As reported - diluted..........................   1.92     2.60     2.19
     Pro forma - diluted............................   1.79     2.50     2.14
</TABLE>

                                        47
<PAGE>   50
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     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.

FIXED STOCK COMPENSATION PLANS:

     Houghton Mifflin maintains two fixed stock compensation plans, the 1995
Stock Compensation Plan and the 1998 Stock Compensation Plan, or 1998 Plan.
Options outstanding include some granted under the 1995 Stock Compensation Plan,
under which no further options may be granted. Houghton Mifflin had authorized
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 prior plans. The 1998 Plan 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 1998 Plan
may also be used to grant options to 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,
and shares may be forfeited due to termination of employment. During the
restriction period, the recipient is entitled to vote and receive dividends. In
2000, grants of 16,640 shares of restricted stock were made; at December 31,
2000, a total of 117,921 restricted shares were not yet vested. In 1999, grants
of 43,594 shares of restricted stock were made; at December 31, 1999, a total of
137,531 restricted shares were not yet vested. The weighted-average grant date
fair value of restricted shares granted was $42.81 in 2000, $47.96 in 1999 and
$28.69 in 1998. 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 both plans become exercisable at such times as the
Compensation & Nominating Committee determines, 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 2000, 1999, and 1998:

<TABLE>
<CAPTION>
                                     2000             1999             1998
                                --------------   --------------   --------------
<S>                             <C>              <C>              <C>
Dividend yield................      1.57%            1.63%            1.69%
Range of expected lives
  (years).....................    0.0 - 5.6        3.1 - 8.6        3.2 - 8.7
Expected volatility...........      33.44%           27.28%           26.59%
Range of risk-free interest
  rates.......................  5.63% - 6.88%    5.38% - 6.63%    5.38% - 6.63%
</TABLE>

     A summary of the status of Houghton Mifflin's two fixed stock compensation
plans as of December 31, 2000, 1999, and 1998, and changes during the years
ending on those dates is presented below:

<TABLE>
<CAPTION>
                                          2000                 1999                 1998
                                   ------------------   ------------------   ------------------
                                            WEIGHTED-            WEIGHTED-            WEIGHTED-
                                             AVERAGE              AVERAGE              AVERAGE
                                   SHARES   EXERCISE    SHARES   EXERCISE    SHARES   EXERCISE
                                   (000)      PRICE     (000)      PRICE     (000)      PRICE
                                   ------   ---------   ------   ---------   ------   ---------
<S>                                <C>      <C>         <C>      <C>         <C>      <C>
FIXED OPTIONS
Outstanding at beginning of
  year...........................   2,191      $36       2,612      $33       1,652      $25
Granted..........................     606       40         139       42       1,270       42
Exercised........................    (716)      30        (463)      23        (267)      23
Forfeited........................    (122)      40         (97)      35         (43)      28
                                   ------               ------               ------
Outstanding at end of year.......   1,959       39       2,191       36       2,612       33
                                   ======               ======               ======
Options exercisable at
  year-end.......................     597                  772                1,008
Weighted-average fair market
  value of options granted during
  the year.......................  $14.03               $10.80               $13.27
                                   ======               ======               ======
</TABLE>

                                        48
<PAGE>   51
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The following table summarizes information about fixed stock options at
December 31, 2000:

<TABLE>
<CAPTION>
                        OPTIONS OUTSTANDING
               -------------------------------------     OPTIONS EXERCISABLE
                              WEIGHTED-                -----------------------
                 NUMBER        AVERAGE     WEIGHTED-     NUMBER      WEIGHTED-
   RANGE OF    OUTSTANDING    REMAINING     AVERAGE    OUTSTANDING    AVERAGE
   EXERCISE    AT 12/31/00   CONTRACTUAL   EXERCISE    AT 12/31/00   EXERCISE
    PRICES        (000)         LIFE         PRICE        (000)        PRICE
   --------    -----------   -----------   ---------   -----------   ---------
  <S>          <C>           <C>           <C>         <C>           <C>
  $20 to $23         75        0.2 years      $21           75          $21
   24 to  29        159        1.0             25          158           25
   30 to  36        280        2.1             35          214           35
   37 to  43      1,395        6.8             42          142           42
   44 to  47         50        5.7             47            8           47
                  -----                                    ---
                  1,959        5.4             39          597           32
                  =====                                    ===
</TABLE>

EXECUTIVE AND SENIOR MANAGEMENT STOCK PURCHASE PLANS:

     In August 1994, pursuant to the 1994 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).

     On February 29, 2000, Houghton Mifflin provided financing for the purchase
of an aggregate of 281,430 shares of Houghton Mifflin common stock pursuant to
the 2000 Senior Management and Director Stock Purchase Plan. The purchases were
made at the fair market value of $39.813 per share. These options, granted under
the 1998 Stock Compensation Plan, were exercisable only on the date granted. A
note was obtained from the participants and is collateralized by the shares of
common stock purchased (see Note 11). Houghton Mifflin has full recourse against
the borrowers.

NOTE 7.  STOCKHOLDERS' RIGHTS 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, 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

                                        49
<PAGE>   52
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 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:

<TABLE>
<CAPTION>
                           YEARS                              IN THOUSANDS
                           -----                              ------------
<S>                                                           <C>
2001........................................................    $ 26,204
2002........................................................      25,977
2003........................................................      25,251
2004........................................................      21,685
2005........................................................      17,223
Thereafter..................................................      23,520
                                                                --------
Total minimum lease payments................................    $139,860
                                                                ========
</TABLE>

     Rent expense, net of sublease income, was approximately $23.7 million in
2000, $21.8 million in 1999, and $17.6 million in 1998.

                                        50
<PAGE>   53
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONTINGENCIES:

     Houghton Mifflin is involved in ordinary and routine litigation and matters
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 the 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 the investment in INSO based upon the equity method of
accounting.

     During 1998, Houghton Mifflin used 1.9 million shares of INSO common stock
to redeem 50%, or $65.3 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%, we no longer recorded our investment in INSO under the
equity method. Instead, Houghton Mifflin accounted for the remaining shares held
of INSO common stock in accordance with SFAS 115. These securities were
classified as available for sale and were carried at fair market value based on
the quoted market price.

     During 1999, Houghton Mifflin elected to deliver approximately 1.9 million
shares of INSO common stock to repay the remaining SAILS. In December 1999,
Houghton Mifflin sold our remaining 22,600 shares of INSO Corporation common
stock. The carrying value of these shares at the time of sale was $195,706. The
shares were sold for $682,149, and Houghton Mifflin recorded a gain of $486,443.

     When Houghton Mifflin recorded the pro-rata share of income and losses and
the impact of INSO's equity activities, if any, on a quarterly basis, we did so
one quarter in arrears.

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, 2000 and 1999, were as follows:

<TABLE>
<CAPTION>
                                            2000                    1999
                                    ---------------------   ---------------------
                                    CARRYING      FAIR      CARRYING      FAIR
                                     AMOUNT       VALUE      AMOUNT       VALUE
                                    ---------   ---------   ---------   ---------
                                                   (IN THOUSANDS)
<S>                                 <C>         <C>         <C>         <C>
FINANCIAL ASSETS:
     Cash, cash equivalents, and
       marketable securities......  $  15,585   $  15,585   $  12,679   $  12,679
     Investments:
     Other........................      7,364       7,364       4,634       4,634
FINANCIAL LIABILITIES:
     7.00% notes..................   (124,882)   (121,638)   (124,859)   (119,925)
     7.125% notes.................    (99,805)    (98,800)    (99,745)    (97,958)
     Credit facility..............         --          --     (20,000)    (20,000)
     Commercial paper.............   (183,791)   (183,791)    (21,358)    (21,358)
     Floating rate notes..........         --          --     (50,000)    (49,988)
     5.99% notes..................    (30,000)    (29,634)    (30,000)    (29,358)
     Other........................        (57)        (57)        (71)        (71)
</TABLE>

                                        51
<PAGE>   54
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The fair market values of financial instruments were estimates based on
market conditions and perceived risks at December 31, 2000 and 1999, and require
varying degrees of management judgment. The factors used to estimate these
values may not be valid on any subsequent date. Accordingly, 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 approximated fair market value due to the short-term
maturity of the instruments.

INVESTMENTS:

     The fair market value of Houghton Mifflin's investments was estimated based
on the quoted market prices, if available, for these securities at December 31,
2000 and 1999, and may thus change as market prices change.

LONG-TERM DEBT:

     The fair market value of the 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, 2000. At December 31, 1999, Houghton Mifflin had
two interest rate swaps on commercial paper which were 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 value of these agreements, representing the estimated
amount that Houghton Mifflin would receive from a third party assuming Houghton
Mifflin obligations under the interest rate agreement ceased at December 31,
1999, was approximately $108,000.

NOTE 11.  RELATED PARTIES

     Houghton Mifflin presently holds notes receivable for a total of $16.1
million from certain corporate officers and members of the Board of Directors.
Houghton Mifflin has provided financing pursuant to the 1994 Executive Stock
Purchase Plan, the 1994 Non-Employee Director Stock Purchase Plan, and the 2000
Senior Management and Director Stock Purchase Plan. The outstanding notes
receivable for the 1994 Executive Stock Purchase Plan and the 1994 Non-Employee
Director Stock Purchase Plan is $4.5 million, and the outstanding notes
receivable for the 2000 Senior Management and Director Stock Purchase Plan is
$11.6 million.

     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; those made to directors were amended in 1999. The amended loans have an
interest rate of 6.25%. Loans to employees are due in the third quarter of 2003;
loans to directors are due in October following normal retirement or six months
after ceasing to serve as a director for any other reason. Loans made to
officers are collateralized by the shares of common stock purchased, while those
loans provided to members of the Board of Directors are unsecured. All loans
have full recourse against the borrower.

     Houghton Mifflin provided financing in 2000 to effect the purchase of
281,430 shares of Houghton Mifflin's common stock pursuant to the 2000 Senior
Management and Director Stock Purchase Plan at the

                                        52
<PAGE>   55
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

fair market value on February 29, 2000, of $39.8125 per share. The loans have an
interest rate of 8.0% and are due on February 28, 2005. The loans are
collateralized by the shares of common stock purchased, and Houghton Mifflin has
full recourse against the borrower.

     The notes receivable are shown as a reduction in stockholders' equity in
the consolidated financial statements. In 2000, Houghton Mifflin recognized
approximately $1.0 million in interest income in connection with the outstanding
loans.

NOTE 12.  SEGMENT AND RELATED INFORMATION

     Houghton Mifflin has eight divisions with separate management teams and
infrastructures that offer different products and services. These divisions have
been aggregated in three reportable segments based on the similar nature of
their products and services, the nature of the production process, class of
customers, and distribution method, as follows:

K-12 Publishing:  This segment consists of five divisions: School Division,
McDougal Littell Inc., Great Source Education Group, Inc., Sunburst Technology
Corporation, and The Riverside Publishing Company. Beginning in 1999, Houghton
Mifflin focused Sunburst Technology's business on the growing educational
technology marketplace rather than on the retail market. Sunburst Technology's
products are sold primarily in the K-12 school marketplace; therefore, the 2000
and 1999 information relating to Sunburst is included in the K-12 Publishing
segment. This operating segment includes textbooks and instructional materials
and services, tests for measuring achievement and aptitude, clinical/special
needs testing products, multimedia instructional programs, and career guidance
products and services. The principal markets for these products are elementary
and secondary schools.

College Publishing:  The College Division is the sole business unit reported in
this segment. This operating segment includes textbooks, ancillary products such
as workbooks and study guides, technology-based instructional materials, and
services for introductory and upper level courses in the post-secondary
education market. Products may be in print or electronic form. The principal
markets for these products are two- and four-year colleges and universities.
These products are also sold to high schools for advanced placement courses and
to for-profit, certificate-granting institutions that offer skill-based training
and job placement.

Other:  This segment consists of the Trade & Reference Division, Computer
Adaptive Technologies, or CAT, and unallocated corporate-related items. The
Trade & Reference Division publishes fiction and nonfiction for adults and
children, dictionaries, and other reference works. The division also licenses
book rights to paperback publishers, book clubs, web sites, and other publishers
and electronic businesses in the United States and abroad. Its principal markets
are retail stores, including Internet bookstore sites, and wholesalers. It also
sells reference materials to schools, colleges, office supply distributors, and
businesses. CAT specializes in the development and delivery of computer-based
testing solutions. Its principal markets are organizations worldwide.

     Houghton Mifflin's geographic area of operation is predominantly the United
States. Export sales for locations outside the United States are not significant
to Houghton Mifflin's three business segments. Houghton Mifflin does not have
any customers which exceed 10% of net sales, and the loss of a single customer,
in management's opinion, would not have a material adverse effect on net sales.

     Houghton Mifflin evaluates the performance of our operating segments based
on the profit and loss from operations before interest income and expense,
income taxes, and nonrecurring 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 tables. The "Other" column includes
unallocated corporate-related items, operations which do not

                                        53
<PAGE>   56
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

meet the quantitative thresholds of SFAS 131, nonrecurring items and, as it
relates to segment profit or loss, income and expense not allocated to
reportable segments.

<TABLE>
<CAPTION>
                                                         K-12       COLLEGE
                                                      PUBLISHING   PUBLISHING    OTHER     CONSOLIDATED
                                                      ----------   ----------   --------   ------------
                                                                       (IN THOUSANDS)
<S>                                                   <C>          <C>          <C>        <C>
2000
Net sales from external customers...................   $750,660     $174,406    $102,571    $1,027,637
Depreciation and amortization.......................     76,241       22,349       4,974       103,564
Segment operating income (loss).....................    116,238       24,427      (4,375)      136,290
Identifiable assets.................................    747,276      196,112     162,214     1,105,602
Acquired assets.....................................     14,567           --       3,805        18,372
Total assets........................................    761,843      196,112     166,019     1,123,974
Investment in equity method investee................         --           --       6,564         6,564
Purchase of property, plant, and equipment,
  including book plates.............................     89,042       17,595       5,656       112,293
1999
Net sales from external customers...................   $684,336     $173,694    $ 91,418    $  949,448
Depreciation and amortization.......................     69,043       21,630       3,442        94,115
Segment operating income (loss).....................     97,114       23,746      (8,900)      111,960
Identifiable assets.................................    653,211      196,655     143,611       993,477
Acquired assets.....................................     39,988        1,650       3,628        45,266
Total assets........................................    693,199      198,305     147,239     1,038,743
Purchase of property, plant, and equipment,
  including book plates.............................     72,864       17,394       8,056        98,314
1998
Net sales from external customers...................   $634,199     $162,518    $ 89,549    $  886,266
Depreciation and amortization.......................     72,672       20,761       2,248        95,681
Segment operating income (loss).....................     97,944       19,734     (19,158)       98,520
Identifiable assets.................................    624,095      195,681     139,047       958,823
Acquired assets.....................................     10,640           --      14,205        24,845
Total assets........................................    634,735      195,681     153,252       983,668
Purchase of property, plant, and equipment,
  including book plates.............................     54,518       16,931       2,535        73,984
</TABLE>

                                        54
<PAGE>   57
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     RECONCILIATION OF SEGMENT INCOME (LOSS) TO CONSOLIDATED STATEMENTS OF
INCOME:

<TABLE>
<CAPTION>
                                                                2000        1999        1998
                                                              --------    --------    --------
                                                                       (IN THOUSANDS)
<S>                                                           <C>         <C>         <C>
     Total income from reportable segments..................  $136,290    $111,960    $ 98,520
     Unallocated income (expense):
     Net interest expense...................................   (31,806)    (29,770)    (33,981)
     Gains (losses) on INSO Corporation common stock and
       equity in earnings (losses) of INSO Corporation......        --      (5,100)     18,797
     Loss on sale of investment.............................        --          --      (3,017)
     Equity in losses of equity method investee.............    (2,737)         --          --
     Write-down of investment...............................    (4,553)         --          --
     Other expense..........................................        --          --      (1,050)
                                                              --------    --------    --------
Income before taxes and extraordinary item..................  $ 97,194    $ 77,090    $ 79,269
                                                              ========    ========    ========
</TABLE>

NOTE 13.   EARNINGS PER SHARE

     The following table sets forth the computation of basic and diluted
earnings per share:

<TABLE>
<CAPTION>
                                                                2000        1999        1998
                                                              --------    --------    --------
                                                              (IN THOUSANDS, EXCEPT PER-SHARE
                                                                          AMOUNTS)
<S>                                                           <C>         <C>         <C>
Numerator:
     Net income.............................................  $55,824     $76,304     $63,649
Denominator:
     Denominator for basic earnings per share:
       Weighted-average shares outstanding..................   28,749      28,823      28,689
Effect of dilutive securities:
     Employee stock options.................................      225         464         389
     Restricted stock.......................................       71          21          33
                                                              -------     -------     -------
                                                                  296         485         422
Dilutive potential common shares:
     Denominator for diluted earnings per share:
     Adjusted weighted-average shares outstanding and
       assumed conversions..................................   29,045      29,308      29,111
                                                              =======     =======     =======
Basic earnings per share....................................  $  1.94     $  2.65     $  2.22
                                                              =======     =======     =======
Diluted earnings per share..................................  $  1.92     $  2.60     $  2.19
                                                              =======     =======     =======
</TABLE>

     Options to purchase 868,838 shares of common stock at December 31, 2000,
22,000 shares of common stock at December 31, 1999, and 1,429,534 shares of
common stock at December 31, 1998, 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.

                                        55
<PAGE>   58
                            HOUGHTON MIFFLIN COMPANY

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 14.  SUBSEQUENT EVENTS

     On January 31, 2001, the Board of Directors declared a quarterly dividend
of $0.13 per share, payable on February 28, 2001, to shareholders of record on
February 14, 2001.

NOTE 15.  SPECIAL CHARGES

     In the third quarter of 2000, Houghton Mifflin recorded a special charge of
$2.5 million ($1.5 million after tax), or $0.05 per share, related to the
write-down of a portion of the goodwill and other long-lived assets attributable
to the Little Planet Literacy Series, a Sunburst Technology product, to their
estimated fair values as determined from estimated future cash flows. In January
1999, Houghton Mifflin purchased the assets of the Little Planet Literacy
Series, a pre-kindergarten to grade three literacy program. During 1999, sales
for the Little Planet Literacy Series fell short of goals established at the
time of the acquisition, and plans were put into place to improve sales of this
product by the third quarter of 2000, when a number of sales are made in the
education marketplace. A significant improvement failed to materialize by the
third quarter, and as a result, future sales are now expected to be lower than
originally expected. Based on these indicators, the goodwill and other
long-lived assets recorded at the time of acquisition were re-evaluated and
compared to the estimated undiscounted cash flows from the Little Planet
products. The undiscounted cash flows indicated there was an impairment, and the
assets were written down to their estimated fair values, as determined from the
estimated anticipated discounted future cash flows. This amount is reported as
an "asset impairment charge" in a separate line item of Costs and Expenses in
the accompanying consolidated financial statements.

                                        56
<PAGE>   59

                   SUMMARY OF QUARTERLY RESULTS OF OPERATIONS
         (UNAUDITED, IN THOUSANDS OF DOLLARS EXCEPT PER-SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                        FIRST QUARTER   SECOND QUARTER   THIRD QUARTER   FOURTH QUARTER      YEAR
                                        -------------   --------------   -------------   --------------   ----------
<S>                                     <C>             <C>              <C>             <C>              <C>
2000
Net sales.............................    $102,509         $259,634        $492,453         $173,041      $1,027,637
Gross profit (net sales less cost of
  sales)..............................      37,225          149,548         321,169           85,428         593,370
Net income (loss).....................    $(39,359)        $ 15,259        $ 95,282         $(15,358)     $   55,824
                                          ========         ========        ========         ========      ==========
Per share:
     Net income (loss) -- basic.......    $  (1.37)        $   0.52        $   3.27         $  (0.55)     $     1.94
                                          ========         ========        ========         ========      ==========
     Net income (loss) -- diluted.....    $  (1.37)        $   0.52        $   3.22         $  (0.55)     $     1.92
                                          ========         ========        ========         ========      ==========
1999
Net sales.............................    $ 87,000         $227,598        $472,672         $162,178      $  949,448
Gross profit (net sales less cost of
  sales)..............................      29,763          125,972         303,288           79,311         538,334
Income (loss) before extraordinary
  item................................    $(36,953)        $  8,373        $ 90,316         $(15,752)     $   45,984
Extraordinary gain on extinguishment
  of debt, net of tax of $21,956......          --               --          30,323               (3)         30,320
                                          --------         --------        --------         --------      ----------
Net income (loss).....................    $(36,953)        $  8,373        $120,639         $(15,755)     $   76,304
                                          ========         ========        ========         ========      ==========
Per share:
     Basic
       Income (loss) before
          extraordinary item..........    $  (1.29)        $   0.29        $   3.13         $  (0.55)     $     1.60
       Extraordinary gain on
          extinguishment of debt......          --               --        $   1.05               --      $     1.05
                                          --------         --------        --------         --------      ----------
       Net income (loss)..............    $  (1.29)        $   0.29        $   4.18         $  (0.55)     $     2.65
     Diluted (except when
       anti-dilutive)
       Income (loss) before
          extraordinary item..........    $  (1.29)        $   0.29        $   3.07         $  (0.55)     $     1.57
       Extraordinary gain on
          extinguishment of debt......          --               --            1.03               --            1.03
                                          --------         --------        --------         --------      ----------
       Net income (loss)..............    $  (1.29)        $   0.29        $   4.10         $  (0.55)     $     2.60
                                          ========         ========        ========         ========      ==========
</TABLE>

     The above quarterly information indicates the seasonal fluctuations of
Houghton Mifflin's educational publishing business.

     In the fourth quarter of 2000, Houghton Mifflin implemented the consensus
of Emerging Issue Task Force Issue 00-10, "Accounting for Shipping and Handling
Fees and Costs," and reclassified its shipping and handling fees from selling
and administrative expenses to net sales. The effect of the reclassification was
to increase net sales and selling and administrative expenses by $4.0 million in
the first quarter of 2000 and $2.7 million in the first quarter of 1999, $8.8
million in the second quarter of 2000 and $6.7 million in the second quarter of
1999, $16.0 million in the third quarter of 2000 and $14.9 million in the third
quarter of 1999, and $6.0 million in the fourth quarter of 2000 and $5.0 million
in the fourth quarter of 1999. The reclassification had no effect on operating
income or net income.

     The 2000 first-quarter seasonal net loss was higher than 1999's
first-quarter loss due to higher selling costs related to greater sales
opportunities in 2000 and higher product development costs due to spending to
complete new programs for sale in 2000 and 2001, partially offset by higher
sales. The increase in net income for the second quarter of 2000 compared to the
same period in 1999 was primarily due to higher net sales,

                                        57
<PAGE>   60

operating efficiencies and greater proportion of more profitable products being
sold, partially offset by higher selling costs related to greater sales
opportunities in 2000, higher intangible asset amortization, and the acquired
in-process research and development charge related to the VLT acquisition. The
increase in income after tax, but excluding extraordinary item, for the third
quarter of 2000 compared to the same period in 1999 was primarily due to higher
net sales and lower editorial costs, partially offset by higher selling and
implementation costs, higher losses at CAT, an asset impairment charge,
increased intangible asset amortization, equity losses of Classwell Learning
Group, and the write-down of an investment in a distance learning start-up
company. The slightly lower 2000 fourth-quarter net loss compared to the same
period in 1999 was attributable to higher net sales in the K-12 segment and
lower administrative costs, mostly offset by lower sales in the College
Division, higher interest expense, and the equity losses of Classwell Learning
Group.

     During the third quarter of 1999, Houghton Mifflin recorded a non-cash loss
of $5.6 million ($3.2 million after tax), or $0.11 per diluted share, resulting
from the surrender of INSO common stock upon maturity of the remaining
outstanding SAILS. Houghton Mifflin also recognized an extraordinary gain of
$52.3 million ($30.3 million after tax), or $1.03 per diluted share, on the
extinguishment of the remaining SAILS indebtedness. In the fourth quarter of
1999, Houghton Mifflin sold its remaining shares of INSO common stock. The sale
generated a one-time gain of $0.5 million ($0.3 million after tax), or $0.01 per
diluted share.

                                        58
<PAGE>   61

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 2001 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 and 8.

ITEM 11.  EXECUTIVE COMPENSATION

     This information is incorporated by reference to the Proxy Statement for
the 2001 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 2001 Annual Meeting of Stockholders.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     This information is incorporated by reference to the Proxy Statement for
the 2001 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 25.

         2. Financial Statement Schedule for the three years ended December 31,
            2000: Schedule II -- Consolidated Valuation and Qualifying Accounts,
            page 60.

            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 62 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 2000:

        None

                                        59
<PAGE>   62

                            HOUGHTON MIFFLIN COMPANY
          SCHEDULE II--CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS

                 YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
                           (IN THOUSANDS OF DOLLARS)

<TABLE>
<CAPTION>
                                                              ADDITIONS
                                                         --------------------
                                                         CHARGED     CHARGED
                                           BALANCE AT    TO COST    TO OTHER                   BALANCE
                                           BEGINNING       AND      ACCOUNTS     DEDUCTIONS    AT END
                                            OF YEAR      EXPENSE    -DESCRIBE    -DESCRIBE     OF YEAR
                                           ----------    -------    ---------    ----------    -------
<S>                                        <C>           <C>        <C>          <C>           <C>
2000
Allowance for bad debts..................   $ 5,765      $ 1,713      $ 20(1)     $   999(4)   $ 6,499
Allowance for book returns...............    25,442       72,226        --         73,310(2)    24,358
Allowance for authors' advances..........    29,631        3,719        --          4,321(3)    29,029
1999
Allowance for bad debts..................   $ 4,875      $   747      $150(1)     $     7(4)   $ 5,765
Allowance for book returns...............    23,094       67,994        --         65,646(2)    25,442
Allowance for authors' advances..........    23,589        6,869        --            827(3)    29,631
1998
Allowance for bad debts..................   $ 4,356      $ 2,411      $105(1)     $ 1,997(4)   $ 4,875
Allowance for book returns...............    20,734       71,967        --         69,607(2)    23,094
Allowance for authors' advances..........    24,290        4,598        --          5,299(3)    23,589
</TABLE>

---------------
(1) Reflects additions to the allowance from acquisitions made during the year.

(2) Books actually returned during the year.

(3) Write-offs of unearned author advances.

(4) Write-offs of uncollectible customer receivables, net of recoveries.

                                        60
<PAGE>   63

                                   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 28, 2001

     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:

<TABLE>
<C>                                        <S>                                      <C>

        /s/ NADER F. DAREHSHORI            Chairman of the Board, President, and
---------------------------------------    Chief Executive Officer, Director
          NADER F. DAREHSHORI                                                       February 28, 2001

            /s/ GAIL DEEGAN                Executive Vice President and Chief
---------------------------------------    Financial Officer
              GAIL DEEGAN                                                           February 28, 2001

          /s/ DAVID R. CARON               Vice President and Controller
---------------------------------------
            DAVID R. CARON                                                          February 28, 2001

         /s/ JAMES O. FREEDMAN             Director
---------------------------------------
           JAMES O. FREEDMAN                                                        February 28, 2001

         /s/ MICHAEL GOLDSTEIN             Director
---------------------------------------
           MICHAEL GOLDSTEIN                                                        February 28, 2001

            /s/ JANET HILL                 Director
---------------------------------------
              JANET HILL                                                            February 28, 2001

          /s/ GAIL H. KLAPPER              Director
---------------------------------------
            GAIL H. KLAPPER                                                         February 28, 2001

       /s/ CHARLES R. LONGSWORTH           Director
---------------------------------------
         CHARLES R. LONGSWORTH                                                      February 28, 2001

        /s/ CLAUDINE B. MALONE             Director
---------------------------------------
          CLAUDINE B. MALONE                                                        February 28, 2001

                                           Director
---------------------------------------
          ALFRED L. MCDOUGAL                                                        February 28, 2001

         /s/ RALPH Z. SORENSON             Director
---------------------------------------
           RALPH Z. SORENSON                                                        February 28, 2001

        /s/ ROBERT J. TARR, JR.            Director
---------------------------------------
          ROBERT J. TARR, JR.                                                       February 28, 2001
</TABLE>

                                        61
<PAGE>   64

                            HOUGHTON MIFFLIN COMPANY

                               INDEX TO EXHIBITS
                                (ITEM 14(a)(3))

<TABLE>
<CAPTION>
EXHIBIT NO.              DESCRIPTION OF DOCUMENT                     PAGE NUMBER IN THIS REPORT
-----------              -----------------------                     --------------------------
<S>            <C>                                           <C>
(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             Filed as Exhibit (3)(i) to Form 10-K for
               Organization of the Company in the form of    the year ended December 31, 1998, and
               a certificate of vote of directors            incorporated by reference into this report
               establishing a series of a class of stock

(3)(ii)        By-laws of the Company                        Filed herewith

(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)(D)    Lease between Two Twenty Two Berkeley         Filed as Exhibit (10)(ii)(D) to Form 10-K
               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

               Office lease between Davis Church Office      Filed herewith
               Development, L.L.C. as landlord, and
               Houghton Mifflin Company, as tenant

               364-Day Credit Agreement between Houghton     Filed herewith
               Mifflin Company and Wachovia Bank, N.A., as
               administrative agent and lender and Bank
               One, N.A., as syndication agent and lender,
               dated December 18, 2000

               Five Year Credit Agreement between Houghton   Filed herewith
               Mifflin Company and Wachovia Bank, N.A., as
               administrative agent and lender and Bank
               One, N.A., as syndication agent and lender,
               dated December 18, 2000

(10)(iii)(A)   Benefits Trust Agreement between Houghton     Filed as Exhibit (10)(iii)(A) to Form 10-K
               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
</TABLE>

---------------

* Denotes a management contract or compensatory plan.

                                        62
<PAGE>   65

<TABLE>
<CAPTION>
EXHIBIT NO.              DESCRIPTION OF DOCUMENT                     PAGE NUMBER IN THIS REPORT
-----------              -----------------------                     --------------------------
<S>            <C>                                           <C>

(10)(iii)(A)   Severance Agreement between the Company and   Filed herewith
               Mr. Darehshori*

               Form of Senior Executive Severance            Filed herewith
               Agreement*

               Form of Key Managers' Severance Agreement*    Filed herewith

               Supplemental Benefits Plan*                   Filed herewith

               Compensation of Non-Employee Directors        Filed herewith
               Policy*

               1999 Senior Executive Incentive               Filed as Exhibit (10)(iii)(A) to Form 10-Q
               Compensation Plan*                            for the quarter ended March 31, 1999, and
                                                             incorporated by reference into this report

               1999 Chief Executive Officer Incentive        Filed as Exhibit (10)(iii)(A) to Form 10-Q
               Plan*                                         for the quarter ended March 31, 1999, 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*                 Filed as Exhibit (10)(iii)(A) to Form 10-K
                                                             for the year ended December 31, 1998, and
                                                             incorporated by reference into this report

               Form of Non-Qualified Option Agreement*       Filed as Exhibit (10)(iii)(A) to Form 10-K
                                                             for the year ended December 31, 1998, and
                                                             incorporated by reference into this report

               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

(12)           Computation of Ratio of Earnings to Fixed     Filed herewith
               Charges

(21)           List of Subsidiaries                          Filed herewith

(23)           Consent of Experts and Counsel                Filed herewith
</TABLE>

---------------

* Denotes a management contract or compensatory plan.

                                        63