UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2005
OR
For the transition period from to
Commission File Number 0-16914
THE E. W. SCRIPPS COMPANY
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
312 Walnut Street
Cincinnati, Ohio
Registrant’s telephone number, including area code: (513) 977-3000
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and 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 whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of October 31, 2005 there were 126,923,062 of the Registrant’s Class A Common Shares outstanding and 36,668,226 of the Registrant’s Common Voting Shares outstanding.
INDEX TO THE E. W. SCRIPPS COMPANY
REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2005
Item No.
Financial Statements
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Controls and Procedures
Legal Proceedings
Unregistered Sales of Equity and Use of Proceeds
Defaults Upon Senior Securities
Submission of Matters to a Vote of Security Holders
Other Information
Exhibits
Signatures
2
PART I
As used in this Quarterly Report on Form 10-Q, the terms “we,” “our,” “us” or “Scripps” may, depending on the context, refer to The E.W. Scripps Company, to one or more of its consolidated subsidiary companies or to all of them taken as a whole.
ITEM 1. FINANCIAL STATEMENTS
The information required by this item is filed as part of this Form 10-Q. See Index to Financial Information at page F-1 of this Form 10-Q.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II
ITEM 1. LEGAL PROCEEDINGS
We are involved in litigation arising in the ordinary course of business, such as defamation actions, employment and employee relations and various governmental and administrative proceedings, none of which is expected to result in material loss.
3
ITEM 2. UNREGISTERED SALES OF EQUITY AND USE OF PROCEEDS
There were no sales of unregistered equity securities during the quarter for which this report is filed.
The following table provides information about Company purchases of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act during the quarter ended September 30, 2005:
Period
7/1/05 - 7/31/05
8/1/05 - 8/31/05
9/1/05 - 9/30/05
Total
Under a share repurchase program authorized by the Board of Directors on October 28, 2004, we are authorized to repurchase up to 5.0 million Class A Common Shares. There is no expiration date for the program and we are under no commitment or obligation to repurchase any particular amount of Class A Common Shares under the program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
There were no defaults upon senior securities during the quarter for which this report is filed.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the quarter for which this report is filed.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
The information required by this item is filed as part of this Form 10-Q. See Index to Exhibits at page E-1 of this Form 10-Q.
4
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Joseph G. NeCastro
5
Index to Financial Information
Item
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Consolidated Statements of Comprehensive Income and Shareholders’ Equity
Condensed Notes to Consolidated Financial Statements
Forward-Looking Statements
Executive Overview
Critical Accounting Policies and Estimates
Results of Operations
Consolidated Results of Operations
Business Segment Results
Scripps Networks
Newspapers
Broadcast Television
Shop At Home
Shopzilla
Liquidity and Capital Resources
F-1
CONSOLIDATED BALANCE SHEETS
( in thousands )
ASSETS
Current assets:
Cash and cash equivalents
Short-term investments
Accounts and notes receivable (less allowances - $18,285, $20,527, $17,804)
Programs and program licenses
Inventories
Deferred income taxes
Assets of discontinued JOA operations
Miscellaneous
Total current assets
Investments
Property, plant and equipment
Goodwill and other intangible assets:
Goodwill
Other intangible assets
Total goodwill and other intangible assets
Other assets:
Programs and program licenses (less current portion)
Unamortized network distribution incentives
Prepaid pension
Total other assets
TOTAL ASSETS
See notes to consolidated financial statements.
F-2
( in thousands, except share data )
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Customer deposits and unearned revenue
Accrued liabilities:
Employee compensation and benefits
Network distribution incentives
Liabilities of discontinued JOA operations
Other current liabilities
Total current liabilities
Long-term debt (less current portion)
Other liabilities and minority interests (less current portion)
Shareholders’ equity:
Preferred stock, $.01 par - authorized: 25,000,000 shares; none outstanding
Common stock, $.01 par:
Class A - authorized: 240,000,000 shares; issued and outstanding: 127,027,297, 126,521,832; and 126,359,198 shares
Voting - authorized: 60,000,000 shares; issued and outstanding: 36,668,226, 36,668,226 and 36,738,226 shares
Additional paid-in capital
Stock compensation:
Performance awards and restricted stock units
Unvested restricted stock awards
Retained earnings
Accumulated other comprehensive income (loss), net of income taxes:
Unrealized gains on securities available for sale
Pension liability adjustments
Foreign currency translation adjustment
Total shareholders’ equity
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
F-3
CONSOLIDATED STATEMENTS OF INCOME ( UNAUDITED )
( in thousands, except per share data )
Operating Revenues:
Advertising
Merchandise
Network affiliate fees, net
Circulation
Referral fees
Licensing
Other
Total operating revenues
Costs and Expenses:
Employee compensation and benefits (exclusive of JOA editorial compensation costs)
Costs of merchandise sold
Marketing and advertising
Newsprint and ink
JOA editorial costs and expenses
Other costs and expenses
Total costs and expenses
Depreciation, Amortization, and Losses (Gains):
Depreciation
Amortization of intangible assets
Gain on sale of production facility
Losses (gains) on disposal of property, plant and equipment
Hurricane losses (recoveries), net
Net depreciation, amortization and losses (gains)
Operating income
Interest expense
Equity in earnings of JOAs and other joint ventures
Interest and dividend income
Other investment results, net of expenses
Miscellaneous, net
Income from continuing operations before income taxes and minority interests
Provision for income taxes
Income from continuing operations before minority interests
Minority interests
Income from continuing operations
Income from discontinued operations, net of tax
Net income
Net income per basic share of common stock:
Income from discontinued operations
Net income per basic share of common stock
Net income per diluted share of common stock:
Net income per diluted share of common stock
F-4
CONSOLIDATED STATEMENTS OF CASH FLOWS ( UNAUDITED )
Cash Flows from Operating Activities:
Adjustments to reconcile income from continuing operations to net cash flows from operating activities:
Depreciation and amortization
Gain on sale of production facility, net of deferred income tax
Investment gains, net of deferred income tax
Other effects of deferred income taxes
Tax benefits of stock compensation plans
Dividends received greater (less) than equity in earnings of JOAs and other joint ventures
Stock and deferred compensation plans
Minority interests in income of subsidiary companies
Affiliate fees billed greater than amounts recognized as revenue
Network launch incentive payments
Payments for programming less (greater) than program cost amortization
Prepaid and accrued pension expense
Other changes in certain working capital accounts, net
Net cash provided by continuing operating activities
Net cash provided by discontinued operating activities
Net operating activities
Cash Flows from Investing Activities:
Purchase of subsidiary companies and long-term investments
Additions to property, plant and equipment
Decrease in short-term investments, net of effects of acquiring Shopzilla
Sale of long-term investments
Proceeds from sale of production facility
Net investing activities
Cash Flows from Financing Activities:
Increase in long-term debt
Payments on long-term debt
Dividends paid
Dividends paid to minority interests
Repurchase Class A Common shares
Proceeds from employee stock options
Net financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents:
Beginning of year
End of period
Supplemental Cash Flow Disclosures:
Interest paid, excluding amounts capitalized
Income taxes paid
Non-Cash Transactions:
Assumption of Summit America note and preferred stock obligations
F-5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
AND SHAREHOLDERS’ EQUITY ( UNAUDITED )
Shareholders’Equity
Comprehensive
Income for the
Three Months Ended
September 30
As of December 31, 2003
Comprehensive income:
Unrealized gains (losses), net of tax of ($1,732) and ($1,370)
Adjustment for losses (gains) in income, net of tax of ($4,611) and ($38)
Change in unrealized gains (losses)
Currency translation, net of tax of $105 and $211
Dividends: declared and paid - $.2875 per share
Compensation plans, net: 1,231,718 shares issued;
70,414 shares
repurchased
Tax benefits of compensation plans
As of September 30, 2004
As of December 31, 2004
Unrealized gains (losses), net of tax of $1,340 and ($1,014)
Adjustment for losses (gains) in income, net of tax of ($480) and $0
Currency translation, net of tax of ($199) and ($374)
Dividends: declared and paid—$.32 per share
Repurchase 562,500 Class A Common shares
Compensation plans, net: 1,133,929 shares issued;
63,464 shares repurchased; 2,500 shares forfeited
As of September 30, 2005
F-6
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation—The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The information disclosed in the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2004, has not changed materially. Financial information as of December 31, 2004, included in these financial statements has been derived from the audited consolidated financial statements included in that report. In management’s opinion all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the interim periods have been made.
Results of operations are not necessarily indicative of the results that may be expected for future interim periods or for the full year.
Nature of Operations - We are a diverse media concern with interests in national television networks, newspaper publishing, broadcast television, television retailing, on-line comparison shopping, interactive media and licensing and syndication. All of our media businesses provide content and advertising services via the Internet. Our media businesses are organized into the following reportable business segments: Scripps Networks, Newspapers, Broadcast television, Shop At Home and Shopzilla.
Scripps Networks includes five national television networks: Home & Garden Television (“HGTV”), Food Network, DIY Network (“DIY”), Fine Living and Great American Country (“GAC”). Scripps Networks also includes our on-line channel HGTVPro.com, and our 12% interest in FOX Sports Net South, a regional television network. Our networks also operate internationally through licensing agreements and joint ventures with foreign entities. We own approximately 70% of Food Network and approximately 90% of Fine Living. Each of our networks is distributed by cable and satellite television systems. Scripps Networks earns revenue primarily from the sale of advertising time and from affiliate fees from cable and satellite television systems.
Our newspaper business segment includes daily and community newspapers in 18 markets in the U.S. Three of our newspapers are operated pursuant to the terms of joint operating agreements (See Note 7). Each of those newspapers maintains an independent editorial operation and receives a share of the operating profits of the combined newspaper operations. We solely manage and operate each of the other newspapers. Newspapers earn revenue primarily from the sale of advertising space to local and national advertisers and from the sale of newspapers to readers.
Broadcast television includes six ABC-affiliated stations, three NBC-affiliated stations and one independent. Each station is located in one of the 61 largest television markets in the U.S. Broadcast television stations earn revenue primarily from the sale of advertising time to local and national advertisers.
Shop At Home markets a range of consumer goods directly to television viewers and visitors to its Internet site. The Shop At Home business segment also includes ownership of five television stations that exclusively broadcast Shop At Home programming. Shop At Home reaches about 55 million full-time equivalent households and can be viewed in more than 152 television markets, including 95 of the largest 100 television markets in the U.S. Shop At Home programming is distributed under the terms of affiliation agreements with broadcast television stations and cable and satellite television systems. Substantially all of Shop At Home’s revenues are earned from the sale of merchandise.
On June 27, 2005, we completed the acquisition of Shopzilla. Shopzilla operates a product comparison shopping service that helps consumers find products offered for sale on the Web by online retailers. Shopzilla aggregates and organizes information on millions of products from thousands of retailers. Shopzilla also operates BizRate, a Web-based consumer feedback network which collects millions of consumer reviews of stores and products each year. Shopzilla earns revenue primarily from referral fees paid by participating online retailers.
Financial information for our business segments is presented in Note 17. Licensing and other media aggregates our operating segments that are too small to report separately, and primarily includes syndication and licensing of news features and comics.
Our operations are geographically dispersed and we have a diverse customer base. We believe bad debt losses resulting from default by a single customer, or defaults by customers in any depressed region or business sector, would not have a material effect on our financial position. Approximately 65% of our operating revenues are derived from advertising. Operating results can be affected by changes in the demand for advertising both nationally and in individual markets.
F-7
The six largest cable television systems and the two largest satellite television systems provide service to more than 95% of homes receiving HGTV and Food Network. The loss of distribution by any of these cable and satellite television systems could adversely affect our business. While no assurance can be given regarding renewal of our distribution contracts, we have not lost carriage upon the expiration of our distribution contracts with any of these cable and satellite television systems.
While a variety of sources are available for most products that Shop At Home sells, two vendors in two different product categories supply us with merchandise that accounts for approximately 21% and 13% of total merchandise costs incurred in 2005. Our Shop At Home business could be adversely affected if these vendors ceased supplying merchandise.
One customer accounts for approximately 30% of Shopzilla’s operating revenues for the year-to-date period of 2005. Our Shopzilla business could be adversely affected upon the loss of this customer.
Use of Estimates - The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make a variety of decisions that affect the reported amounts and the related disclosures. Such decisions include the selection of accounting principles that reflect the economic substance of the underlying transactions and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgment based on our understanding and analysis of the relevant circumstances, including our historical experience, actuarial studies and other assumptions.
Our financial statements include estimates and assumptions used in accounting for our defined benefit pension plans; the recognition of certain revenues; product returns and rebates due to customers; the periods over which long-lived assets are depreciated or amortized; the fair value of securities that do not trade in a public market; income taxes payable; estimates for uncollectible accounts receivable; the fair value of our inventories and self-insured risks.
While we re-evaluate our estimates and assumptions on an ongoing basis, actual results could differ from those estimated at the time of preparation of the financial statements.
Revenue Recognition - Our primary sources of revenue are from:
The revenue recognition policies for each source of revenue, except for referral fees, are described in our annual report on Form 10-K for the year ended December 31, 2004.
Referral fees. Referral fee revenues consist of fees earned when consumers using our Company Web sites are directed to participating online retailers. Referral fee revenues are recognized at the time the related transactions occur.
Marketing and Advertising Costs - Marketing and advertising costs include costs incurred to promote our businesses. Marketing and advertising costs also include fees paid to search-engines to attract traffic to our web sites. Advertising production costs are deferred and expensed the first time the advertisement is shown. Other marketing and advertising costs are expensed as incurred.
Newspaper Joint Operating Agreements (“JOA”) - We include our share of JOA earnings in “Equity in earnings of JOAs and other joint ventures” in our Consolidated Statements of Income. The related editorial costs and expenses are included in “JOA editorial costs and expenses.” Our residual interest in the net assets of the Denver and Albuquerque JOAs is classified as an investment in the Consolidated Balance Sheets. We do not have a residual interest in the net assets of our other JOA.
F-8
Stock-Based Compensation - We have a stock-based compensation plan, which is described more fully in our Annual Report on Form 10-K for the year ended December 31, 2004. We measure compensation expense using the intrinsic-value based method of Accounting Principles Board Opinion 25 - Accounting for Stock Issued to Employees, and its related interpretations (collectively “APB 25”). Under that method, total compensation is determined on the measurement date as the difference between the fair value of the underlying shares and the price the employee will pay for those shares. The measurement date is the date upon which both the number of shares that will be issued and the price the employee will pay are known.
Options to purchase Class A Common shares (“stock options”) are granted under the plan with exercise prices not less than 100% of the fair market value on the date of the award. As a result, we do not recognize compensation expense in our financial statements for grants of stock options to employees or directors. However, if the terms of such options are subsequently modified, compensation expense is recognized for the difference between the fair value of the underlying stock at the time of modification and the option exercise price. The compensation expense is amortized over the remaining vesting period stated in the option agreement, or immediately if the options are fully vested.
F-9
Performance awards represent the right to receive restricted shares if certain performance measures are met. Each award specifies a target number of shares to be issued and the specific performance criteria that must be met. The number of shares that an employee receives may be less or more than the target number of shares depending on the extent to which the specified performance measures are met or exceeded. The measurement date for performance awards does not occur until the number of shares that will be issued is known. Until that date, we estimate total compensation expense based upon the number of shares that we expect to be issued and the period end fair value of the underlying shares. Total compensation expense is recognized over the vesting period stated in the performance award.
Awards of Class A Common shares (“restricted stock”) and restricted stock units (“RSU”) generally require no payment by the employee. Restricted stock and RSUs generally vest over a one to three-year incentive period conditioned upon the individual’s continued employment through that period. The fair value of restricted stock and RSUs at the measurement date is amortized to expense over the vesting period stated in the restricted stock and RSU agreements. Cliff vested awards are amortized on a straight-line basis over the vesting period and pro-rata vested awards are amortized as each vesting period expires. The vesting of certain awards may be accelerated if certain financial targets are met. If it is expected those targets will be met, the awards are amortized over the accelerated vesting period.
The fair value of options granted and assumptions used to determine the fair values were as follows:
Weighted-average fair value of options granted
Assumptions used to determine fair value:
Dividend yield
Expected volatility
Risk-free rate of return
Expected life of options
In 2005, we changed our method of estimating the fair value of options granted. In years prior to 2005, we estimated the fair value of our options granted using the Black-Scholes model. In 2005, we began estimating the value of these options using a lattice-based binomial model. The use of a lattice-based binomial model did not materially impact the fair value of options granted or the pro-forma expense reported for stock option grants.
Options granted prior to 2005 generally had a ten-year term. Options granted in 2005 generally have an eight-year term. The expected life assumption was adjusted to reflect the shorter terms of the options.
F-10
The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of Financial Accounting Standard No. (“FAS”) 123 - Accounting for Stock-Based Compensation, as amended by FAS 148 - Accounting for Stock-Based Compensation - Transition and Disclosure, to all stock-based employee compensation for the periods covered in this report:
Net income as reported
Add stock-based compensation included in reported income, net of related income tax effects
Deduct stock-based compensation determined under fair value based method, net of related income tax effects
Pro forma net income
Net income per share of common stock
Basic earnings per share:
As reported
Additional stock-based compensation, net of income tax effects
Pro forma basic earnings per share
Diluted earnings per share:
Pro forma diluted earnings per share
Net income per share amounts may not foot since each is calculated independently.
On April 14, 2004, shareholders approved amendments to the 1997 Long-Term Incentive Plan (the “Plan”) that, among other things: (a) extended the term of the Plan to June 1, 2014 and (b) modified provisions with respect to vesting and the term of outstanding stock options when employment is terminated due to death or disability. Under the prior Plan provisions, stock options held by an employee whose employment was terminated due to death or disability were immediately vested with the exception of stock options granted less than one year prior to the termination of employment. The employee forfeited any stock options granted less than one year prior to termination of employment due to death or disability. Vested stock options granted prior to 1999 were exercisable for the lesser of one year or the remaining terms of the stock options, while vested stock options granted after 1998 were exercisable for the remaining terms of the stock options. The amended and restated Plan provides that all stock options held by an employee will immediately vest upon termination of employment due to death or disability and those stock options will remain exercisable for the remaining terms of the options.
The terms of approximately 3.4 million stock options, representing substantially all outstanding stock options granted after 1994 but before 1999, and from April 15, 2003, through April 14, 2004, were modified by the Plan amendments with respect to termination of employment due to death or disability. Because we are unable to estimate which employees, if any, will benefit from these modifications, the intrinsic-value based method of APB 25 requires us to record compensation expense for any such options that are held by an employee at the time their employment is terminated due to death or disability. No compensation expense would be recognized if such stock options were exercised or forfeited prior to termination of employment due to death or disability.
Under the terms of the prior Plan, a change in control of The E.W. Scripps Company resulted in immediate vesting of all stock options held by employees, while a change in control of a subsidiary or division thereof (“subsidiary”) alone did not trigger vesting of stock options held by employees of that subsidiary. Vested stock options held by employees of a subsidiary whose employment was terminated due to a change in control of that subsidiary were exercisable for a period of 90 days. The amended and restated plan provides that all stock options held by an employee of a subsidiary will vest and remain exercisable for the remaining terms of the stock options upon termination of employment due to a change in control of that subsidiary.
F-11
The Plan amendments with respect to termination of employment due to change in control modified the terms of approximately 4.6 million stock options held by employees of subsidiary companies. Approximately 1.4 million of those stock options were also modified by the plan amendments with respect to termination of employment due to death or disability. Because we are unable to estimate which employees may benefit from the Plan modifications, the intrinsic-value based method of APB 25 requires us to record compensation expense for any such stock options that are held by an employee of a subsidiary company at the time their employment is terminated due to a change in control of that subsidiary. No compensation expense would be recognized if such options were exercised or forfeited prior to termination of employment due to a change in control.
While we measure compensation expense in our financial statements using the intrinsic-value based method of APB 25, we must also report pro forma net income and earnings per share assuming we had used the fair-value based methods of FAS 123. Both the amount of compensation expense and the timing of recognition of compensation expense resulting from the Plan modifications is different if fair-value based methods are used instead of intrinsic-value based methods. Under the fair-value based method, Plan modifications are accounted for as the retirement of the outstanding stock options and the issuance of new stock options at the modification date. The fair value of the modified stock options exceeded the fair value of the stock options held as of the date of the modifications by approximately $2.8 million. That compensation expense is recognized over the remaining vesting period of the stock options, or immediately for vested stock options. The pro forma effect of the stock option modifications is included in the preceding table.
Net Income Per Share - The following table presents information about basic and diluted weighted-average shares outstanding:
Basic weighted-average shares outstanding
Effect of dilutive securities:
Unvested restricted stock held by employees
Stock options held by employees and directors
Diluted weighted-average shares outstanding
Reclassifications - For comparative purposes, certain prior year amounts have been reclassified to conform to current classifications.
2. ACCOUNTING CHANGES AND RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (“FASB”) issued FAS 123 (revised 2004) - Share-Based Payments (“FAS 123-R”). FAS 123-R replaces FAS 123 - Accounting for Stock-Based Compensation, and supersedes APB 25 - Accounting for Stock Issued to Employees. As revised by the Securities and Exchange Commission, we will be required to adopt FAS 123-R beginning January 1, 2006. FAS 123-R requires all share-based awards to employees, and any subsequent modifications to those awards, to be recognized in the financial statements based on a fair-value-based method. The pro forma disclosures previously permitted under FAS 123 will no longer be an alternative to financial statement recognition.
Under FAS 123-R, we must determine the appropriate fair-value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. Upon adoption, we expect to utilize the modified prospective transition method. Using this method, compensation expense for all unvested awards included in our pro forma disclosures will be recognized over the award’s remaining vesting period beginning in the first quarter of 2006. Compensation expense recognized will be based upon the values assigned to grants and modifications of stock compensation used in the pro forma disclosures.
We are currently evaluating the requirements of this standard. Except for the effects of stock compensation grants to retiree-eligible employees disclosed below, we expect that the effect on net income and earnings per share in the periods following adoption will be consistent with amounts reported in our pro forma disclosures under FAS 123 (see Note 1). However, the actual effect on net income and earnings per share will vary depending on the terms and number of options ultimately granted.
F-12
Upon the adoption of FAS 123-R, we will be required to record compensation expense over the period in which the employee becomes eligible to retire, if that period is shorter than the stated vesting period. If employees are eligible to retire at the date of grant, compensation expense will be recognized immediately. If these provisions had been applied in 2005, performance awards of $3.4 million would have been expensed over the 2005 performance period rather than over the stated vesting period. In addition, approximately $4.2 million of stock options would have been immediately expensed in our pro forma disclosures rather than over the stated vesting period.
In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 (“FSP 109-1”) - Application of FASB Statement No. 109, “Accounting for Income Taxes,” to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (“AJCA”). The AJCA introduces a special 9% tax deduction on qualified production activities. FSP 109-1 clarifies that this tax deduction should be accounted for as a special tax deduction in accordance with Statement 109. Pursuant to the AJCA, we will be eligible to claim the benefit beginning in 2005. Our income tax provision includes the effects of the estimated deduction we expect to take on our 2005 consolidated federal income tax return (See Note 6).
In March 2005, the FASB issued FASB Interpretation No. (“Interpretation”) 47 - Accounting for Conditional Asset Retirement Obligations – an Interpretation of FASB Statement No. 143. Interpretation 47 clarifies the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or method of settlement are conditional on a future event. This Interpretation will be effective for us no later than December 31, 2005. The application of this Interpretation is not expected to have a material effect on our consolidated financial statements.
In May 2005, the FASB issued FAS 154 - Accounting Changes and Error Corrections, which replaces Accounting Principles Opinion No. 20 - Accounting Changes and FAS 3 - Reporting Accounting Changes in Interim Financial Statements. FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. The standard requires retrospective application to prior period financial statements for changes in accounting principles and the reporting of a correction of an error. FAS 154 also requires a change in accounting estimate that is effected by a change in accounting principle to be accounted for as a change in accounting estimate. FAS 154 will be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The application of this standard is not expected to have a material effect on our consolidated financial statements.
In June 2005, the Emerging Issues Task Force issued EITF No. 05-06 (“EITF”) - Determining the Amortization Period for Leasehold Improvements Purchased After Lease Inception or Acquired in a Business Combination. The EITF requires that leasehold improvements acquired in a business combination or purchased after the inception of a lease be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals deemed to be reasonably assured at the date of acquisition. The EITF became effective beginning July 1, 2005 and did not have a material effect on our consolidated financial statements.
3. ACQUISITIONS
2005
2004
F-13
The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed in these acquisitions.
Other current assets
Indefinite-lived intangible assets
Amortizable intangible assets
Other assets
Net operating loss carryforwards
Total assets acquired
Current liabilities
Obligations under notes receivable and redeemable preferred stock
Other long term obligations
Total purchase price
The allocation of the purchase price to the assets and liabilities of the Shopzilla acquisition is based upon preliminary appraisals and estimates and is therefore subject to change.
The following table summarizes, on a pro forma basis, the estimated combined results of operations of Scripps and Shopzilla had the transaction taken place at the beginning of 2004. The pro forma information includes adjustments for interest expense that would have been incurred to finance the acquisition, additional depreciation and amortization of the assets acquired and excludes transaction related expenses incurred by Shopzilla in the 2005 periods. The unaudited pro forma financial information is not necessarily indicative of the results that actually would have occurred had the acquisition been completed at the beginning of the period. Pro forma results are not presented for the other acquisitions completed during 2005 and 2004, including GAC which was acquired in the fourth quarter of 2004, because the combined results of operations would not be significantly different from reported amounts.
Operating revenues
Income from continuing operations per share of common stock:
Basic
Diluted
F-14
4. DISCONTINUED OPERATIONS
In the third quarter of 2005, we reached an agreement with Advance Publications, Inc., the publisher of the Birmingham News (“News”), to terminate the Birmingham joint operating agreement between the News and our Birmingham Post-Herald newspaper. During the quarter, we also ceased publication of our Birmingham Post-Herald newspaper and sold certain assets to the News. We received cash consideration of approximately $40.8 million from these transactions. Third quarter net income was increased by $24.2 million, $.15 per share. In accordance with the provisions of FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the results of the Birmingham Post-Herald have been treated as a discontinued operation for all periods presented within our results of operations. Accordingly, the results of the newspaper have also been excluded from our Newspaper segment results for all periods presented.
Operating results for the Birmingham Post-Herald were as follows:
Share of earnings of JOA, including termination fee
Income from discontinued operations, before tax
Income taxes
F-15
5. INVESTMENT RESULTS AND OTHER ITEMS
2005 - The American Jobs Creation Act of 2004 (“AJCA”) provides a tax deduction for qualifying domestic production activities. During the third quarter, we completed an evaluation of our business’ qualifying production activities and increased our estimated tax deduction. Primarily due to this change in estimate, we reduced our expected annual effective income tax rate from 35.8% to 35.5%. This change in estimate reduced our third quarter 2005 tax provision and increased net income by $2.3 million, $.01 per share. Our estimated tax deduction for qualifying domestic production activities is subject to further adjustment for, among other things, the adoption of final regulations by the United States Department of the Treasury (“Treasury”). Proposed regulations were issued by the Treasury in October 2005.
In the third quarter of 2005, the management committee of the Denver News Agency (“DNA”) approved plans to consolidate DNA’s newspaper production facilities. As a result, assets used in certain of the existing facilities will be retired earlier than previously estimated. The reduction in these assets’ estimated useful lives increased DNA’s third quarter depreciation expense, resulting in a $9.1 million decrease in our equity in earnings from JOAs. Third quarter net income was decreased by $5.7 million, $.03 per share. The increased depreciation is expected to decrease equity in earnings from JOAs by $11.3 million in the fourth quarter of 2005 and approximately $3 million in each remaining quarter until the second quarter of 2007.
Certain of our Florida operations sustained hurricane damages in 2004. In the second quarter of 2005, we reached agreement with insurance providers on our property damage and business interruption claims for our affected television stations. We also reached agreement with other responsible parties for certain property damage at our affected newspapers. These recoveries, which totaled $2.2 million, were partially offset by additional estimated losses of $0.3 million recorded in 2005. Year-to-date net income was increased by $1.2 million, $.01 per share. Our affected newspapers are currently in discussions with our insurance providers to assess the amount of the claim and the amount of covered losses. Insurance recoveries for these claims will not be recorded until settlement agreements are reached with the insurance providers.
2004 – Third quarter and year to date operating results were affected by the impact of hurricanes at our Florida operations. Our Florida operations sustained wind and water damage and the hurricanes interrupted operations at our affected businesses and at certain of their customers, resulting in lost revenues. Estimated asset impairment losses and restoration costs recorded through September 30, 2004, totaled $2.4 million, of which approximately $1.1 million related to the newspaper segment and $1.3 million related to the broadcast television segment. Net income was reduced by $1.5 million, $.01 per share.
Year-to-date operating results include an $11.1 million pre-tax gain on the sale of our Cincinnati television station’s production facility to the City of Cincinnati. The gain on sale had previously been deferred while the station continued to use the facility until construction of a new production facility was complete. Net income was increased by $7.0 million, $.04 per share.
Year-to-date other investment results represent realized gains from the sale of certain investments, including Digital Theater Systems. Net income was increased by $9.5 million, $.06 per share.
F-16
6. INCOME TAXES
We file a consolidated federal income tax return and separate state income tax returns for each subsidiary company. Included in our federal and state income tax returns is our proportionate share of the taxable income or loss of partnerships and incorporated limited liability companies that have elected to be treated as partnerships for tax purposes (“pass-through entities”). Our financial statements do not include any provision (benefit) for income taxes on the income (loss) of pass-through entities attributed to the non-controlling interests.
Food Network is operated under the terms of a general partnership agreement. Fine Living and Shop At Home are limited liability companies (“LLC”) and are treated as partnerships for tax purposes. As a result, federal and state income taxes for these pass-through entities accrue to the individual partners.
Consolidated income before income tax consisted of the following:
Income allocated to Scripps
Income of pass-through entities allocated to non-controlling interests
Income from continuing operations before income taxes and minority interest
The income tax provision for interim periods is determined based upon the expected effective income tax rate for the full year and the tax rate applicable to certain discrete transactions in the interim period. To determine the annual effective income tax rate for the full year period we must estimate both the total income before income tax for the full year and the jurisdictions in which that income is subject to tax. The actual effective income tax rate for the full year may differ from these estimates if income before income tax is greater or less than what was estimated or if the allocation of income to jurisdictions in which it is taxed is different from the estimated allocations. We review and adjust our estimated effective income tax rate for the full year each quarter based upon our most recent estimates of income before income tax for the full year and the jurisdictions in which we expect that income will be taxed.
F-17
Information regarding our expected effective income tax rate for the full year of 2005 and the actual effective income tax rate for the full year of 2004 is as follows:
Statutory rate
Effect of:
State and local income taxes, net of federal income tax benefit
Effective income tax rate
The provision for income taxes consisted of the following:
Current:
Federal
Tax benefits from NOLs
Federal, net
State and local
State and local, net
Foreign
Tax benefits of compensation plans allocated to additional paid-in-capital
Total current income tax provision
Deferred:
Deferred tax allocated to other comprehensive income
Total deferred income tax provision (benefit)
F-18
The approximate effects of the temporary differences giving rise to deferred income tax liabilities (assets) were as follows:
Temporary differences:
Goodwill and other intangible assets
Investments, primarily gains and losses not yet recognized for tax purposes
Accrued expenses not deductible until paid
Deferred compensation and retiree benefits not deductible until paid
Other temporary differences, net
Total temporary differences
Tax basis capital loss carryforwards
Federal net operating loss carryforwards
State net operating loss carryforwards
Valuation allowance for state deferred tax assets
Net deferred tax liability
Investment losses on our portfolio of investments in development-stage businesses were recognized for book purposes when it was determined the carrying values of the investment would not be recovered. For tax purposes such losses are generally recognized when the securities become worthless. Federal tax law provides that such losses may not be deducted from ordinary income, and that any losses in excess of capital gains can be carried forward for up to five years. At September 30, 2005, such tax-basis capital loss carryforwards totaled $35.7 million. We expect to generate sufficient capital gains to fully utilize the capital loss carryforwards prior to the expiration of the carryforward periods between 2008 and 2010.
At the date of acquisition, Shopzilla had federal net operating loss carryforwards totaling $54.1 million. These net operating loss carryforwards and the loss carryforwards obtained in the Summit America acquisition totaled $113 million at September 30, 2005. The federal net operating loss carryforwards expire between 2018 and 2024. We expect to be able to fully utilize the carryforwards on our federal income tax returns.
At the date of acquisition Shopzilla had state tax loss carryforwards totaling $37.8 million. Total state net operating loss carryforwards, including those acquired in the Summit America acquisition and of certain of our other subsidiary companies, were $581 million at September 30, 2005. Our state tax loss carryforwards expire between 2005 and 2023. Because separate state income tax returns are filed, we are not able to use state tax losses of a subsidiary company to offset state taxable income of another subsidiary company.
Federal and state carryforwards are recognized as deferred tax assets, subject to valuation allowances. At each balance sheet date we estimate the amount of carryforwards that are not expected to be used prior to expiration of the carryforward period. The tax effect of the carryforwards that are not expected to be used prior to their expiration is included in the valuation allowance.
F-19
7. JOINT OPERATING AGREEMENTS
In the third quarter of 2005, we reached an agreement with Advance Publications, Inc. to terminate the Birmingham joint operating agreement (See Note 4).
Three of our newspapers are operated pursuant to the terms of joint operating agreements (“JOAs”). The Newspaper Preservation Act of 1970 provides a limited exemption from anti-trust laws, permitting competing newspapers in a market to combine their sales, production and business operations to reduce aggregate expenses and take advantage of economies of scale, thereby allowing the continuing operation of both newspapers in that market. Each newspaper maintains a separate and independent editorial operation.
The table below provides certain information about our JOAs.
Newspaper
Publisher of Other Newspaper
The Albuquerque Tribune
The Cincinnati Post
Denver Rocky Mountain News
The JOAs generally provide for renewals unless an advance termination notice ranging from two to five years is given to either party. Gannett Newspapers has notified us of its intent to terminate the Cincinnati JOA upon its expiration in 2007.
The combined sales, production and business operations of the newspapers are either jointly managed or are solely managed by one of the newspapers. The sales, production and business operations of the Denver newspapers are operated by the Denver Newspaper Agency, a limited liability partnership (the “Denver JOA”). Each newspaper owns 50% of the Denver JOA and shares management of the combined newspaper operations. We have no management responsibilities for the combined operations of the other two JOAs.
The operating profits earned from the combined operations of the two newspapers are distributed to the partners in accordance with the terms of the joint operating agreement. We receive a 50% share of the Denver JOA profits and between 25% and 40% of the profits from the other two JOAs.
8. INVESTMENTS
Investments consisted of the following:
Securities available for sale (at market value):
Time Warner (2,017,000 common shares)
Other available-for-sale securities
Total available-for-sale securities
Denver JOA
FOX Sports Net South and other joint ventures
Other equity securities
Total investments
Unrealized gains (losses) on securities available for sale
Investments available for sale represent securities in publicly-traded companies. Investments available for sale are recorded at fair value. Fair value is based upon the closing price of the security on the reporting date. As of September 30, 2005, there were no significant unrealized losses on our available-for-sale securities.
Other equity securities include securities that do not trade in public markets, so they do not have readily determinable fair values. We estimate the fair values of the other securities approximate their carrying values at September 30, 2005. There can be no assurance we would realize the carrying values of these securities upon their sale.
F-20
9. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
Land and improvements
Buildings and improvements
Equipment
Accumulated depreciation
Net property, plant and equipment
F-21
10. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consisted of the following:
Other intangible assets:
Amortizable intangible assets:
Carrying amount:
Acquired network distribution
Broadcast television network affiliation relationships
Customer lists
Total carrying amount
Accumulated amortization:
Total accumulated amortization
Net amortizable intangible assets
Other indefinite-lived intangible assets:
FCC licenses
Total other indefinite-lived intangible assets
Total other intangible assets
F-22
Activity related to goodwill and other intangible assets by business segment was as follows:
Goodwill:
Balance as of December 31, 2003
Summit America acquisition
Balance as of September 30, 2004
Balance as of December 31, 2004
Business acquisitions
Adjustment of purchase price allocations
Balance as of September 30, 2005
Reclassification from indefinite-lived intangible assets
Other additions
Amortization
Reclassification to amortizable intangible assets
The goodwill acquired in the GAC acquisition and $27 million of the goodwill acquired in the Summit America acquisition is expected to be deductible for income tax purposes.
Amortizable intangible assets acquired in the Shopzilla acquisition include contractual relationships with customers and vendors and intellectual property. The acquired intangibles are estimated to have useful lives of three to five years. The allocation of the Shopzilla purchase price is based upon preliminary appraisals and estimates, and is therefore subject to change.
Intangible assets acquired in the Summit America acquisition primarily include customer lists, network distribution relationships and FCC licenses. Customer lists are amortized over three years and network distribution relationships are amortized over their
F-23
contractual terms. FCC licenses are not amortized. Final appraisals were issued for the Summit America acquisition in the second quarter of 2005.
Intangible assets acquired in the GAC acquisition are primarily network distribution relationships, which are amortized over periods of up to 15 years. Final appraisals of the assets acquired and liabilities assumed were received in the fourth quarter of 2005.
Estimated amortization expense of intangible assets for each of the next five years is expected to be $9.1 million for the remainder of 2005, $34.5 million in 2006, $34.5 million in 2007, $34.3 million in 2008, $33.6 million in 2009, $16.1 million in 2010 and $46.5 million in later years.
F-24
11. PROGRAMS AND PROGRAM LICENSES
Programs and program licenses consisted of the following:
Cost of programs available for broadcast
Accumulated amortization
Progress payments on programs not yet available for broadcast
Total programs and program licenses
In addition to the programs owned or licensed by us included in the table above, we have commitments to license certain programming that is not yet available for broadcast, including first-run syndicated programming. Such program licenses are recorded as assets when the programming is delivered to us and is available for broadcast. First-run syndicated programming is generally produced and delivered at or near its broadcast date. Such contracts may require progress payments or deposits prior to the program becoming available for broadcast. Remaining obligations under contracts to purchase or license programs not yet available for broadcast totaled approximately $301 million at September 30, 2005. If the programs are not produced, our obligations would generally expire without obligation.
Progress payments on programs not yet available for broadcast and the cost of programs and program licenses capitalized totaled $59.0 million in the third quarter of 2005 and $50.5 million in the third quarter of 2004. Year to date progress payments and capitalized programs totaled $160 million in 2005 and $153 million in 2004.
Estimated amortization of recorded program assets and program commitments for each of the next five years is as follows:
Remainder of 2005
2006
2007
2008
2009
2010
Later years
Actual amortization in each of the next five years will exceed the amounts presented above as our broadcast television stations and our national television networks will continue to produce and license additional programs.
F-25
12. UNAMORTIZED NETWORK DISTRIBUTION INCENTIVES
Unamortized network distribution incentives consisted of the following:
September 30,
December 31,
Network launch incentives
Net book value
Unbilled affiliate fees
Total unamortized network distribution incentives
We capitalized network launch incentives totaling $1.2 million year-to-date in 2005 and $2.4 million year-to-date in 2004.
Amortization recorded as a reduction to affiliate fee revenue in the consolidated financial statements, and estimated amortization of recorded network launch incentives for each of the next five years, is presented below.
Amortization of network launch incentives
Estimated amortization for the next five years is as follows:
Actual amortization will be greater than the above amounts as additional incentive payments will be capitalized as we expand distribution of Scripps Networks.
F-26
13. LONG-TERM DEBT
Long-term debt consisted of the following:
Variable-rate credit facilities, including commercial paper
$100 million, 6.625% notes, due in 2007
$50 million, 3.75% notes, due in 2008
$100 million, 4.25% notes, due in 2009
$150 million, 4.30% notes, due in 2010
$200 million, 5.75% notes, due in 2012
Other notes
Total face value of long-term debt less discounts
Fair market value of interest rate swap
Total long-term debt
We have Competitive Advance and Revolving Credit Facilities expiring in July 2009 (the “Revolver”) and a commercial paper program that collectively permit aggregate borrowings up to $450 million (the “Variable-Rate Credit Facilities”). Borrowings under the Revolver are available on a committed revolving credit basis at our choice of three short-term rates or through an auction procedure at the time of each borrowing. The Revolver is primarily used as credit support for our commercial paper program in lieu of direct borrowings under the Revolver. The weighted-average interest rate on borrowings under the Variable-Rate Credit Facilities was 3.7% at September 30, 2005, 2.3% at December 31, 2004, and 1.9% at September 30, 2004.
We have a U.S. shelf registration statement which allows us to borrow up to an additional $300 million as of September 30, 2005.
We entered into a receive-fixed, pay-floating interest rate swap to achieve a desired proportion of fixed-rate versus variable-rate debt. The interest rate swap expires upon the maturity of the $50 million, 3.75% notes in 2008, and effectively converts those fixed-rate notes into variable-rate borrowings. The variable interest rate was 4.2% at September 30, 2005, which was based on six-month LIBOR minus a rate spread. The swap agreement was designated as a fair-value hedge of the underlying fixed-rate notes. Accordingly, changes in the fair value of the interest rate swap agreement (due to movements in the benchmark interest rate) are recorded as adjustments to the carrying value of long-term debt with an offsetting adjustment to either other assets or other liabilities. The changes in the fair value of the interest rate swap agreements and the underlying fixed-rate obligation are recorded as equal and offsetting unrealized gains and losses in the Consolidated Statements of Income. We have structured the interest rate swap to be 100% effective. As a result, there is no current impact to earnings resulting from hedge ineffectiveness.
Certain long-term debt agreements contain maintenance requirements for net worth and coverage of interest expense and restrictions on incurrence of additional indebtedness. We were in compliance with all debt covenants.
Current maturities of long-term debt are classified as long-term to the extent they can be refinanced under existing long-term credit commitments.
F-27
14. OTHER LIABILITIES AND MINORITY INTERESTS
Other liabilities and minority interests consisted of the following:
Program rights payable
Total other liabilities and minority interests
Current portion of other liabilities
Non-controlling interests hold an approximate 10% residual interest in Fine Living. The minority owners of Fine Living have the right to require us to repurchase their interests. We have an option to acquire their interests. The minority owners will receive the fair market value for their interests at the time their option is exercised. The put and call options become exercisable at various dates through 2016. Put options on an approximate 6% non-controlling interest in Fine Living are currently exercisable. The remaining put options become exercisable in 2006.
Non-controlling interests hold an approximate 30% residual interest in Food Network. The Food Network general partnership agreement terminates on December 31, 2012, unless amended or extended prior to that date. Upon termination, the assets of the partnership are to be liquidated and distributed to the partners in proportion to their partnership interests.
Minority interests include non-controlling interests of approximately 8% in the capital stock of the subsidiary companies that publish our Memphis and Evansville newspapers. The capital stock of these companies does not provide for or require the redemption of the non-controlling interests by us.
F-28
15. SUPPLEMENTAL CASH FLOW INFORMATION
The following table presents additional information about the change in certain working capital accounts:
Other changes in certain working capital accounts, net:
Accounts receivable
Accrued income taxes
Accrued employee compensation and benefits
Accrued interest
Other accrued liabilities
Other, net
16. EMPLOYEE BENEFIT PLANS
We sponsor defined benefit pension plans that cover substantially all non-union and certain union-represented employees. Benefits are generally based upon the employee’s compensation and years of service.
We also have a non-qualified Supplemental Executive Retirement Plan (“SERP”). The SERP, which is unfunded, provides defined pension benefits in addition to the defined benefit pension plan to eligible executives based on average earnings, years of service and age at retirement.
Substantially all non-union and certain union employees are also covered by a company sponsored defined contribution plan. We match a portion of employee’s voluntary contributions to this plan.
Other union-represented employees are covered by defined benefit pension plans jointly sponsored by us and the union, or by union-sponsored multi-employer plans.
We use a December 31 measurement date for our retirement plans. Retirement plans expense is based on valuations performed by plan actuaries as of the beginning of each fiscal year. The components of the expense consisted of the following:
( in thousands)
Service cost
Interest cost
Expected return on plan assets, net of expenses
Net amortization and deferral
Total for defined benefit plans
Multi-employer plans
SERP
Defined contribution plans
For the year-to-date period of 2005, we made required contributions of $0.6 million and voluntary contributions of $42.0 million to our defined benefit plans. We anticipate contributing $0.4 million to meet minimum funding requirements of our defined benefit plans during the remainder of fiscal 2005. During 2005, we have also contributed $2.0 million to fund current benefit payments for our non-qualified SERP plan. We anticipate contributing an additional $0.6 million to fund the SERP’s benefit payments during the remainder of fiscal 2005.
F-29
17. SEGMENT INFORMATION
We determine our business segments based upon our management and internal reporting structure. Our reportable segments are strategic businesses that offer different products and services (See Note 1).
The accounting policies of each of our business segments are those described in Note 1 in our Annual Report on Form 10-K for the year ended December 31, 2004.
Each of our segments may provide advertising, programming or other services to our other business segments. In addition, certain corporate costs and expenses, including information technology, pensions and other employee benefits, and other shared services, are allocated to our business segments. The allocations are generally amounts agreed upon by management, which may differ from amounts that would be incurred if such services were purchased separately by the business segment. Corporate assets are primarily cash, cash equivalent and other short-term investments, property and equipment primarily used for corporate purposes, and deferred income taxes.
Our chief operating decision maker (as defined by FAS 131 – Segment Reporting) evaluates the operating performance of our business segments and makes decisions about the allocation of resources to our business segments using a measure we call segment profit. Segment profit excludes interest, income taxes, depreciation and amortization, divested operating units, restructuring activities, investment results and certain other items that are included in net income determined in accordance with accounting principles generally accepted in the United States of America.
As discussed in Note 1, we account for our share of the earnings of JOAs using the equity method of accounting. Our equity in earnings of JOAs is included in “Equity in earnings of JOAs and other joint ventures” in our Consolidated Statements of Income. Newspaper segment profits include equity in earnings of JOAs. Scripps Networks segment profits include equity in earnings of FOX Sports Net South and certain other joint ventures.
F-30
Information regarding our business segments is as follows:
Nine months ended
Segment operating revenues:
Newspapers:
Newspapers managed solely by us
Newspapers operated pursuant to JOAs
Total newspapers
Broadcast television
Licensing and other media
Segment profit (loss):
Corporate
Total segment profit
Depreciation and amortization of intangibles
Gains (losses) on disposal of property, plant and equipment
Hurricane asset impairment losses
Depreciation:
Total depreciation
Amortization of intangibles:
Total amortization of intangibles
F-31
Additions to property, plant and equipment:
Total additions to property, plant and equipment
Business acquisitions and other additions to long-lived assets:
Assets:
Total assets of continuing operations
Discontinued operations
Total assets
No single customer provides more than 10% of our revenue. International revenues are primarily derived from licensing comic characters and HGTV and Food Network programming in international markets. Licensing of comic characters in Japan provides approximately 50% of our international revenues, which are less than $60 million annually.
Other additions to long-lived assets include investments, capitalized intangible assets and Scripps Networks capitalized programs and network launch incentives.
F-32
18. STOCK COMPENSATION PLANS
The following table presents information about stock options:
Options outstanding at December 31, 2003
Options granted during the period
Options exercised during the period
Options forfeited during the period
Options outstanding at September 30, 2004
Options outstanding at December 31, 2004
Options outstanding at September 30, 2005
Substantially all options granted prior to 2003 are exercisable. Options generally become exercisable over a one-to-three-year period. Information about options outstanding and options exercisable by year of grant is as follows:
Year of Grant
Options
on SharesOutstanding
on SharesExercisable
1996 - expire in 2006
1997 - expire in 2007
1998 - expire in 2008
1999 - expire in 2009
2000 - expire in 2010
2001 - expire in 2011
2002 - expire in 2012
2003 - expire in 2013
2004 - expire in 2014
2005 - expire in 2013
Total options on number of shares
F-33
Information related to awards of Class A Common Shares is presented below:
Number ofShares
Unvested shares at December 31, 2003
Shares awarded during the period
Shares vested during the period
Shares forfeited during the period
Unvested shares at September 30, 2004
Unvested shares at December 31, 2004
Unvested shares at September 30, 2005
During 2004, 40,000 restricted stock awards were converted to RSUs. The RSUs vest in 2006.
Performance awards with a target of 147,764 Class A Common shares were issued in 2005. The number of shares ultimately awarded depends upon the extent to which specified performance measures are met. The shares earned vest between 2006 and 2008.
F-34
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion and analysis of financial condition and results of operations is based upon the consolidated financial statements and the condensed notes to the consolidated financial statements. You should read this discussion in conjunction with those financial statements.
FORWARD-LOOKING STATEMENTS
This discussion and the information contained in the condensed notes to the consolidated financial statements contain certain forward-looking statements that are based on our current expectations. Forward-looking statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from the expectations expressed in the forward-looking statements. Such risks, trends and uncertainties, which in most instances are beyond our control, include changes in advertising demand and other economic conditions; consumers’ taste; newsprint prices; program costs; labor relations; technological developments; competitive pressures; interest rates; regulatory rulings; and reliance on third-party vendors for various products and services. The words “believe,” “expect,” “anticipate,” “estimate,” “intend” and similar expressions identify forward-looking statements. All forward-looking statements, which are as of the date of this filing, should be evaluated with the understanding of their inherent uncertainty. We undertake no obligation to publicly update any forward-looking statements to reflect events or circumstances after the date the statement is made.
EXECUTIVE OVERVIEW
We are a diverse media concern with interests in national television networks (“Scripps Networks”), newspaper publishing, broadcast television, television retailing (“Shop At Home”), on-line comparison shopping (“Shopzilla”), interactive media and licensing and syndication. Scripps Networks includes five cable and satellite television programming services, Home & Garden Television (“HGTV”), Food Network, DIY Network (“DIY”), Fine Living and Great American Country (“GAC”). Our media businesses provide high quality news, information and entertainment content to readers and viewers. We have undergone a strategic transformation during the past 10 years, evolving from our historical role as a pioneer newspaper publisher and television broadcaster to one of the country’s leading providers of content for a growing range of print, video and electronic media platforms. Scripps Networks revenue and segment profits surpassed our newspaper segment results in 2004.
To create new businesses or acquire businesses that are expected to significantly increase shareholder value, we operate our core media businesses to maximize sustainable cash flow and place a high priority on allocating capital to businesses that will produce the best returns for our shareholders. We have used a portion of the cash produced by our newspapers and broadcast television stations to develop HGTV, DIY and Fine Living and to acquire Food Network, Shop At Home, GAC, and Shopzilla. The expansion of Scripps Networks, implementation of our commerce strategy at Shop At Home, and expanding our electronic media platform continue to be our company’s top strategic priorities.
Scripps Networks has sustained a period of rapid growth, successfully monetizing viewership gains, especially at its two more established networks, HGTV and Food Network. Strong upfront advertising sales at HGTV and Food, combined with a healthy scatter advertising market, has resulted in a prolonged period of strong, double digit profit and revenue growth that the company projects will continue through 2005. We also have successfully extended Scripps Networks brands to the Internet. The number of unique visitors to Scripps Networks’ Internet sites is up 45% year-over-year.
At Shop At Home, we are investing capital to develop an innovative electronic commerce business. Our vision for Shop At Home is to provide a pure electronic commerce environment for products and services that, in part, parallel the consumer categories targeted by our national television networks. Shop At Home’s revenue increases in 2005 reflect improvements we have made in both the quality and variety of products that we are offering to home shoppers. We are also continuing to build the business through the Internet. Traffic to the Shop At Home Internet site has nearly quadrupled from the same period last year.
During the second quarter of 2005, we completed the acquisition of Shopzilla. Shopzilla operates a product comparison shopping service that helps consumers find products offered for sale on the Web by online retailers. Shopzilla aggregates and organizes information on millions of products from thousands of retailers. Shopzilla also operates BizRate, a popular Web-based consumer feedback network which collects millions of consumer reviews of stores and products each year. The acquisition enables us to capitalize on the rapid growth and rising profitability of specialized Internet search businesses and expands our electronic media platform.
F-35
At our newspapers, we are continuing efforts to strengthen the competitive position of our newspapers. In the third quarter, along with MediaNews Group, our joint operating partner in Denver, we decided to consolidate newspaper production operations from two plants into a single facility. The consolidation of facilities seeks to reduce costs and increase efficiencies for the production of both newspapers. In addition, we have introduced a number of new product initiatives. Examples include new zoned sections in Memphis and a popular Spanish-language publication in Ventura County. We are continuing to achieve significant increases in advertising revenues for these types of publications in hopes of offsetting some of the declines in traditional advertising revenue streams.
At our broadcast television stations, revenue and profits were expectedly lower due to the absence of political advertising.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) requires us to make a variety of decisions which affect reported amounts and related disclosures, including the selection of appropriate accounting principles and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgment based on our understanding and analysis of the relevant circumstances, including our historical experience, actuarial studies and other assumptions. We are committed to preparing financial statements incorporating accounting principles, assumptions and estimates that promote the representational faithfulness, verifiability, neutrality and transparency of the accounting information included in the financial statements.
Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K describes the significant accounting policies we have selected for use in the preparation of our financial statements and related disclosures. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in estimates that are likely to occur could materially change the financial statements. We believe the accounting for Network Affiliate Fees, Investments, Goodwill and Other Indefinite-Lived Intangible Assets, Income Taxes and Pension Plans to be our most critical accounting policies and estimates. A detailed description of these accounting policies is included in the Critical Accounting Policies Section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2004. There have been no significant changes in those accounting policies.
F-36
The trends and underlying economic conditions affecting the operating performance and future prospects differ for each of our five business segments. Accordingly, we believe the discussion of our consolidated results of operations should be read in conjunction with the discussion of the operating performance of our business segments that follows on pages F-40 through F-52.
In the third quarter of 2005, we reached an agreement with Advance Publications, Inc., the publisher of the Birmingham News (“News”), to terminate the Birmingham joint operating agreement between the News and our Birmingham Post-Herald newspaper. During the quarter, we also ceased publication of our Birmingham Post-Herald newspaper and sold certain assets to the News. We received cash consideration of approximately $40.8 million from these transactions. Third quarter net income was increased by $24.2 million, $.15 per share. In accordance with the provisions of Financial Accounting Standard (“FAS”) 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the results of the Birmingham Post-Herald have been treated as a discontinued operation for all periods presented within our results of operations.
Consolidated Results of Continuing Operations - Consolidated results of continuing operations were as follows:
Costs and expenses
Hurricane recoveries (losses), net
Income from continuing operations per basic diluted share of common stock
The increase in operating revenues was primarily due to the continued growth in advertising and network affiliate fee revenues at our national television networks and our June 2005 acquisition of Shopzilla. The growth in advertising revenues was primarily driven by increased demand for advertising time and higher advertising rates at our networks. The growth in affiliate fee revenues is attributed to scheduled rate increases, wider distribution of our networks, and the impact of reaching several renewal agreements with cable television operators during September of 2004. Increases in operating revenues were also attributed to increases in merchandise sales at Shop At Home and continued improvement in help wanted and real estate classified advertising at our newspapers. These increases in revenue were partially offset by declines in revenue at our broadcast television stations attributed to the absence of political advertising.
Costs and expenses were impacted by the expanded hours of original programming and costs to promote our national networks, increases in costs of merchandise sold at Shop At Home and increased personnel and infrastructure costs incurred to support the growth at Shop At Home, and the acquisition of Shopzilla. Employee benefit costs, particularly health care benefits, increased approximately $3.4 million year-over-year in the year to date period.
F-37
Depreciation and amortization increased primarily as a result of the acquisitions of Shopzilla, Summit America and Great American Country.
Operating results in 2004 include an $11.1 million gain on the sale of our Cincinnati television station’s production facility to the City of Cincinnati. Net income was increased by $7.0 million, $.04 per share.
During the third quarter of 2004, certain of our Florida operations were affected by the impact of hurricanes. Our Florida operations sustained wind and water damage and the hurricanes interrupted operations at our affected businesses and at certain of their customers, resulting in lost revenues. Third quarter and year-to-date operating results in 2004 included asset impairment charges and restoration costs totaling $2.4 million related to these hurricanes. Net income was reduced by $1.5 million, $.01 per share.
During 2005, we reached agreement with insurance providers and other responsible third parties on certain of our property and business interruption claims resulting from hurricanes in 2004 and recorded insurance recoveries of $2.2 million. These insurance recoveries were partially offset by additional estimated losses of $0.3 million recorded in 2005. Year-to-date net income in 2005 was increased by $1.2 million, $.01 per share. Our affected newspapers have filed a claim with the insurance providers seeking recoveries of $3.1 million for property and business interruption losses. We are currently in discussions with our insurance providers to negotiate the final settlement. Insurance recoveries for these claims will not be recorded until settlement agreements are reached with the insurance providers.
Certain of our Florida operations were also affected by the impact of hurricane Wilma. Operations at our affected businesses have been interrupted and damage has been incurred that may result in restoration costs and asset impairment losses being recorded in the fourth quarter of 2005.
Interest expense includes interest incurred on our outstanding borrowings and interest incurred on deferred compensation and other employment agreements. Interest incurred on our outstanding borrowings increased during the quarter and year-to-date periods due to higher average debt levels attributed to the Shopzilla acquisition. The average balance of outstanding borrowings was $616 million in the year-to-date period of 2005 compared with $513 million in the year-to-date period of 2004 and $875 million in the third quarter of 2005 compared with $516 million in the third quarter of 2004.
Interest and dividend income increased in the third quarter and year-to-date periods as a result of $3.0 million of interest income due to us a result of favorable court rulings with respect to certain disputes with the Internal Revenue Service.
Other investment results in 2004 represent realized gains from the sale of certain investments, including Digital Theater Systems. Net income was increased by $9.5 million, $.06 per share.
F-38
Information regarding our effective tax rate is a follows:
Income from continuing operations before income taxes and minority interests as reported
Income allocated to non-controlling interests
Effective income tax rate as reported
Effective income tax rate on income allocated to Scripps
Our effective income tax rate is affected by the growing profitability of Food Network. Food Network is operated pursuant to the terms of a general partnership, in which we own an approximate 70% residual interest. Income taxes on partnership income accrue to the individual partners. While the income before income tax reported in our financial statements includes all of the income before tax of the partnership, our income tax provision does not include income taxes on the portion of Food Network income that is attributable to the non-controlling interest.
The income tax provision for interim periods is determined by applying the expected effective income tax rate for the full year to year-to-date income before income tax. Tax provisions are separately provided for certain discrete transactions in interim periods. To determine the annual effective income tax rate for the full year period we must estimate both the total income before income tax for the full year and the jurisdictions in which that income is subject to tax.
The American Jobs Creation Act of 2004 (“AJCA”) provides a tax deduction for qualifying domestic production activities. During the third quarter, we completed an evaluation of our business’ qualifying production activities and increased our estimated tax deduction. Primarily due to this change in estimate, we reduced our expected annual effective income tax rate from 35.8% to 35.5%. The effects of changes made to the estimated effective income tax rate for the full year during a quarter are reflected in the tax provision for that quarter. This change in estimate reduced our third quarter 2005 tax provision by $2.3 million, $.01 per share. Our estimated tax deduction for qualifying domestic production activities is subject to further adjustment for, among other things, the adoption of final regulations by the United States Department of the Treasury (“Treasury”). Proposed regulations were issued by the Treasury in October 2005.
Minority interest increased in the third quarter of 2005 primarily due to the increased profitability of the Food Network. Food Network’s profits are allocated in proportion to each partner’s residual interests in the partnership, of which we own approximately 70%. We expect minority interest will be between $15 million and $16 million in the fourth quarter of 2005.
Business Segment Results - As discussed in Note 17 to the Consolidated Financial Statements our chief operating decision maker (as defined by FAS 131 - Segment Reporting) evaluates the operating performance of our business segments using a performance measure we call segment profits. Segment profits excludes interest, income taxes, depreciation and amortization, divested operating units, restructuring activities, investment results and certain other items that are included in net income determined in accordance with accounting principles generally accepted in the United States of America.
Items excluded from segment profits generally result from decisions made in prior periods or from decisions made by corporate executives rather than the managers of the business segments. Depreciation and amortization charges are the result of decisions made in prior periods regarding the allocation of resources and are therefore excluded from the measure. Financing, tax structure and divestiture decisions are generally made by corporate executives. Excluding these items from our business segment performance measure enables us to evaluate business segment operating performance for the current period based upon current economic conditions and decisions made by the managers of those business segments in the current period.
F-39
Information regarding the operating performance of our business segments determined in accordance with FAS 131 and a reconciliation of such information to the consolidated financial statements is as follows:
The increase in Licensing and other media’s revenues for the year-to-date period is primarily attributed to the renewals of multi-year license agreements with the ABC Television Network for certain of our Peanuts animated films.
Discussions of the operating performance of each of our reportable business segments begin on page F-42.
F-40
Segment profits include our share of the earnings of JOAs and certain other investments included in our consolidated operating results using the equity method of accounting. Newspaper segment profits include equity in earnings of JOAs and other joint ventures. Scripps Networks segment profits include equity in earnings of FOX Sports Net South and other joint ventures.
A reconciliation of our equity in earnings of JOAs and other joint ventures included in segment profits to the amounts reported in our Consolidated Statements of Income is as follows:
Scripps Networks:
Equity in earnings of joint ventures
Equity in earnings of JOAs
Equity in earnings (loss) of joint ventures
Total equity in earnings of JOAs and other joint ventures
Certain items required to reconcile segment profitability to consolidated results of operations determined in accordance with accounting principles generally accepted in the United States of America are attributed to particular business segments. Significant reconciling items attributable to each business segment are as follows:
Depreciation and amortization:
Gains (losses) on disposal of PP&E:
Gains (losses) on disposal of PP&E
Interest and dividend income:
Summit America note
Total interest and dividend income
F-41
Scripps Networks - Scripps Networks includes our national lifestyle television networks: Home & Garden Television (“HGTV”), Food Network, DIY Network (“DIY”), Fine Living and Great American Country (“GAC”). Programming from our networks can be viewed on demand (“VOD”) on cable television systems in about 84 markets across the United States. Scripps Networks also includes our on-line channel, HGTVPro.com, and our 12% interest in FOX Sports Net South, a regional television network. Our networks also operate internationally through licensing agreements and joint ventures with foreign entities.
We launched HGTV in 1994. Food Network launched in 1993, and we acquired our controlling interest in 1997. We launched DIY in 1999 and Fine Living in the first quarter of 2002. We acquired GAC on November 17, 2004. We have used a similar strategy in developing each of our networks. Our initial focus is to gain distribution on cable and satellite television systems. We may offer incentives in the form of cash payments or an initial period in which payment of affiliate fees by the systems is waived in exchange for long-term distribution contracts. We create new and original programming and undertake promotion and marketing campaigns designed to increase viewer awareness. We expect to incur operating losses until network distribution and audience size are sufficient to attract national advertisers. As distribution of the network increases, we make additional investments in the quality and variety of programming and increase the number of hours of original programming offered on the network. Such investments are expected to result in increases in viewership, yielding higher advertising revenues.
While we have employed similar development strategies with each of our networks, there can be no assurance DIY, Fine Living and GAC will achieve operating performances similar to HGTV and Food Network. There has been considerable consolidation among cable and satellite television operators, with the eight largest providing services to approximately 95% of the homes that receive cable and satellite television programming. At the same time, there has been an expansion in the number of programming services seeking distribution on those systems, with the number of networks more than doubling since 1996.
F-42
The networks utilize common facilities and certain sales, operational and support services are shared by the networks. Expenses directly attributable to the operations of a network are charged directly to that network. The costs of shared facilities and services are not allocated to individual networks.
Financial information for Scripps Networks is as follows:
Operating revenues:
HGTV
Food Network
DIY
Fine Living
GAC
Total segment operating revenues
Contribution to segment profit (loss):
Unallocated costs and other
Homes reached in September (1):
Advertising and network affiliate fees provide substantially all of each network’s operating revenues and employee costs and programming costs are the primary expenses. The trends and underlying economic conditions affecting each of our networks are substantially the same as those affecting all of our networks, primarily the demand for national advertising.
F-43
Operating results for Scripps Networks were as follows:
Segment costs and expenses:
Other segment costs and expenses
Total segment costs and expenses
Segment profit before joint ventures
Equity in income of joint ventures
Segment profit
Supplemental Information:
Billed network affiliate fees
Capital expenditures
Business acquisitions and other additions to long-lived assets
Advertising revenues increased due primarily to an increased demand for advertising time and higher advertising rates at our networks. Advertising revenues are expected to increase approximately 25% year-over-year in the fourth quarter of 2005.
The increase in network affiliate fees reflects both scheduled rate increases and wider distribution of the networks. Affiliate fee revenue in 2005 was favorably affected by the completion of several renewal agreements with cable television operators that occurred during the third quarter of 2004. Network affiliate fees are expected to be about $41 million in the fourth quarter of 2005.
Employee compensation and benefit expenses increased due to the hiring of additional employees to support the growth of Scripps Networks.
Marketing efforts to promote our programming and to attract larger audiences led to the increase in other segment costs and expenses. Our continued investment in building viewership across all of our networks is expected to increase total segment expenses approximately 15% year-over-year in the fourth quarter of 2005.
F-44
Newspapers - We operate daily and community newspapers in 18 markets in the U.S. Our newspapers earn revenue primarily from the sale of advertising space to local and national advertisers and from the sale of newspapers to readers. Three of our newspapers are operated pursuant to the terms of joint operating agreements. Each of those newspapers maintains an independent editorial operation and receives a share of the operating profits of the combined newspaper operations.
Newspapers managed solely by us:The newspapers managed solely by us operate in mid-size markets, focusing on news coverage within their local markets. Advertising and circulation revenues provide substantially all of each newspaper’s operating revenues and employee and newsprint costs are the primary expenses at each newspaper. Declines in circulation of daily newspapers have resulted in a loss of advertising market share throughout the newspaper industry. Further declines in circulation in our newspaper markets could adversely affect our newspapers.
The trends and underlying economic conditions affecting the operating performance of any of our newspapers are substantially the same as those affecting all of our newspapers. Our newspaper operating performance is most affected by newsprint prices and economic conditions, particularly within the retail, labor, housing and auto markets. While an individual newspaper may perform better or worse than our newspaper group as a whole due to specific conditions at the newspaper or within its local economy, we do not expect such near-term variances to significantly affect the overall long-term operating performance of the newspaper segment.
Operating results for newspapers managed solely by us were as follows:
Local
Classified
National
Preprint and other
Newspaper advertising
Contribution to segment profit before joint ventures
Contribution to segment profit
Hurricane asset impairments
F-45
Third quarter and year-to-date operating results in 2004 were affected by the impact of hurricanes at our Florida operations. Our Florida operations sustained wind and water damage and the hurricanes interrupted operations at our affected businesses and at certain of their customers, resulting in lost revenues. Advertising revenues at our other newspapers increased 2.0% year-over-year in the third quarter. The increase in advertising revenues was primarily due to increases in classified advertising and preprint and other advertising. The increase in classified advertising was primarily attributed to continued improvement in help wanted and real estate advertising. Excluding any impacts hurricane Wilma may have on our operations, we expect newspaper advertising revenue to increase between 4% and 6% year-over-year in the fourth quarter of 2005.
Increases in preprint and other advertising reflect the continued development of new print and electronic products and services. These products include niche publications such as community newspapers, lifestyle magazines, publications focused upon the classified advertising categories of real estate, employment and auto, and other publications aimed at younger readers. Additionally, our Internet sites had advertising revenues of $6.5 million in the third quarter of 2005 compared with $3.8 million in the third quarter of 2004. Year-to-date Internet advertising revenues were $16.3 million in 2005 compared with $11.3 million in 2004. We expect continued growth in advertising on our Internet sites as we continue to leverage our local franchises in help wanted, automotive and real estate advertising.
Employee compensation and benefit expenses increased due primarily to higher employee benefit costs.
Increases in newsprint and ink costs reflect an increase in newsprint prices of approximately 10% that was partially offset by a 4% decrease in newsprint consumption.
The increases in other segment costs and expenses reflect costs associated with the development of new ancillary products and services.
F-46
Newspapers operated under Joint Operating Agreements (“JOAs”): In the third quarter of 2005, we reached an agreement with Advance Publications, Inc. to terminate the Birmingham joint operating agreement.
Three of our newspapers are operated pursuant to the terms of joint operating agreements (“JOAs”). The table below provides certain information about our JOAs.
Year JOA
Entered Into
Year of JOA
Expiration
Operating results for our newspapers operated under JOAs were as follows:
Equity in earnings of JOAs included in segment profit:
Denver
Cincinnati
Albuquerque
Total equity in earnings of JOAs included in segment profit
JOA editorial costs and expenses:
Total JOA editorial costs and expenses
JOAs contribution to segment profit:
Total JOA contribution to segment profit
Additional depreciation incurred by the Denver News Agency in the third quarter of 2005 reduced equity in earnings of JOAs by $9.1 million (See Note 5 to the Consolidated Financial Statements). The increased depreciation is expected to decrease equity in earnings from JOAs by $11.3 million in the fourth quarter of 2005 and approximately $3 million in each remaining quarter until the second quarter of 2007.
Gannett Newspapers has notified us of its intent to terminate the Cincinnati JOA upon its expiration in 2007.
F-47
Broadcast Television – Broadcast television includes six ABC-affiliated stations, three NBC-affiliated stations and one independent. Each station is located in one of the 61 largest television markets in the U.S. Our broadcast television stations earn revenue primarily from the sale of advertising time to local and national advertisers.
National broadcast television networks offer affiliates a variety of programs and sell the majority of advertising within those programs. We may receive compensation from the network for carrying its programming. In addition to network programs, we broadcast locally produced programs, syndicated programs, sporting events, and other programs of interest in each station’s market. News is the primary focus of our locally-produced programming.
Advertising provides substantially all of each station’s operating revenues. Employee and programming costs are the primary expenses. Increased viewing choices on cable and satellite television systems and the growth of alternative electronic entertainment devices has resulted in fragmentation of the viewing audience. Further audience fragmentation could adversely affect our broadcast television stations.
The trends and underlying economic conditions affecting the operating performance of any of our broadcast television stations are substantially the same as those affecting all of our stations. The operating performance of our broadcast television group is most affected by the health of the economy, particularly conditions within the retail and auto markets, and by the volume of advertising time purchased by campaigns for elective office and for political issues. The demand for political advertising is significantly higher in even-numbered years, when congressional and presidential elections occur, than in odd-numbered years. From time-to-time, individual television stations may perform better or worse than our television station group as a whole due to specific conditions at that station or within its local economy. We do not expect such near-term variances to significantly affect the overall long-term operating performance of the broadcast television segment.
Operating results for broadcast television were as follows:
Political
Network compensation
F-48
Third quarter and year-to-date operating results in 2004 were affected by the impact of hurricanes at our Florida operations. Our Florida operations sustained wind and water damage and the hurricanes interrupted operations at our affected businesses and at certain of their customers, resulting in lost revenues. Excluding political advertising, revenues at our other television stations decreased 0.7% year-over-year in the third quarter.
Broadcast television operating results are significantly affected by the political cycle. Excluding any impacts hurricane Wilma may have on our operations, total advertising revenue will be down approximately 12% to 14% year-over-year in the fourth quarter of 2005 due to political revenues earned in 2004 that will not repeat in 2005. Political advertising revenues were $21.0 million in the fourth quarter of 2004. Advertising revenues, excluding political, are expected to increase between 6% and 8% year-over-year in the fourth quarter of 2005.
Negotiations continue on new affiliation agreements for our six ABC affiliate stations. Five of our ABC affiliation agreements, whose expiration dates fell in 2004 and 2005, have been extended on a monthly basis under their original terms while negotiations proceed. The affiliation agreement of our remaining ABC affiliated station expires in 2006. Our ABC affiliates recognized $1.3 million of network compensation revenue in the third quarter of 2005 and $2.1 million in 2004. Year-to-date network compensation revenue was $4.0 million in 2005 and $6.5 million in 2004. We are unable to predict the amount of network compensation we may receive upon renewal of these agreements.
F-49
Shop At Home - On April 14, 2004, we completed our acquisition of Summit America. Summit America owned a 30% minority interest in Shop At Home and owned and operated five Shop At Home-affiliated broadcast television stations.
Shop At Home markets a range of consumer goods directly to television viewers and visitors to its Internet site. Programming is distributed on a full or part-time basis under the terms of affiliation agreements with broadcast television stations and cable and satellite television systems. Affiliates are paid a fee (“network distribution fee”) based upon the number of cable and direct broadcast satellite households reached by the affiliate.
Retail merchandise sales provide substantially all of Shop At Home’s operating revenues and cost of merchandise sold and network distribution costs are the primary expenses. Shop At Home’s operating results are influenced by the distribution of the network, our ability to attract an audience, our selection and mix of product, and by consumers’ discretionary spending.
Operating results for Shop At Home were as follows:
Retail merchandise
Shipping and handling
Cost of merchandise sold
Network distribution fees
Segment profit (loss)
Interest and dividend income from Summit America
We continue to implement our merchandising plan and electronic commerce strategy at Shop At Home, improving the mix, quality and appeal of products offered for sale both online and on air. Sales of products in the home and cookware categories increased by 81% in the year-to-date period of 2005 compared with the year-to-date period of 2004 and represent approximately 13% of total revenue in 2005.
Shop At Home programming reached an average full-time equivalent of 54.5 million homes in the third quarter of 2005, up from 51.2 million homes in the third quarter of 2004. Average revenue per full-time equivalent home was $6.67 for the twelve months ended September 30, 2005, compared with $5.57 for the previous year period.
Increases in other segment costs and expenses reflect additional costs to support Shop At Home’s growth. These costs include increases in the costs of facilities, outside services, uncollectible accounts receivable, marketing and consumer research costs.
In connection with the acquisition of Summit America, we assumed Summit America’s obligations to us under the $47.5 million secured loan and $3 million redeemable preferred stock extended to Summit America as part of the 2002 acquisition of the controlling interest in Shop At Home. We also assumed Summit America’s rights under the Shop At Home affiliation agreements with the Summit America broadcast television stations. Accordingly, interest and dividend income from Summit America and network distribution fees paid to the Summit America broadcast television stations ceased upon the acquisition of Summit America.
F-50
Shopzilla - On June 27, 2005, we completed our acquisition of Shopzilla, Inc., a Web-based product comparison shopping service.
Shopzilla operates a comparison shopping service that helps consumers find products offered for sale on the Web by online retailers. Shopzilla aggregates and organizes information on millions of products from thousands of retailers. Shopzilla also operates BizRate, a popular Web-based consumer feedback network which collects millions of consumer reviews of stores and products each year.
Shopzilla earns revenue primarily from referral fees collected when consumers using the Shopzilla Web site click through to participating online retailers. Employee costs and marketing costs intended to attract traffic to our Web site are the primary expenses.
Shopzilla is a relatively new business operating in a competitive and constantly developing marketplace. Volatility is expected as the company grows and takes steps to capture marketshare and secure long-term relationships with consumers and merchants. Shopzilla’s operating results are influenced by our ability to attract traffic to our Web Site and to negotiate fees from our merchants.
Operating results for Shopzilla were as follows:
Segment operating revenues
Operating results for Shopzilla are included in our results of operations from the June 27, 2005 acquisition date. On a pro-forma basis, operating revenues nearly doubled year-over-year in the third quarter. Segment profit increased nearly six-fold.
Shopzilla is expected to generate segment profits of $13 million to $15 million in the fourth quarter of 2005.
F-51
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity is our cash flow from operating activities. Advertising provides approximately 65% of total operating revenues, so cash flow from operating activities is adversely affected during recessionary periods. Information about our use of cash flow from operating activities is presented in the following table:
Dividends paid, including to minority interests
Employee stock option proceeds
Other financing activities
Cash flow available for acquisitions and debt repayment
Sources and uses of available cash flow:
Business acquisitions and net investment activity
Other investing activity
Increase (decrease) in long-term debt
Our cash flow has been used primarily to fund acquisitions and investments and to develop new businesses. There are no significant legal or other restrictions on the transfer of funds among our business segments.
Net cash provided by operating activities increased year-over-year due to the improved operating performance of our business segments. Cash required for the development of our emerging brands (DIY, Fine Living, GAC, video-on-demand and Shop At Home) was approximately $42 million for the year-to-date period of 2005. We expect cash flow from operating activities in 2005 will provide sufficient liquidity to continue the development of our emerging brands and to fund the capital expenditures necessary to support our businesses.
In the third quarter of 2005, the management committee of the Denver JOA approved plans to consolidate the JOA’s newspaper production facilities and authorized the incurrence of up to $150 million of debt by the JOA to finance the building and equipment costs related to the consolidation. We own a 50% interest in the Denver JOA. Scripps and Media News Group (“MNG”), our Denver JOA partner, are not parties to the arrangement and have not guaranteed any of the Denver JOA’s obligations under the arrangement.
On June 27, 2005, we acquired 100% ownership of Shopzilla for approximately $570 million in cash. Assets acquired in the transaction included approximately $34.0 million of cash and $12.3 million of short-term investments. The acquisition was financed using a combination of cash on hand and additional borrowings.
On April 14, 2004, we completed the acquisition of Summit America for approximately $180 million in cash. The acquisition was financed through cash and short-term investments on hand and additional borrowings on our existing credit facilities.
In the second quarter of 2004, the Denver JOA entered into an $88 million financing arrangement with a group of banks to construct a new office building for the non-production related employees of the Denver JOA and the editorial departments of both the Rocky Mountain News and Media News Group’s (“MNG”) Denver Post. Upon completion of construction, which is expected to take approximately 24 months, the Denver JOA will lease the building for an initial term of five years. Scripps and MNG are not parties to the arrangement and have not guaranteed any of the Denver JOA’s obligations under the arrangement. At the end of the initial lease term the Denver JOA will either renegotiate an additional lease term, relocate to an alternative building or acquire the building. Relocation or acquisition of the building may require capital contributions by the JOA partners.
Pursuant to the terms of the Food Network general partnership agreement, the partnership is required to provide cash distributions to the general partners equal to each partner’s share of the partnership tax liability. Cash distributions to Food Network’s non-controlling interests totaling $29.0 million were made for the first time in 2005. In prior years, available cash was used by the partnership to repay loans to its partners. We expect these cash distributions will be about $5 million in the fourth quarter of 2005.
F-52
We are authorized to repurchase up to 5 million of our Class A Common shares. In 2005, we have re-purchased 562,500 shares costing $27.9 million to offset the dilution resulting from our stock compensation programs. The stock repurchase program can be discontinued at any time.
We have a credit facility that permits $450 million in aggregate borrowings and expires in July 2009. Total borrowings under the facility were $259 million at September 30, 2005.
Our access to commercial paper markets can be affected by macroeconomic factors outside of our control. In addition to macroeconomic factors, our access to commercial paper markets and our borrowing costs are affected by short and long-term debt ratings assigned by independent rating agencies.
F-53
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Earnings and cash flow can be affected by, among other things, economic conditions, interest rate changes, foreign currency fluctuations (primarily in the exchange rate for the Japanese yen) and changes in the price of newsprint. We are also exposed to changes in the market value of our investments.
We may use foreign currency forward and option contracts to hedge our cash flow exposures that are denominated in Japanese yen and forward contracts to reduce the risk of changes in the price of newsprint on anticipated newsprint purchases. We held no foreign currency or newsprint derivative financial instruments at September 30, 2005.
The following table presents additional information about market-risk-sensitive financial instruments:
Cost
Basis
Fair
Value
Financial instruments subject to interest rate risk:
Total long-term debt including current portion
Interest rate swap
Financial instruments subject to market value risk:
Total investments in publicly-traded companies
Our objectives in managing interest rate risk are to limit the impact of interest rate changes on our earnings and cash flows and to reduce our overall borrowing costs. We manage interest rate risk primarily by maintaining a mix of fixed-rate and variable-rate debt. In February 2003, we issued $50 million of 3.75% notes due in 2008. Concurrently, we entered into a receive-fixed, pay-floating interest rate swap, effectively converting the notes to a variable-rate obligation indexed to LIBOR. We account for the interest rate swap as a fair-value hedge of the underlying fixed-rate notes. As a result, changes in the fair value of the interest rate swap are offset by changes in the fair value of the swapped notes and no net gain or loss is recognized in earnings.
F-54
CONTROLS AND PROCEDURES
Scripps’ management is responsible for establishing and maintaining adequate internal controls designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The company’s internal control over financial reporting includes those policies and procedures that:
All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error, collusion and the improper overriding of controls by management. Accordingly, even effective internal control can only provide reasonable but not absolute assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
The effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) was evaluated as of the date of the financial statements. This evaluation was carried out under the supervision of and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures are effective. There were no changes to the company’s internal controls over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.
We completed the acquisition of Shopzilla, a leading online comparison shopping service, on June 27, 2005. This business represents a separate segment with total assets of $625 to $650 million as of September 30, 2005, subject to final asset valuation, and expected segment profits of $34 to $36 million for the full year 2005. It is also a separate control environment. We have excluded this segment from management’s report on internal control over financial reporting, as permitted by SEC guidance, for the quarter ended September 30, 2005.
F-55
Index to Exhibits
Ratio of Earnings to Fixed Charges
Section 302 Certifications
Section 906 Certifications
E-1